August 11, 2016/FBNQuest Research

PT down 13% to N6.1 on the back of a higher discount rate
Dangote Sugar Refinery’s (DSR) Q2 earnings beat our forecast by 24%. The drivers were better-than-expected sales and a positive surprise on the opex line. Sales were driven by growth in both pricing (25.1% y/y) and unit volume (4.8% y/y) to N172,000/tonne and 211,000 metric tonnes (MT) respectively in Q2.

Going forward, we expect continued growth in the corporate segment in Lagos to support sales in the short term. We have also slightly raised capacity utilisation for DSR’s Lagos Refinery to 56% (vs. 54% prev.) for 2016E on the back of improved operational efficiency.

Additionally, in view of escalating costs, management has guided to price increases in H2. Given this, we estimate a sugar sales price of around N200,000/tonne by end-2016 on the back of increasing fx volatility. To our minds, this could negatively weigh on sales volumes. We have cut gross margin by around 400bps to 18.0% on the back of higher energy costs due to the shortage of gas and a steady rise in raw sugar prices (a key input for DSR, up 38.0% year-to-date).

Although opex positively surprised in Q2, we believe rising transportation costs and increased labour during the planting season at Savannah Sugar (DSR’s first farm-to-table project) are likely to increase costs in H2. Taking all these into consideration, we have raised our EPS estimates over the 2016-17E period by 5% on average.

Although we have rolled forward our valuation to 2017, our new price target of N6.1 is lower by around -13% because we have increased our risk free rate by 200bps to 14.5%.

From current levels, our new price target shows a potential downside of -8.9%. At current levels, DSR shares are trading on a 2016E P/E multiple of 6.0x for 5% y/y EPS growth over the 2017-18E period. Ytd, DSR shares have gained 10.6%, outperforming the broad market by 15%. We have retained our Neutral rating.

Rising cogs and opex weigh on y/y performance
In Q2 2016, while sales were up 32% y/y to N37.9bn, PBT and PAT were both flattish y/y respectively. A 28% y/y rise in operating expenses and a 623bp y/y gross margin contraction completely offset any benefits coming from the sales growth. Sales were mainly driven by finished sugar in Lagos which more than doubled y/y to N30.7bn in H1 2016.

The gross margin contraction is unsurprising given the recent devaluation of the naira. DSR imports almost all of its raw sugar, which accounts of around 70% of COGS. Sequentially, sales were up 16% q/q. PBT and PAT both grew by 18% q/q and 20% q/q respectively. Compared with our estimates, sales and PBT beat by 34%, and 22% respectively.