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Cement stocks: Investment positioning for short to medium term

By Emeka Anaeto, Business Editor

Stocks in the Cement subsector of the Nigerian Stock Exchange, NSE, has been well received by investors for most part of this year especially during the massive bull run of April – July 2017. Cement Company of Northern Nigeria, CCNN, at comparatively low base, has done 84.2 % gains so far this year while Wapco Plc has done 22%, and the Africa’s industry leader, Dangote Cement Plc (DCP), closed last Friday at 18.3%.

The closing prices of the stocks last Friday, however, represented lower ends of the latest bear run on the stock market which started since mid-August, behind a far more impressive gains they had all recorded before then.

But recent bear run in the market appears to have set the sun on the stocks as not only are they on downward pricing, but even some key investment information are largely ignored.

For instance, late last month BUA Group, owners of CCNN, had indicated that major expansion of output was underway, a development which would likely push up the market share and total volume sales of the company. But the stock did not respond to the information. Instead the dominant bear trend swallowed the it.

Similarly last week, information filtered in that Dangote Cement was bidding to acquire a dominant player in the Southern Africa cement market, PPC Limited of South Africa. There was enough information to this effect.

Responding to media reports on this, the Board of Dangote Cement wrote to NSE last Thursday stating: ‘‘In light of the foregoing, DCP hereby confirms that the Board of Directors of DCP has communicated its interest to the Board of Directors of PPC with respect to the acquisition of the entire share capital of PPC.’’

However, though DCP’s stock had risen 2.4% upon the announcement, it slumped -4.0% the next day, indicating, at best, no value for the investment information.

The other aspect of the information was the involvement of Lafarge Africa Plc, owners of Wapco Plc, as front-runners in the bid for PPC. Again, instead, Wapco’s stock depreciated 1.1% while the news swirled.

The development smacks of the typical bandwagon effect NSE’s market sentiments take most times whether in bear or bull run. But some financial analysts believe the cement industry in Nigeria and they key operators have fundamentals that should drive up prices beyond current levels even without new investment information such as was out last week.

Nigerian cement companies reported solid first half 2017 (H1-17) results, helped principally by the price increases of late 2016 and early this year, and fuel flexibility underlying. Though analysts had pointed out at the beginning of the year that earnings outlook is better compared to last year, the results for the H1’17 announced by most companies were well-ahead of consensus view.

‘‘Following the currency crisis of 2016, Nigerian cement producers have fastened their pricing belts, and from our recent conversation with managements, loosening is not an option at the moment,’’ analysts at Cordros Capital, a Lagos based investment house stated:

Non-Nigerian cement prices are equally higher. In addition, after suffering from acute gas shortages the previous year, investment in fuel flexibility has gained significant traction. Strong pricing has a historically positive correlation with the performance of cement companies in Nigeria.

On energy flexibility and availability, while noting that gas supply has improved from the low level of 2016, DCP has achieved significant substitution of coal, Lafarge/ Wapco has increased the utilization of alternative fuel and coal as well, while the less disruptive performance of the Kaduna refinery is encouraging for CCNN in terms of easy access to LPFO.

At the macro level, industry observers have noted that gradually recovering economic activity (pulled back from recession in Q2‘17), moderately optimistic business expectations, the implementation of the 2017 budget (wherein capital expenditure remains a priority with a lot of product demand on the cement firms), as well as improved monthly earnings of of all tiers of government (up 39% Year-on-Year, YoY, between January and May), are supporting factors for cement companies to thrive on.

Revenues continue to grow at double-digit on YoY basis, gross margins are nearing the pre-2016 levels, robust Earnings Before Interest, Tax, Depreciation and Amortisation, EBITDA, and more importantly, impressive growth in operating profits.

For these reasons, analysts at Cordros Capital stated: ‘‘For the companies within our universe, we have revised revenue, EBITDA, and net profit growth forecasts over 2017 to 31%, 69%, and 42% respectively on average, from 22%, 37%, and 17% at the beginning of the year. While acknowledging possible FX shock, we also believe that the accretive potential of the nation’s external reserve remains descent, and would offer the CBN the comfort to continue to intervene in the markets for the rest of this year, and that cement producers’ margins have been fairly covered (Dangote’s management was particularly emphatic about this) by aggressive price increases and energy efficiency investments.’’

Industry experts also noted that though Nigerian cement sales volume may decline by 10% over 2017, it is also expected to rise by 12% in 2018. Since producers commenced implementing hikes in 2016, cement prices have increased by a huge magnitude (75% in Nigeria, amidst the recession) local consumption will struggle to adjust to, but sales revenue would rise to make up for decline in sales volume.

But in the meantime as regards pricing, feedback from the management of cement companies is that price reduction is currently not an option.

Consequently, analysts forecast a sharp increase in industry operating margin to 32% in 2017 as against 23% in 2016, consistent with the recovery seen from Q4-16.

One of the key drawbacks investors have over cement stocks is the high level of short term loans and servicing obligations which eat deep into earnings.

Courtesy of Lafarge (65%) and Dangote (27%), the Nigerian cement industry gross debt has increased by 34% compounded rate between 2013 and 2016.

The impact of the debt has been more daunting for Lafarge (with USD590 shareholder loan as at end-March 2017), wherein in addition to financing costs rising as a proportion of operating profit, the significant composition of US dollar borrowings in the mix increased the vulnerability of earnings to weakness in naira.

Lafarge and Dangote’s estimated average debt-to-equity and interest coverage ratios of 55% and 6.2x, and 40.1% and 6.9x respectively compare poorly to CCNN’s 11.3% and 8.2x. Forex loss arising from the repayment of Lafarge’s US dollar borrowings was N22.7 billion in 2016, from N8.4 billion in 2015.

However, in June this year, the shareholders of Lafarge approved a resolution for the company to raise the sum of N140 billion by way of Rights Issue, including the application of shareholder USD loans (USD287 million or N105 billion) towards payment for any shares subscribed for by the parent company under the Rights Issue. A hedged balance of USD308 million will be retained for subsequent refinancing using short term local debt.

The management of Dangote Cement is in the course of refinancing short term debt, most (N160 billion as at Q1-17) of which was granted by the parent, Dangote Industries Limited (DIL), at estimated interest rate of 15% (MPR + 1%). Management said it will refinance the debt by raising dollar bonds.

All the above positioning and more by the cement companies point to stocks that would best buy for medium to long term investors while even the short term investors can still position for 2017 full year impressive performance.

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