April 21, 2022/United Capital Research

During the recent FY-2021 earnings season, Dangote Sugar (“DANGSUGAR” or “the company”) released its audited FY-2021 numbers showing sustained growth in Revenue, climbing 28.8% y/y to N276.1bn, from N214.3bn in FY-2020. Despite the growth in Revenue, profitability was disappointing as Net Income fell 25.9% y/y to print at N22.1bn in FY-2020. The weakness in profitability was down to elevated cost pressures (stemming from higher raw material and energy costs). In this report, we provide an update on expectations for the company in 2022 and an updated position on valuation.

Double-digit revenue growth aided by price increases: DANGSUGAR reported Revenue growth of 28.8% y/y to N276.1bn in FY-2021 from N214.3bn in FY-2020. Across business segments, Refined Sugar sales (+29.0% y/y) was the underlying driver of growth, with Revenue from Molasses (+44.0% y/y) providing further boost. However, Freight income (-15.2% y/y) was weaker on lower trucking activities. Across price and volume dynamics, revenue growth was broadly hinged on price increases which management reported was 21.9% (to N17,848 per bag, from N14,644 in 2020). The increase in price of refined sugar was necessitated by the significant upward pressure in the cost environment. The company continued to record an increase in volumes sold, albeit slowing down for the second consecutive year as sugar volumes sold rose 5.7% y/y to 773,341 metric tonnes in FY-2021. The growth in volumes reflects resilient consumption despite unabating pressure on consumer income.

Cost pressures erode revenue gains: Sugar producers faced intense cost pressures in 2021 as the price of raw sugar rose significantly.  Sugar futures contract rose 35.5% y/y in 2021, while the World Bank’s benchmark rose 33.8% y/y. For DANGSUGAR, the pressure was worsened by FX illiquidity and the consequent currency depreciation (the naira lost c.10.0% in value in 2021). As disclosed by management, the company recorded a 54.0% y/y increase in average cost per ton of raw sugar consumed. That said, cost pressures were not limited to raw material costs alone, as energy and freight costs were also pain points. As a result of a surge in Gas prices (+46.9% y/y) and the impact of the Naira devaluation, conversion costs rose 9.0% y/y. Meanwhile, Freight costs jumped 35.2% y/y on the back of a surge in the cost of diesel, spare parts, and truck depreciation. Overall, these cost pressures drove Cost of Sales higher by 43.8% y/y (faster than revenue growth of 28.8%) to N225.8bn in FY-2021. As a result of the surge in Cost of Sales, Gross margin contracted by 8.5ppts y/y to 18.2% (vs 2020’s 26.7% and the prior five-year average of 23.1%). Similarly, Gross profit fell 2.3% y/y to print at N50.2bn in FY-2021, from N57.2bn in FY-2020.

Increase in operating expenses another pain point: An elevated inflationary environment fed a surge in Operating expenses which climbed 19.1% y/y to N11.5bn in FY-2021. Both components of Opex recorded strong double-digit growth with both Selling & Distribution expenses (+33.9% y/y) and Administrative expenses (+18.0% y/y) on the receiving end of higher business running costs. As a result of weaker Gross profit and higher Operating expenses, Operating profit dipped 18.6% y/y to N38.7bn in FY-2021, from N47.5bn in FY-2020.

Cost pressures underline weak profitability: Strong cash generation in FY-2021 (+129.6% y/y) supported a surge in Interest income, rising by 107.2% y/y to N1.4bn. However, Interest expense rose 23.0% y/y to N6.6bn from N5.4bn in FY-2020. The increase in Interest expense was primarily driven by an increase in Finance cost on Letters of Credit taken to guarantee payments to suppliers as FX illiquidity has reduced DANGSUGAR’s ability to pay foreign suppliers in time. Interestingly, the company’s Letters of Credit balance rose 64.5% y/y to N154.4bn—consequently, Net Finance Cost 10.7% y/y to N5.2bn in FY-2021.

Overall, evident cost pressures (underpinned by FX concerns and commodity inflation) resulted in downbeat profitability performance. Profit before Tax (PBT) and Profit after Tax (PAT) declined 25.4% and 25.9% y/y to N34.0bn and N22.1bn, respectively. Earnings per share printed at N1.82/s in FY-2021 compared to N2.45/s in FY-2020.

Industry competition and cost outlook weigh on growth: Looking ahead to FY-2022, the landscape of sugar producers appears to be more negative than positive. First, volume growth is expected to slow in line with the trend observed in the past two years. The dynamic shift towards healthy alternatives is well documented, while the recent surge in price has forced consumers to reduce consumption. Also, industrial consumption (Food & Beverage, Confectionery, Dairy, Pharmaceuticals etc.) is expected to remain weak as many players within those sectors grapple with slowing demand. Thus, we estimate refined sugar volume growth at 3.0% for FY-2022. On the price side, we expect DANGSUGAR to sustain price increases during the year. Production and conversion costs (materials, logistics, and energy) are expected to remain elevated due to prevalent issues (preference for ethanol production & weather concerns) around raw sugar production in Brazil, and higher gas and fuel prices. Thus, we expect the company to pass on some of these costs in the form of price increases. However, we note that the ability to pass on cost will be limited by competition as BUA Sugar continues to attempt to sell at attractive prices. Thus, while we project Cost per bag growth of 18.0% y/y, we forecast a price increase of 15.0% y/y. Overall, we forecast Revenue growth of 18.4% y/y to N326.8bn in FY-2022.

We expect the aforementioned cost drivers to remain a pain point for the company. We project Cost of sales per bag will grow by 18.0% y/y, factoring in higher energy costs, increase in sugar prices and a stable exchange rate. As a result, we forecast Cost of Sales will be higher by 21.5% y/y, reflecting higher costs and volume growth. The faster increase in Cost of Sales will lead to margin compression and subdued profitability. We project Gross margin and EBITDA margin will fall by 2.2ppts and 1.8ppts, respectively. Overall, we forecast a 4.1% y/y increase in Gross profit (to N52.3bn) and a 1.1% decline in Operating Profit. We forecast a PBT growth and PAT growth of 3.6% y/y and 8.7% y/y to N35.3bn and N23.9bn, driven by lower Net Interest cost, based on expectations of lower Letters of Credit balance.

Valuation attractive…BUY rating retained: As a result of the increase in our cost forecasts and consequent cut to our profit projection, we lower our target price to N20.37/s, from N24.36/s previously. Our target price implies an upside of 27.3% on the current price of N16.00/s. The decent upside on the stock reflects the attractive valuation the stock is trading at. At current price levels, DANGSUGAR trades at a 44.8% discount to our peer average trailing PE ratio as well as a 78.6% discount to our peer average EV/EBITDA. At our target price of N20.37/s, our implied forward PE ratio is 11.2x, a 37.2% discount to our peer average forward PE multiples. As a result, we retain our BUY recommendation despite the subdued outlook on company performance.