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Lafarge Africa Plc Q3 17 - Surprise loss unsteadies wave of recovery

• Amidst rebounding earnings across other cement names, Lafarge reported a shock N18 billion loss in Q3 17. For context, the current loss was more than double that of Q3 16, a period in which the business’ energy flexibility efforts were still at infancy, energy set-backs were more evident and prices reasonably lower. With this loss, our EPS target of N5.30, which based on H1 17’s performance (EPS: N3.61) looked very realistic, is also now a tall order. In this report therefore, we analyse the drivers of the company’s current loss, re-evaluate our expectation for 2017, and provide guidance for the coming year. 

• Negative one-offs drag Lafarge back into red. Going by provided breakdowns, the company’s current loss was driven by a combination of higher admin expense (+73% YoY to N8 billion), surge in other losses & net finance cost, and reversal to tax charge (N1.7 billion). Although the company expectedly grew gross profits by over four-folds YoY to N13 billion (gross margin: +14pps YoY to 20%), the pressure from higher admin expense drove it to an operating loss of N383 million in Q3 17. More pertinent though was the four-fold YoY jump in other operating loss to N9.3 billion which management linked to foreign exchange losses arising from the conversion of its $220 million debt (formerly part of quasi equity) into naira using exchange rate of N385/$, and FX liabilities on operating cost settling differences. In a related development, the implied rise in debt levels (more than double YoY to N267 billion) cascaded to strong pressures at the net finance cost level (over two-fold higher YoY to N7.4 billion). Elsewhere, management opted to delay draw-down on its over N40 billion tax asset related to UNICEM until processes associated with the consolidation are fully finalized. In view of this, the company reported tax charge of N1.7 billion (vs. N3.0 billion tax credit in the corresponding period of 2016) with the concoction of the aforenoted pressures driving an after-tax loss of N18 billion in Q3 17. 

• Shock Q3 loss to soil an otherwise impressive 2017. Having adjusted volume and cost in line with current run rate and factored in the recent one-off cost and return to tax payment, we now expect PAT of N4 billion for FY 17 (vs. N16.9 billion in 2016). However, we note that the company still has potential tax writebacks in excess of N40 billion that is related to the UNICEM business. A deployment of some or all of these potential writebacks could substantial inflate Q4 and FY 17 earnings as was the case in 2016. 

• Base effect from current one-offs to flatter 2018 earnings. Going into 2018, we adjust our mean Nigerian cement price significantly higher to N40,000/ton (vs. N29,008/ton previously) in line with that of industry leader—Dangcem. In anticipation of consumer response to the relatively favourable price, we also project Nigerian cement volumes 13% higher YoY to 5.3MT (vs. 8.7MT in previous forecast). The duo should drive 2018E Nigerian revenue to N214 billion (vs. N253 billion previously). Elsewhere, we look to see a more substantial recovery in South Africa in 2018, with the attendant impact informing our cement volume and revenue forecast of 2.3MT (+49% YoY) and N98 billion (+30% YoY). At the group level therefore, we see scope for sales in excess of N324 billion in 2018E (vs. N337 billion previously). In addition, although gains from energy flexibility have scarcely impacted 2017 performance, we look for improvement on this front in 2018 and therefore stick to a slightly lower cost to sales ratio of 70%. Thus, we expect a 29% YoY increase in gross profit to N97 billion (gross margin: +4pps YoY to 30%). Furthermore, we review our FY 18 OPEX to N45 billion in tune with current realities to leave our implied FY 18E PAT at N29 billion (vs. N4 billion in FY 17E) barring any positive surprise in form of tax writeback. 

• Importantly, we have already reviewed our models to reflect impact of the forthcoming N131billion rights issue offered to shareholders at N5 per share. As oft noted, the rights issue is principally targeted at converting the company’s outstanding $287 million quasi equity owned by parent—Lafarge Holcim—to ordinary shares. Given that the parent owns ~72.6% of Lafarge Africa, the proportion of the potential rights due to it is expected to be worth around N95.6 billion with the balance N36.07 billion set to be allocated to minority stakeholders. This, alongside the forthcoming N24 billion commercial paper borrowing, implies a rise in cash balance of ~N60 billion that could be used to slightly palliate pressures from working capital (9M 17 negative working capital: N171 billion) and expensive overdraft (N35 billion as at 9M 17). On balance, we expect the company’s net debt position to print at N219 billion by year end (vs. N245 billion as at 9M 17). 

• In view of our recent adjustments, we now have a FVE of N45 (vs. N49.51 in previous communication). Lafarge trades at 2017E EV/EBITDA of 8.0x vs 8.5x for Bloomberg EMEA peers. We retain a SELL rating on the stock and re-emphasize that the implied dilution from the rights has been factored into our model.