Using volume and price assumptions of Dangote Group and Lafarge, Renaissance Capital rates market performance in the Nigerian cement sector.
Price elasticity on margins
Although we expect 2017 Nigerian cement demand to decline by 8%, vs 6% demand growth in 2016, we believe EBITDA margins will strengthen due to price increases. We attribute this decline in volumes to the 49% increase in average cement prices YoY and the weak economy. Although the Nigerian market is resilient and we do not expect volumes to fall at the same rate as the price increase, we believe volumes will reduce.
In addition, we do not think EBITDA margins will be hit by lower volumes. Our sensitivity analysis suggests that an increase in cement prices and a decrease in volumes by the same percentage has a net positive effect on margins. We calculate that a 20% increase in price and a 20% decrease in volumes would boost Dangote’s 2017 margins in Nigeria by 460 bpts and Lafarge’s by 825 bpts.
Dangote – short-term upside priced in
We estimate 2017 cement volumes for Dangote at 12.8mnt and 9mnt in and outside Nigeria, respectively. We expect group volumes to drop by 9%, due to the fall in Nigeria. However, we forecast group EBITDA margins to rise by 937 bpts to 51%, supported by the price increase. We continue to see Dangote as the dominant cement player in Africa: it has the lowest cash costs in the sector, strong margins, and its dominance means it can move pricing and make it stick.
However, Dangote’s current 12M forward P/E of 13.4x is at respective 25% and 19% premiums to the frontier and SSA peer average. In our view, Dangote should trade at a premium and the current level is justified. With expansion outside Nigeria not contributing significantly to margins and enterprise value, we think a higher premium would be unjustified and short- to medium-term upside is priced in.
Lafarge – possible share dilution
We estimate 2017 cement volumes for Lafarge at 7.3mnt, up by 6% YoY from a low base in 2016. We expect group EBITDA margins to jump by 1,224 bpts to 26%, supported by the price increase and improved fuel mix. Given that Lafarge has resolved its 2016 operational problems, and with strong 4Q16 results, we believe 2017 earnings and margins will mirror those of 4Q16. We still see risks from its ‘quasi equity’ debt of $493mn, and estimate that a possible equity conversion (which we think is imminent) would dilute existing shareholders’ equity by 72% and decrease 2018 EPS by 41%.
The dilution implies a 2018E P/E of 12.3x, in line with average frontier peer 2018E P/E of 12.5x. After the possible dilution, we think Lafarge’s valuation will be in line with peers. While at current levels the stock looks attractively valued and our TP implies 53% upside, with no clarity on the ‘quasi equity’ debt and the possibility of a dilution, we downgrade market performance.
What do you think of the coverage of both Nigerian cement players? Should we expect a more favourable pricing environment?