DANGOTE CEMENT PLC: Cut in cement prices expected to drive up sales volume

Dangote Cement Plc remains the largest company listed on the Nigerian Stock Exchange with a total market value of about N3.2 trillion, accounting for about 29% of the total market capitalisation. The Company is a fully integrated quarryto-depot producer with a total installed capacity of 29.25 million metric tonnes per annum (mtpa). According to the Company’s management, this capacity is poised to increase by 42 million mtpa in 2015 in addition to plans to build more integrated, grinding and import facilities across Africa, bringing total production capacity to more than 50-60 million mtpa by the end of 2016. The Company currently operates in Nigeria through three major plants- Obajana cement plant located in Kogi State - the largest of its kind in Africa with 13.25 million mtpa capacity across four lines-,the Ibese plant situated in Ogun State with four cement lines and a combined installed capacity of 12 million mtpa, and the Gboko plant in Benue State with an installed capacity of 4 million mtpa. The Company’s third quarter results for the period ended September 30, 2014 showed an increase of 7.35% in turnover and 3.55% in operating profit year-on-year. Net income however dipped by 10.02% due to an income tax expense of N13.58 billion in 2014 from a tax credit of N 4.4 billion in 2013 as the tax holiday granted by the Nigerian Federal Government on the Company’s Obajana and Gboko Plants expired at the end of the 2013 financial year.

MODEST GROWTH IN GROSS PROFIT

For the third quarter period ended September 2014, Dangote Cement recorded a modest growth of 1.42% in gross profit to N199.71 billion from N196.91 billion in the corresponding period of 2013. The marginal growth in gross profit was as a result of the 20% increase in cost of goods sold from N92.08 billion to N110.5 billion Year-On-Year as to revenue, which increased by a only 7.35% from N288.98 billion to N310.21 billion over the period was just enough to cover the increase in cost of sales. Operating expenses declined mildly by 2.77% to N39.95 billion in September 2014 from N41.09 billion in September 2013, spurred by a fall in selling and distribution expenses to N23.57 billion from N25.20 billion over the period. In addition, other operating income more than doubled to N2.69 billion in 2014 from N1.06 billion in 2013, supporting the growth of 3.55% in operating profit to N162.46 billion from N156.89 billion over the period.

INCREASE IN FINANCE COST PREVENTED A STRONGER GROWTH IN PRE-TAX PROFIT

For the nine month period ended September 2014, the Company’s net finance costs increased by 62.78% to N8.40 billion from N5.16 billion in the corresponding period of 2013. The increase in finance costs was due to increase in net financial liabilities to N227.36 billion from N194.32 billion over the period. The increase in debt was to facilitate the production facility expansion programme of the Company both domestically and internationally. The completion of the second line and the coal mills on line 1 and 2 at Ibese, the ongoing construction of coal mill on line 3 and the Obajana plant, and investment across the Company’s locations led to the acquisition of N168.83 billion in property, plant and equipment during the period. A significant portion of these investments were funded through new loans obtained by the company, totalling N97.45 billion. The increase in net finance costs prevented a stronger growth on profitability as pretax profit only grew by 1.53% to N154.05 billion in September 2014 from N151.73 billion in September 2013. In addition, the commencement of tax payments after the expiration of the tax holiday granted the Company’s Obajana and Gboko plants led to a decline in net profit. Provision for tax expenses was N13.58 billion in September 2014, an effective tax rate of 8.82% from a tax credit of N4.40 billion in the corresponding period of 2013. Net profit Recently, the Management of Dangote Cement Plc unveiled to the general public the new 32.5 grade 50kg Dangote cement in addition to the 42.5 grade introduced earlier in the year as well as the new packaging of the Company’s products as ordered by SON (Standards Organisation of Nigeria) for clear distinction among the various cement grades. Furthermore, due to the drag in local demand for cement (demand for cement grew by 1.3% to 16.2 million tonnes in the nine months to September 2014), the Company’s management announced their decision to cut down the ex-factory prices of the Company’s products by an average of about 15%. The 50 kg bag of 32.5 Grade Dangote Cement will now sell for N1,000 (ex-factory) while the 50kg of the 42.5 Grade will hence forth sell for N1,150. The old price of the 42.5 grade was N1335 (ex-factory) after the deduction of lift bonus of N125/bag. This is expected to bring down the retail price of cement to N1,300 from about N1700. The price cut is expected to increase affordability and stimulate demand for the products. Also, in addition to several cost-cutting measures, Dangote Cement is optimistic about growing profitability in the very near future.

WE MAINTAIN OUR BUY RECOMMENDATION

The Nigerian cement market grew by 15.6% to 21.2 million tonnes in 2013, as a result of solid economic growth, a rising population, urbanization and rising incomes. However, 2013 was an exceptional year due to the sharp increase in building works after the flooding of 2012. In addition, the National Bureau Statistics (NBS) reported that building and construction in Nigeria grew by 14.31% in the third quarter of 2013, and this single factor has continued to drive the strong demand for cement. The real estate sector also recorded a 10.35% growth and has grown at a double-digit rate every quarter since the first quarter of 2012. On the demand side, growth in Nigerian cement consumption has risen consistently since 2004. The implication is that the Nigerian cement industry is poised for further growth in 2014, and with Dangote Cement positioned as market leader, we are optimistic about the Company’s revenue and growth potential. We are mindful of the recent price cut and the rising costs on the Company’s profitability. While the disruptions to gas supply and the use of the expensive LPFO as back-up fuel for operation have a significant effect on the Company’s direct cost of operations, the installation of coal mills to serve as alternative gas plants should help to control costs in the near term. In addition, the strong growth in sales from the mothballed Gboko Plant is a good development for the Company. However, considering the tight monetary environment and low effective demand for industry goods, it is not entirely certain if the price cut will lead to the expected demand to cover and add to the revenue gap that the price cut would create. Based on the above stated developments, we have lowered our projections for the Company’s turnover to N394.55 billion and net income to N160.32 billion for the year ended December 2014. Using the discounted cash flow (DCF) method of valuation with an estimated long term growth rate of 6.28% and weighted average cost of capital (WACC) for the Company, we therefore arrive at a target price of N244.14 for each share of Dangote Cement Plc. We therefore maintain our BUY recommendation.