October 18, 2018/InvestmentOne Report

§  Mixed Turnover:  down 11.81% q/q, up 4.62% y/y

§  Mixed Opex/sales ratio: up 651 bps q/q, down 18 bps y/y.

§  Mixed gross margin performance: down 188 bps q/q, up 423 bps y/y.

§  Mixed Net Finance Cost: down 20% q/q, up 47% y/y. 

Lafarge Africa published its Q3 2018 results yesterday and it is to no surprise that the company reported a loss before tax which was consequent of its surging net finance cost. Top line performance may have been waned as a result of seasonality in Nigeria on a quarter-on-quarter basis. Nonetheless, management announced the success of its turnaround plan in South Africa operation which made the segment report at a breakeven after recording losses in FY 2017, Q1 2018 and Q2 2018. 

Marginal Improvement in Revenue  

The results showed a marginal improvement (+4.62% y/y) in revenue at N72 billion in Q3 2018. We are of the view that the slowdown in production activities in the South Africa operation may have limited the ability of the cement producer to boost revenue from the South African market.  

Margin wise, Lafarge’s gross profit margin expanded by 423bps y/y to 24% in Q3 2018, driving the 27% y/y growth in gross profit to N17.13bn. This may be as a result of cost management as well as an  effective energy efficiency plan through increased use of Alternative Fuel and Coal. We believe this also resulted in 455bps y/y increase in EBIT margin to 3.88% in Q3 2018. 

Revival of South African Operations

The South African operation which accounts for about 26% of Lafarge Africa production capacity, came in at a breakeven. According to management during the conference call, the challenges which affected the firm’s capacity to produce cement have been largely addressed by the turnaround plan implemented.  

We believe this may be a positive for the cement manufacturer going forward. However, the recession in SA which has led to a slowdown in economic activities may be a down side risk to revenue generation in the medium to near term.  

The Continual Distress in Finance Cost 

As expected, net finance cost continues to be a hostage to the fortune of bottom line performance. Despite the successful of N131 billion right issue in Q4 2017, Lafarge continues to record a loss before tax as a result of its recurring high finance cost.  The net finance cost of N10.79 billion in Q3 2018 represents a 47% y/y growth albeit it declined by 19% q/q. We spotlight the leverage (175% Q3 2018 vs 151% Q4 2017) of the firm continues to be a major factor to be addressed in order to alleviate losses. 

We also highlight that consistent losses may begin to eat away at the equity position of the firm as we have seen so far this year. The cement producer has recorded a loss before tax of N14.36billion in 9m 2018 which has led to a c.15% YTD decline in retained earnings to N136 billion as at September 2018.

9M Performance is Less Inspiring 

Looking at the 9M 2018 performance, the company reported a revenue of N234 billion, showing a 4.75%y/y increase. The positive performance was mainly driven by strong volume growth in Nigeria and favourable pricing trends in South Africa. However, the 195bps y/y decline in gross profit margin performance to 23.94% was driven by a 64% y/y rise in raw materials to N36.9 billion.  

In terms of bottom-line performance, the company recorded a negative profit before tax margin of 6.13% owing to the disturbing level of net finance expense (N33.48 billion, 9M 2018) which completely eroded the company’s EBIT of N19.13billion in 9M 2018.  

Outlook 

Overall, the results were headlined by increase in finance cost, revival in South Africa operations as well as effective cost management. Going forward we expect that prices to be stable in the Nigeria market while the potential increase in government capital expenditure may be supportive of top line. We expect to see a better revenue performance in Q4 2018 vs Q3 2018 as the federal government has recently released about N460 billion for CAPEX. We also point that, the cement company has commissioned a new grinding station in Ghana with a capacity of 600KT, we believe this may bode for top line performance in the long run. 

Although, management announced the success of its turnaround plan in the South African operations combined with the SA construction sector recording a growth for the first time in six quarters in Q2 2018, we are conscious of the potential of revenue generation in that market as a result of the fall in the value of the rand and economic recession which may slow down economic activities in the medium to long term. 

Furthermore, we opine that a successful right issue may aid in reducing the impact of finance cost on bottom line performance albeit to a slight extent as we do not expect a significant decline in debt levels. According to management guidance, if the N90 billion rights issue is successful, N46 billion is intended to repay debts owed to Bank of Industry as well as outstanding commercial papers. Management also intends to commit about N36 billion to working capital requirements while the remaining N8 billon will be utilised in reducing dollar denominated related party loan from US$315million to US$293 million.