Lafarge's Rough Patch

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Goddy Egene writes that the naira devaluation and other logistics challenges negatively impacted on Lafarge Africa’s bottomline, leading to a loss of N40 billion as of September 30, 2016

“The Federal Government of Nigeria has also shown strong indications to support infrastructure growth in the coming year. Lafarge Africa will be able to leverage its unique footprint in 2016 with Ashaka returning to growth, ReadyMix securing high volume contracts to support its eight existing, and new plants to be commissioned as well as the new 2.5 million tons cement line due to be commissioned in Mfamosing in half year of 2016.”

The above were the words of Lafarge Africa Plc, predicting what 2016 business year would offer. While the company was prepared to take advantage of the prospects seen at the beginning of the year to record improved performance, the devaluation of the Naira in June has combined with other factors to dim the hopes of improved fortunes for the year. Lafarge Africa, which is a subsidiary of LafargeHolcim, the world’s largest building materials company, had ended 2015 with a profit after tax of N27 billion and recommended a cash dividend of 300 kobo per share and a bonus of one new share for every 10 shares already held. And the company had hoped to improve on the 2015 performance

But rather than record higher profit at the end of 2016, Lafarge Africa Plc is very likely to record full year loss.
Already it has posted a loss of N40 billion for the nine months ended September 30, 2016, as against a profit of N36 billion recorded in the corresponding period of 2015.

Profit warning
Shortly after the devaluation of the naira, Lafarge Africa sent a profit warning to the stock market that its second quarter(Q2) financial results to June 30, 2016, would be affected by an unrealised foreign exchange loss of about N28 billion.

The company added that gas supply shortage would also impact on volumes for the quarter.
“The impact of the naira devaluation is expected to be a N28 billion unrealised exchange loss arising from the USD borrowings, which at the time of the devaluation, consisted of $310 million shareholders loans and $85 million external loans. These loans relate to the United Cement Company of Nigeria Limited (Unicem) and were mainly set up prior to the acquisition by Lafarge Africa of its original 35 per cent stake in Unicem. Lafarge Africa has since then increased its stake in Unicem and held at the time of the devaluation, 50 per cent of Unicem which was fully consolidated. Lafarge Africa now holds 100 per cent of Unicem. The N28 billion unrealised exchange loss will not have immediate impact on our cash flow,” the company said.

Despite the exchange loss, Lafarge Africa expressed confidence in the future of Unicem, saying the company was well strategically located in Calabar, Cross Rivers State.

“It is major cement plant in the South-south and South-east region of Nigeria. The plant has a cement capacity of 2.5 metric tonnes and will double capacity with the commissioning of 2.5 million line in the second half of this year,” the company said.
True to the profit warning, the company recorded a loss of N30 billion for the six months ended June 2016.

Nine months results
Lafarge Africa reported a revenue of N161 billion for the nine months to September 30, 2016, showing a fall of 25 per cent from N215 billion in 2015. Cost of sales was flat at N143 billion, while distribution expenses fell by 9.6 per cent from N22.4 billion to N20.2 billion in 2016. Net finance cost fell from N3.7 billion to N796 million. However, the company ended the period with a loss of N40 billion, compared with a profit of N36 billion in 2015.

An analysis of the results showed that Lafarge Africa suffered volume decline in all plants in Nigeria for the third quarter (Q3). According analysts at FBN Quest, while Ashaka’s Q3 unit volumes were down by around seven per cent to 0.15 million metric tonnes (mmt), volumes for WAPCO and United Cement (Unicem), declined even more, by 21 per cent and 47 per cent to around 0.21mmt and 0.7mmt respectively.

“The volume shortfall, particularly for WAPCO and Unicem, was due to gas supply disruptions as a result of the vandalised gas pipeline infrastructure across the western and eastern gas grids. Logistics challenges due to deterioration of road conditions also played a major part. Lafarge’s gross margin was also severely impacted by elevated fuel costs due to the utilisation of more expensive fuels,” they said.

Dollar loans renegotiation

In a move that was expected to reduce the volatility of exchange rate fluctuations and impact positively on its cost of finance, Lafarge Africa said it renegotiated about $493 million shareholder loans (out of a total loan balance of $594 million) to quasi equity with effect from July 1, 2016, with the principal repayable at the borrower’s discretion. The company explained that the interest (average of six per cent) on the debt will also be paid at the borrower’s discretion and will be recognised through retained earnings (similar to dividends).

Although the share of Unicem’s loan on Lafarge books as at H1 2016 was around $395 million (consisting of shareholder loans of $310 million and external loans of $85 million), the loan balance increased by $197 million following the full consolidation of Unicem shares. The $197million represents shareholders loans from Lafarge’s intermediate subsidiaries – Egyptian Cement Holdings and Nigerian Cement Holdings (NCH) – which were used to finance the purchase of Unicem shares.

Analysts’ assessment
Commenting on the loan renegotiation analysts at Cordros Capital Limited said it will remove volatility on the income statement by significantly reducing losses from currency depreciation to only those emanating from outstanding third party United States dollar(USD) borrowings and charging interest expenses accruing from the loan to retained earnings.

“Going forward, while acknowledging the impact of the debt conversion as par the summary above, we choose to focus more on the impact of higher cement price on margins, beginning from this quarter; somewhat stable, but still expensive energy supply; and on-boarding of 2.5mmt Unicem’s line II at Mfamosing. We believe these have more direct link with the company’s operations and in determining earnings over next year. We expect Lafarge to return to profitable operation in 2017 and forecast PAT of N11.2 billion. The assumptions driving this forecast are: five per cent volume growth; higher average cement prices in Nigeria; significantly lower forex losses; and reduction in finance charges,” they said.

The analysts noted that notwithstanding the expected return to profitable operation next year, they think fundamentally, the company’s earnings recovery (to pre consolidation levels) has some miles to cover.

“Key risk is that the current high price of cement (N41,000/tonne price), which is imperative to a quick and strong earnings recovery, is not sustainable. Even in terms of volume, growth expectation (from the newly commissioned plant) is doused by the weak national consumption outlook (short term) and especially, the expected fierce competition from Dangote Cement (DangCem).

The analysts added that the performance of the South African subsidiary has been unimpressive. Down 64 per cent as at nine months, the group’s Earnings before Interest, tax, depreciation and amortisiation (EBITDA) from the subsidiary in Africa’s second largest economy has fallen consistently in each of the three years since consolidation. Outlook remains weak, in light of intense competition and weak infrastructure investments faced in that market. We think the price increase implemented in July will be reversed in 2017,” they said.

Cordros Capital Limited, said following the revision to their forecasts, we have increased 2017 target price to N60.10 (from N50.38) and upgrade recommendation to buy (from hold) due to the 31 per cent correction in the company’s share price since we last updated.

“At current price, the stock is trading on a forward price earning (PE) and Enterprise value (EV/EBITDA of 14.8x and 6.7x, at 33 per cent and 13 per cent premium respectively to Bloomberg’s Sub-Sahara Africa comparables. While acknowledging the risks to earnings recovery in the short term, we think Lafarge Africa’s shares have faced intense pressure and expect the market price to rise to our 2017 TP on relatively (compared to 2016) better performance,” they said.