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Dangote Sugar Q1 2019 - Sustained cost Efficiency to salvage lost sales

• Amidst pressures from smuggled low-priced sugar and the Apapa gridlock, Dangote Sugar’s Q1 2019 numbers came in strong with the company reporting gross margin expansion of 800bps YoY to 33%. The expansion emanated largely from faster decline in raw material cost which more than offset the decline in revenue over the same period. Further supported by moderation in its operation expenses, PAT over Q1 19 grew 32.7 % YoY to N7.0 billion.
• Volume declined much slower than estimate. Over Q1 19, sales declined by 7.3% YoY to N38.1 billion (coming higher than our estimate of N36.1 billion) despite volume increasing 4% YoY. The revenue decline clearly reveals the telling impact of unlicensed sugar, which has led to downward adjustment in local sugar prices – 50kg bag price came down by 11% YoY to N14,400 over 2018.  Notwithstanding the revenue decline, we believe the growth in volume (+4% YoY) is positive as it implies that some level of progress in moving its refined sugar out of the port to its consumers. Recall over 2018, the Apapa gridlock was a major challenge for the company, as the unavailability of trucks required to move out its refined sugar from the factory led to slowdown in production.
• Cost savings, amidst decline in sugar prices drives margin expansion. Compared to the growth in volume, Dang Sugar posted a much stronger decline in cost (-17.2% YoY to N25.6 billion) emanating from lower raw material cost (-21% YoY) as global raw sugar prices continues to trend lower. Accordingly, gross margin expanded to 33% (+800bps YoY). That said, coupled with a 9% moderation in its operation expenses, EBIT printed at N10.8 billion (+29.7% YoY) with related margin at 28%.
• For the rest of the year, we do not see a change to the current operating environment, as the government continues to drag its feet in battling the smuggling activities – that said, we leave our sales estimate for the full year at N134.9 billion (-10% YoY). However, management guided to some key projects that are expected to further increase cost optimization. Firstly, management further emphasized its resolve to adopt alternative routes of evacuating refined sugar from the refinery to limit exposure to the gridlock on the Apapa axis. Secondly, they plan to complete refinery efficiency projects in a bid to maximize cost savings benefit. Thirdly, construction of additional storage facility for finished products in the refinery to optimize production cycle hampered by unavailability of trucks due to the traffic gridlock.
• With the second and third relating largely to production activities, we see further moderation in production cost in the near term. However, with the absence of key timelines to deliver the respective projects, we expect the implementation of the refinery optimization project to be completed in the course of the year with construction of the additional storage facility expected for delivery in the first half of 2020. Accordingly, we have revised our cost estimate downwards with cost to sales ratio at 72.5% (previously 74.5%), which translates to gross profit of N37.1 billion, with related margin at 27.5% (+145bps YoY).
• Although management guided to the adoption of more efficient means of distributing goods to customers in the course of the year. Given that the gridlock on the Apapa axis still persists, we do not see any improvement in its selling and distribution spend. As a result, we leave our FY 19E OPEX to sales unchanged at 4.5%. Coupled with our expectation of lower net finance income, we estimate FY 19 PAT of N21.1 billion (-4.0% YoY) with EPS printing at N1.76.
• Coalescing the above adjustments, we raised our FVE slightly higher to N15.67 (previously: N14.11). Nonetheless, we retain our OVERWEIGHT recommendation. Dangote sugar currently trades at a FY 19E P/E of 9.1x, compared to Bloomberg MENA peer average of 17.1x.