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Initial View - Dangote Sugar Refinery Plc - Volumes recovery muddled by biological asset gains

• Dangote Sugar refinery (DSR) released it 9M 19 result yesterday, with reported EPS down 12.6%YoY to N23 following lower finance income and cost pressures relative to same period in the prior year. Similarly, EPS over Q3 19 dropped by 6.7% YoY muddled by the dip in biological asset gains and lower interest income, both of which trumped gains from improved operating performance. Noteworthy, excluding the revaluation gains from both periods, Q3 19 earnings is up by 5% YoY. Relative to our estimates, sales and EPS came in lower by 2.5% and 7.7% respectively.
• Hurray, as sugar sales picks up: Coming from downbeat levels in 2018, we are quite impressed by DSR’s growth in volume since Q2 19. Going by our estimates, volumes grew by 16.1% YoY in Q3 19 (Q2 19: 13.4% YoY) assuming flat prices between Q2 and Q3. This is quite impressive coming from a double-digit decline in volumes recorded all through 2018. Most of the gains emanated from its northern operation where it had to combat with influx of smuggled sugar into the country. While we recognise DSR’s effort in confronting its devil in the north, we do not rule out the plus from the border closure which was implemented towards the end of August as a further support to sales. On cost, average raw sugar prices over Q3 19 was up by 7.8% YoY driving an increase in input cost (+12.6% YoY) – albeit, the faster increase in sales left margins in a favourable position.
• Biological asset gains muddles improved operating performance: Atypical to the prior quarter, DSR recorded an improvement in operating performance over Q3 19, with gross and EBIT margin expanding 55bps and 12bps YoY to 21.3% and 15.1% respectively. Improved margins were largely supported by higher sugar sales (+13.4% YoY) observed over the period which overshadowed increase in input cost (+12.6% YoY). However, the significant drop in gains from fair value adjustment on biological assets, left PBT lower 5.8% YoY. For context, excluding the revaluation gains, PBT would have been higher by 5% YoY, despite the dip in finance income. Largely reflecting lower cash balance (with ending cash balance as at 9M 19 printing at N6 billion – a reflection of the company’s struggle to generate funds from operations), finance income declined to N5.5 million (Q3 18: N481.8 million). Notably, 9M FFO printed at N27.4 billion from N37.4 billion recorded in 2018, with cash margin contracting 467bps to 9.8% YTD.
• Though earnings declined over the period, we are quite impressed by the gradual recovery in the company’s market share, which we believe would be sustained in the near-term supported by the border closure. While we do not rule out the plausibility of an increase in raw sugar prices, we think the growth in sales would be able to sustain the improved margins seen thus far. Our FVE of N14.02 coupled with our expected dividend yield of 10%, presents 46% upside using last closing price, which translates to a BUY rating. DSR currently trades at a P/E of 6.2x which is at a discount to Bloomberg MENA peer average of 21.7x, respectively.