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Nigerian Cement Producers - Competition upsetting the status quo

Competition upsetting the status quo

• Following the higher than expected decline in ‘cementitious’ volumes over the third quarter 2018 by Lafarge (-16.3% QoQ) and DANGCEM (-23.3% QoQ), we have revised our FY 18E for Nigeria cement volume lower to 20.4mt (previously 21.4mt) which is a growth of 11%. Our cautious approach reflects the impact of the prolonged rainy season, which still prevailed for most part of October and the electioneering concerns which has now slowed ongoing infrastructure projects. Farther out in 2019, the construction sector is set to witness an uncertain environment. Specifically, we believe most part of the first half of 2019 will be focused on assessing the political environment and the likely delay from the passage of the 2019 budget. Thus, we expect a moderate growth in domestic cement volume by 7.4% to 21.9mt (Previous: +11% to 23.9mt) in 2019.
• The market witnessed price erosion over Q3 2018, with average cement price declining by ~N850 and ~ N1,770 relative to Q2 2018 and Q3 2017 respectively. On one hand, we attribute the decline to the seasonal price adjustment during the rainy season, while on the other hand, we believe the recently ignited competition following the commissioning of the Kalambaina Cement plant by BUA Group in Sokoto State further amplified the price erosion. For the rest of 2018, we expect price to stay at current levels with average price for the year settling at N43,625 (previous estimate of N43,769). In 2019, we believe the price competition will enter a new realm and estimate average of ~2.5% annual price erosion over FY 19 – 22.
• We have lowered our FVE on DANGCEM to N253.03 following i) downward revision of our 2018 and 2019 volume growth to 8.7% and 11.8% to 23.5mt and 26.5mt respectively ii) slight adjustment to revenue per ton over Q4 18, with average price for the year now settling at N43,921 per ton (lower by 3.7% YoY); iii) N513 upward revision in cost per ton to N16,061, with gross profit now expected to expand by 121bps (previously: +223bps) to 57.6%; and iv) an 100bps upward review in opex to sales to 21% following a faster growth in both distribution and administrative expenses over Q3 18. On the positive, we remain sanguine on volume growth beyond 2019, following expectation of clinker exports to West African countries and improved cement consumption in Nigeria over the next five years as capex spend by government across levels gain traction. Due to current pricing and attractive valuation, we still maintain a STRONG BUY rating on DANGCEM. 
• For Lafarge, we lowered our LAFARGE FVE to N18.07 (from N29.93) as we now expect i) a more significant dilution with additional shares of 7.4 billion (previous 3.0 billion using a high price of  N29) from the proposed N89.2 billion rights issue; and ii) downward revision to our 2019 volume growth estimate to 3% (previous 5.4%) with a slight downward revision in price per ton by ~4% over 2019-2020. While we lowered our forecast cost to sales ratio at the South Africa operation on average by ~1.2% to adjust for our projected speedy turnaround of the plant, the reduction was offset by expected shut-ins at either of Shagamu or Ashaka plants over our forecast period. Our discussion with management revealed that plans are in place for possible expansion at either of the Ashaka or Shagamu plants, with our thought suggesting that cashflow from the sale of the South African operation could be deployed for the construction. As a result, we have raised our cost to sales ratio to average 76% (prior average of 74.7%) over FY 19 - 20.