Here is why Dangote Cement was downgraded to a “sell”

Dangote Cement Plc. (Dangcem) released its unaudited Q2 16 result wherein pre-tax earnings rose 20% YoY to N70 billion well ahead of our estimates of N19 billion. However, PAT was 5% lower YoY at N50 billion following a 19pps rise in effective tax rates to 28%.

• FX translation gains flatter earnings: In contrast to peer Lafarge, whose net short dollar position drove sizable FX losses in the aftermath of the 42% naira depreciation, Dangcem’s net long dollar position translated to net FX gains of N38billion which masked weak operating performance. Adjusting for the exchange rate impact, pre-tax earnings slides 46% YoY to N32 billion with related margins shrinking 24.9pps to 21% (vs. +40bps to 46.4% prior to adjustment).
• Focusing on core operating performance, we note that significantly higher costs underpinned weak underlying earnings performance in Q2 16. Specifically, although group revenue rose 19% YoY to N152 billion following strong growth in West & Central Africa (over two-fold YoY to N26 billion) and South & East Africa (+85% YoY to N16 billion), a combination of higher input and distribution costs eroded top-line gains. According to management, input cost pressures (+73% YoY to N77 billion) was underpinned by prolonged gas shortage across Nigeria which forced the company to rely on the more expensive back-up—LPFO.
• Overall, although the huge currency gains does provide some earnings buffer for Dangcem over 2016, we remain cautious on the business’ core operating performance. In Nigeria, for instance, prices are set to remain depressed over Q3 16 with management given only little weight to probability of price increase in Q4 16 at the earliest. To this effect, we have reviewed our average Nigerian prices 11% lower to N25,734/tonne (-12% YoY). However, current run rate of volume growth (+39% YoY to 8.8MT) suggests our target volume estimate of 14.6MT for Nigeria may be slightly pessimistic. Thus, we have also increased our Nigerian volume growth target to 15.7MT (+18% YoY) with net impact of the top-line adjustments cascading to a 4% YoY rise in our target Nigerian cement revenues to N404 billion (vs. +9% YoY to N424 billion in previous estimate).
• Net the impact of these adjustments, our FVE is now 3% lower at N161.48, which currently stands at a 10% discount to the stock’s last market price. Dangcem trades at current EV/EBITDA of 12.6x relative to 9.1x for Bloomberg EMEA peers. We downgrade our recommendation on the stock to SELL (vs. NEUTRAL in previous communication).

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