August 6, 2019/InvestmentOne Report

§  Mixed top line:  up 10.67% q/q,  down 1.68% y/y

§  Lower Gross profit margin: down 1281bps q/q; 1011ps y/y 

§  Stable OPEX to sales ratio: up 47bps q/q; down 25bps y/y

§  Lackluster PBT performance: down 40.84% q/q; 45.01% y/y 

Recently, Dangote Sugar Refinery Plc published its Q2 2019 results which were reflective of the fall in refined sugar prices in the local market. Similarly, due to the marginal uptick in raw sugar prices in the international market as well as the fall in refined sugar, gross profit margin was under pressure in the quarter. We highlight that the lingering challenge of smuggling on the back of insecurity (North East) still remains. 

Lower Prices Weigh on Turnover  

The company’s turnover fell by 1.68% y/y to N42.22billion in Q2 2019, which may not be unconnected with the challenge of smuggling. In the same vein, the drop in revenue could be as a result of the reduction in price on account of the competition from low quality substitutes. On the average, sugar prices declined by 8.94% y/y to N13,468.33 per 50kg (wholesale price) in Q1 2019 according to our estimate from daily prices released by the National Sugar Development Council. 

We believe the fall in refined sugar prices and the rise in raw sugar prices (+2.97%y/y on the average in Q2 2019), despite the stability in FX market, could have led to the fall in gross profit margin to 20.19% in Q2 2019 from 30.30% in Q2 2018.  

Weaker Margin Drives Profit Down 

Moving down to the P& L line, Dangote Sugar recorded a lower PBT margin of 15.00% in Q2 2019 from 26.81% in Q2 2018. This was due to the combination of the fall in gross profit margin, a 76.85%y/y decline in other income and a 67.04%y/y decline in net finance income which offset the effects of the 25bps fall in OPEX/Sales.  

We believe the fall in net finance income could be attributed to the lower interest rate environment as well as the company’s lower cash position in 2019 relative to 2018. Overall, the company recorded a 45.01% y/y increase in PBT to N6.33billion in Q2 2019.  

Higher Volume Supports Quarter On Quarter Performance 

On a sequential basis, turnover increased by 10.67% q/q in Q2 2019 which may be due to higher volume as price remained under pressure. In the same vein, the company’s gross profit margin declined to 20.19% from 33.00% in Q1 2019, which may be due to the fall in refined sugar prices in the local market. That said, a combination of the decline in gross profit margin, a 41.27%q/q decline in net finance income and a 47bpsq/q increase in OPEX/ sales put pressure on the bottom line. As such, PBT margin fell to 15.00% from 28.05% in Q1 2019 and PBT fell by 40.84%q/q in Q2 2019. 

Weak Q2 Result Weighs on H1 Performance 

The company’s turnover declined by 4.42% y/y to N80.36billion in H1 2019 which may be due to the price cut on sugar. We highlight that average selling price fell by 9.11% to N13, 636.67 per 50kg bag according to our estimate from daily prices released by the National Sugar Development Council.  

In the same vein, the gross profit margin declined by 143bps y/y to 26.27% due to the cut in prices of refined sugar in the local market as Dangote Sugar tries to maintain market share in the face of influx of low quality sugar by smugglers. That said, a combination of the fall in gross profit margin and a 66.98%y/y drop in net finance income offset the impact of the 17bps decline in OPEX/Sales ratio and 26.67%y/y fall in Fair Value loss. As a result, PBT margin dropped by 436bpsy/y to 21.19% and PBT fell by 20.73%y/y to N17.03billion in H1 2019.   

Summary and Outlook 

Overall, the results were headlined by decline in revenue due to price reduction which weighed on margins and total earnings.

Going forward, we believe the recent reduction in sugar prices due to stable FX market as well as the issue of smuggling of sugar through the North East may continue to weigh on the company’s gross profit margin in the near term. We highlight that the impact may be more if low price sugar is able to infiltrate the company’s largest source of sales, Kano State, which accounts for major revenue source. 

Nonetheless, we believe the recovery in the non-oil sector particularly the Consumer Goods sector could trickle down to the company through demand for items like sugar which are used to produce other consumer goods. This could support top line growth of the company in the near term. 

In the same vein, the recent stability in raw sugar prices (-0.25%YTD) and FX market may continue to support the company’s cost of sales with about 56% of the company cost of sales incurred in foreign exchange. Similarly, the Federal Government’s plans for self-sufficiency in Sugar by 2023 may support the company’s growth going forward with government trying to channel efforts to build plantations and cane-crushing mills. It is expected that these plantations and cane-crushing mills will produce about 2million tons of sugar annually in order to meet the annual demand of about 1.5 million metric tons within a decade. This may support the company’s backward integration programme to boost sugar output from 300,000 to 700,000 tons by 2021 as it has a market share of 60% having dropped recently due to influx of sugar from smugglers. 

In the same vein, the company’s long term plan to raise about N200billion through right issue and N2.5billion from CBN may boost its backward integration plan and expand its Sugar Plantation in order to produce 1.08million metrics tonnes of refined sugar in the next 6 years. This should be positive for top line and margin expansion in the long run.

Sources: Company financials, Investment One Research