We highlight the operating performance of Lafarge Africa Plc for FY’19 and Q1’20 in this report. Based on our analysis of the Company’s performance and our expectations for future performances, we estimated the fair value of N8.05 for the stock, representing a 27% downside to the current market price.
Resulting from the persistent macroeconomic weaknesses in the South African economy, and persistent losses being generated from the South African subsidiary, the Group made the decision to dispose of the South African subsidiary. The South African subsidiary became a part of the Group following a 100% acquisition in 2014. However, the downturn in economic activities, coupled with a very competitive market dampened the growth and earnings potential of the South African business. Prior to the industry weaknesses, it had initially recorded significantly higher levels of demand induced by increasing infrastructural spending between 2000 to 2007. In recent times, infrastructural spending has declined. Furthermore, consumer income and expenditure has also declined. As a result, industry volumes were constrained in the South African building sector. The highly competitive industry further exacerbated the situation, as market share was lost despite efforts to defend it via price reductions which weighed heavily on operating margins.
Therefore, in a bid to protect margins and keep the Group’s overall business on the path of profitability for shareholders, the Group’s management agreed to sell the South African subsidiary. The decision to sell the South African subsidiary was done to avert a potential N70bn impairment of the subsidiary if the Group continued to carry it in its books. Therefore, to prevent the potential value erosion, the Group considered the option of disposing of the subsidiary.
The disposal was structured in a ‘set-off’ deal, in a way that LafargeHolcim (the parent company of Lafarge Africa Plc) agreed to purchase the sale of the South African subsidiary in exchange of all the outstanding amounts due by Lafarge Africa to Caricement (another subsidiary of LafargeHolcim) under the inter-group loan agreements. The total value of the outstanding amount was $316.29mn. The implication of the transaction meant a full extinguishment of the only foreign-denominated debt in the Group’s books which had been eroding cash flows in recent times. The transaction also aimed to lower the Group’s finance costs and further position the Group to make investments for growth opportunities.
The disposal of the subsidiary was successful, and it resulted in a 79% YoY decline in the Group’s total borrowings from N301.49bn in FY’18 to N64.21bn in FY’19. Consequent to the significant decline in total borrowings, the Group’s leverage (and by extension, its financial risk) improved. The Group’s gearing ratio, which measures debt relative to equity, lowered from 2.24x in FY’18 to 0.19x in FY’19. In addition, the disposal further positively impacted the Group in other areas. Notably, trade receivables nosedived by 61% YoY from N21.16bn in FY’18 to N8.19bn in FY’19. Inventories also declined by 31% YoY from N47.16bn in FY’18 to N32.44bn in FY’19. Therefore, the Group’s working capital improved. Cash flows from operations grew by 187% YoY from N27.97bn in FY’18 to N80.23bn in FY’19. The significant increase majorly resulted from a working capital surplus of N15.54bn recorded in FY’19; meanwhile in the previous year, working capital was negative to the tune of N16.13bn.
The Group’s income statement figures were restated to reflect the disposal effect of the South African subsidiary (LSAH). Hence, the income statement figures reported stood for Nigerian operations only. Based on the reported figures, revenue declined by 2% YoY from N217.81bn in FY’18 to N212.99bn in FY’19. We attribute the decline in revenue to slower demand during the year, amid rising competition. We note the production ramp-up by competitors, particularly BUA Cement Plc. The increase in production levels of competitors resulted in heightened competition in the industry. The weak public infrastructure spending by the government further contributed to the lull in the demand. In addition, the relatively adverse weather and other climatic conditions, especially in Q3’19, possibly negatively impacted topline growth.
Cost of sales, however, rose by 4% YoY from N150.70bn in FY’18 to N157.05bn in FY’19. Thus, the cost margin rose by 400 basis points from 70% in FY’18 to 74% in FY’19. The rise in costs was majorly induced by higher depreciation charge during the period. Depreciation charges, which contributed an average of 16% to the total cost of sales, spiked by 48% YoY from N19.19bn in FY’18 to N28.36bn in FY’19. As a result of the higher cost of sales recorded in FY’19, gross profit declined by 17% YoY from N67.11bn to N55.95bn.
Supported by a 70% increase in other income from N1.38bn in FY’18 to N2.35bn in FY’19, the 17% decline in gross profit moderated to a 15% decline in total operating income (from N68.49bn to N58.30bn). Operating expenses declined by 22% YoY from N29.89bn in FY’18 to N23.42bn in FY’19. The decline in operating expenses resulted from lower expenses incurred on consultancy fees (-72% YoY from N3.07bn to N847.91mn), supplies and spare parts (-84% from N1.00bn to N156.87mn), rent (-93% from N836.20mn to N62.53mn), repair and maintenance expense (-98% from N736.77mn to N17.94mn), technical services fees (-39% from N6.30bn to N3.85bn), and office and general expenses (-34% YoY from N2.51bn). In addition, other operating expenses declined by 32% YoY from N1.12bn to N764.26mn.
Despite the improvement in cost management, operating profit stood at N34.91bn in FY’19, representing a 9% decline relative to N38.83bn recorded in FY’18. Net finance costs decreased by 57% YoY from N40.04bn in FY’18 to N17.02bn in FY’19, reflecting the positive impact of the deleveraging efforts of the Group, and lower foreign exchange losses in FY’19. Specifically, the Group did not incur any foreign exchange loss in FY’19, meanwhile, a foreign exchange loss of N8.02bn was recorded in the previous year.
Consequent to the steep decline in finance costs, the Group rebounded from a loss before tax of N1.51bn in FY’18 to a profit before tax of N17.89bn in FY’19. Net income grew by 92% YoY from N8.09bn in FY’18 to N15.52bn in FY’19. The Group declared a dividend of N16.11bn (N1.00 per share) for FY’19.
The Group recorded revenue growth of 10% YoY from N58.02bn in Q1’19 to N63.69bn in Q1’20. The revenue growth recorded in Q1’20 was driven by an 8% volume growth and a 2% price increase. Meanwhile, cost of sales rose by 14% YoY, driven by increases in line items such as distribution variable cost (+23% YoY from N9.54bn to N11.72bn), fuel and power (+52% YoY from N4.58bn to N5.55bn). According to the management, the significant rise in fuel and power costs is attributed to increased production level, in anticipation of high volume growth in Q2’20 before the COVID-19 pandemic.
Consequent to the higher increase in the cost of sales relative to revenue, gross profit remained flat at N17.63bn in Q1’20 (FY’19: N17.59bn). Meanwhile, on the back of a 4% YoY decline in operating expenses from N6.17bn in Q1’19 to N5.91bn in Q1’20, operating profit grew by 3% from N11.52bn in Q1’19 to N11.84bn in Q1’20.
The deleveraging efforts by the Group continued to positively impact the earnings of the Group, as reflected in the 105% YoY growth in profit before tax from N4.59bn in Q1’19 to N9.38bn in Q1’20. Specifically, the profit driver was a 65% YoY decline in net finance costs from N8.31bn in Q1’19 to N2.57bn in Q1’20. Profit after tax grew by 28% YoY from N6.30bn in Q1’19 to N8.07bn in Q1’20. The slower growth in PAT relative to PBT was due to an income tax expense of N1.32bn incurred in Q1’20, relative to an income tax credit of N1.71bn in Q1’19.
We assessed the outlook and prospects of Lafarge Africa on a short-term and long-term basis. We acknowledge the efforts of the management of the Group on the restructuring that yielded positively to the bottom line. Notably, the South African subsidiary had constituted a drag to the Group’s overall performance in the past few years. While we note the double-digit revenue growth in Q1’20, we expect that the negative impact of the COVID-19 pandemic will weigh on the Group’s topline growth in the subsequent periods of the year. We posit a slower demand in Q2’20 and Q3’20. In Q2’20, we maintain that the lockdown directive and the disruption in the supply chain will take a toll on operating performance. Also, owing to the volatility in the global crude oil market and the implications on the Federal Government’s revenues, we expect to see a lower capital expenditure, therefore potentially resulting in lower demand for cement. In Q3’20, we posit that the seasonality (climatic) factors could have a bearing on operating performance.
In the medium to long term, we believe that the Group is well-positioned to compete in the industry. The operating efficiency drive of the Group is expected to be accretive to the bottom line. We also think that the efforts of the management to continuously invest in fixed assets and alternative source of power would drive cost optimisation in production activities. In our view, we expect to see the impact on cost margins in our forecast periods.
In addition, we posit that the deleveraging of the balance sheet, and therefore an expected improvement in cash flows, will possibly enable the Group to invest in growth opportunities in the medium to long term.
Overall, we estimate FY’20 earnings per share (EPS) of N1.87, representing a 95% YoY increase from FY’19 actual EPS of N0.96. The major growth driver is our projected 79% decline in finance costs, as we expect the Group to continue its balance sheet deleveraging efforts. We valued the Group using the Discounted Cash Flow (DCF) and Dividend Discounted Model (DDM) valuation methodologies. The inputs used in our cost of equity estimate of 22% include a risk-free rate of 11%, a beta of 0.79x, and an equity risk premium of 14%.
Overall, we arrived at a fair value of N8.05 for the stock. At current market price, the stock trades at a 27% premium to our fair value estimate. Hence, we recommend a SELL.