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Lafarge Africa Plc Q2 17 - Margins break historical bounds

• ​Sustaining the trend from the first quarter of the year, Lafarge recorded another strong topline growth in Q2 17 (+34% YoY to N74 billion) with its PAT of N14.6 billion (vs. N28 billion loss in Q2 16) exciting equity investors (company share price: +48% YTD at N60.75) in the last few days. Without doubt, Q2 17 EPS, which rose to its second highest level since consolidation after being flattered by a N6 billion tax credit from UNICEM, provides some explanation to the company’s recent share price rally. That said, this report focuses on a comparison between Lafarge’s rebounding margins and pre-2016 levels to ascertain the true depth of current earnings resurgence.

• Price is everything to Nigerian top-line for now: Going by breakdowns provided, Lafarge raised cement prices (+81% YoY to N48,260/ton, +54% from Q2 15 levels) multiple times in the past few months to recover from gross margin contraction and align with the trend in Nigeria. However, the cumulative price increase was enough to sustain top-line growth despite weaker sales volumes (down 23% and 38% from Q2 16 and Q2 15 levels to 1.1MT) in Nigeria over the review period. In South Africa, operations also benefitted from price increases effected in the prior quarter as well as the appreciation of the rand over naira that left revenues 21% higher YoY at N21 billion despite reported contraction in cement demand in the clime. 

• Going forward, we expect ex-factory gate prices to remain at currently elevated levels of N48,260/ton as Nigerian companies make up for lingering energy challenges despite reported investments in energy flexibility projects. On the volume end, we expect pass-through from prices to continue to inform volume weakness. Thus, we see Nigerian output dropping 16% YoY to ~4.4MT. Irrespective, Nigerian revenues should print N192 billion (vs. N155 billion in 2016). In South Africa, recessionary impacts and higher prices should continue to discourage customer patronage in cyclical sectors including cement. This guides our expectation for 28% YoY contraction in South African cement volumes to 1.6MT. On balance, pass-through from strong price increases in both the domestic and SA market should leave 2017 revenues in good shape (FY 17: +21% YoY to N265 billion; H1 17: +44% YoY to N155 billion) in our view. Overall, we expect pass-through from strong top-line growth to support earnings for the rest of 2017 with 2017E EPS at N5.30.

• Lafarge trades at 2017E EV/EBITDA of 7.7x (vs. 8.3x for Bloomberg EMEA peers). Our FVE of N52.33, which already factors in dilution with the company due to go ahead with its N140 billion rights, implies a SELL recommendation by our rating system. Instructively, we note that without the dilution adjustment our FVE should sit at N66.54.

• See attached for full report