Friday, June 22, 2012 / ARM Research
 

Dangote Cement Plc (DCP) significantly increased domestic installed capacity from 8MMT in FY 2011 to ~19MMT in H1 2012, after the completion of its 6MMT Ibese plant and, more recently, the 5MMT Obajana expansion during the period. With these additions, we estimate that DCP now accounts for~71% market share of cement sales in Nigeria.
 

The company also recently announced that it had settled contentious issues around land rights at its Cameroon plant and has resumed work on the site with expected completion date of Q3 2013. With these, the company ambitions of becoming Africa’s dominant player in the cement space, with target pan-African installed capacity of ~46.3MMT by 2015--and 19MMT (41%) already on stream--appear to be on course. If met, this target assures a dominant presence and diversified operations across a region that promises rapid demand growth and relatively high prices. Demand growth for cement in SSA cement estimated at ~10% p.a. through 2020 to ~154MMT, well ahead of the 5.5% global average.
 

Despite ongoing expansion, DCP still maintains strong operating metrics. Q1 2012 sales stood at N64.1 billion, a 17.6% YoY rise, which nevertheless fell slightly short of our N66.1 billion forecast on account of delays in the completion of the now launched Obajana (5MMT) and Gboko (1MMT) plant expansions. However, DCP still maintain the highest margins of virtually any industry in Nigeria with gross, pre-tax and net profit margins of 57.2%, 47.3% and 47.3% respectively.
 

Additional capacity mitigates risk
As these expansions highlighted have come on stream, the cash flow impact has helped to boost the company’s ability to cover its short-term obligations. Its estimated liquidity ratios for FY2012 (Current ratio) has risen from 0.73 for FY 2011 to 1.55 in FY2012.  Efficiency is also on the increase; we estimate that fixed asset turnover ratio will increase from 0.52 in FY 2011 to 0.63 FY 2012. The gradual realisation of promised capacity additions over the past year and half and its impact on cash-flows introduces greater certainty into our forecasts and has leads to a progressive reassessment of our required cost of capital.
 

Trimming forecasts on higher costs, delays
Our previous FY2012 forecasts had incorporated slightly earlier timelines for production launch at the newly commissioned plants, which were eventually launched this June.  We also revise timelines for the yet-to-be completed Gboko expansion, which was previously scheduled for H1 2012.  In addition, we cut our revenue forecasts from the 1.5MMT Senegal plant  which we had expected to, come on stream Q2 2012, but is not yet producing commercial quantities, according to management, who also put imports at 141,000 MT in Q1, relative to our 450,000MT forecast. Management reports that importation has now ceased though we couldn’t ascertain if this was to be a permanent feature in the company’s operations—we assume it is. These revisions to our production—and initial running capacity—estimates lower forecast of  FY2012 sales by ~9.6% to ~N380billion implying a ~66% YoY growth in revenues, down from ~76% earlier.
 

DCP plans further increases in its domestic capacity to ~32MMT (Obajana plant expansion: 3MMT, Ibese plant expansion: 6MMT and 3MMT Greenfield plant in Calabar) by 2015.
 

On the costs side, media reports and our discussions with management and industry sources suggest that a simmering natural gas shortage problem continues to plague DCP (and other cement makers’) operations, necessitating increased use of more expensive LPFO.  We now believe these gas supply problems could persist into the medium term and adjust our estimates accordingly, revising forecast energy costs higher across the industry. For DCP specifically, we use the corresponding margin impact in Q1 figures, where the company faced similar problems, as the baseline for adjusting forecast margins over the next three years.
 

Figure 1: Dangote Cement- Installed capacity and Capacity Utilization

Lower cost of equity outweighs drop in forecast earnings

The impact of these adjustments to price targets see a ~100 bps, cut to our required cost of equity to reflect the lower risk in expected revenues, dominate receding timelines for full realisation of earnings forecasts, as well as prospects for lower margins, in our valuation . Based on our DCF model for the stock we arrived at a new TP of N134.45 which is 3.5% higher than our previous N129.85 target, implying a 24.5% upside to current market price of N108. On a relative basis, DCP currently trades at a 2012 P/E, P/B and P/S of 7.89x, 5.11x and 3.92x compared to industry averages of 6.00x, 2.15x and 1.89x. We therefore issue a BUY rating on the stock upgrading from the previous neutral.
 

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