Lafarge Africa Plc. (Lafarge) released unaudited Q3 16 results, wherein it reported a pre-tax loss of N12billion (Q3 16E – N10billion) which extended the company’s run of losses to the fourth consecutive quarter.
FX loss and net debt shrink on debt conversion.: Following significant pressure from FX losses in prior quarters, Lafarge converted $493 million of its shareholder dollar debt into equity instrument in Q3 16. During discussions, management insisted that the equity instrument is not dilutive to current shareholders in any form and would now reside directly in retained earnings along with associated FX volatility. Under the new arrangement, interest and principal payments are now to be made at the discretion of the borrower (Lafarge). In providing rationale for the decision, management explained that the conversion would reduce volatility from dollar denominated debt, which drops to $102 million (vs. $595 million previously).
…but weak operating performance underpins Q3 16 loss: Away from debt issues, Lafarge recorded a third consecutive dip in group revenue in Q3 16 (-15% YoY to N54 billion) missing our estimates by 3.7%. Sales weakness stemmed from a contraction in Nigeria (-29% YoY to N29.5 billion) which neutered the strong growth in South Africa (+19% YoY to N23 billion). Worse still, sharp increases in input cost (+12% YoY to N51 billion) drove 22.4 pps YoY contraction in gross margins to 5.5% with gross profits declining 83% YoY to N2.97 billion—lowest level since consolidation.
Reduction in net debt drives FVE expansion: Given the negative demand response across peers to the price increase, we expect Lafarge to experience constrained volume growth over Q4 16. Thus, in line with current run rate (-27% YoY in Nigeria), we now look for 26% YoY contraction in Nigerian cement volumes to 4.92MT (vs. -5% YoY to 6.3MT previously) with 2016 weighted prices now at N29,053 (vs. N23,500 in previous estimates). Similarly, given sustained energy pressures over 9M 16, we expect COGS to rise by 9% to N178 billion (-3.6% YoY), implying 17.4pps contraction in gross margin to 14%. However, going into 2017, we expect the company to benefit from higher prices (+5% YoY) and significant moderation in earnings volatility following the successful restructuring of its shareholder dollar loan. Furthermore, our model adjustment for the consequent 43% contraction in net debt to N116 billion drives a 24% rise in our FVE to N66.15.
Largely reflecting pressures from significant FX losses and weak operating performance thus far in 2016, Lafarge trades at a 2016 EV/EBITDA of 53.9x vs. 8.4x for its Bloomberg peers. Father out however, a combination of higher prices and expected cutback in earnings volatility following debt reduction drives moderation in our forward EV/EBITDA to 6.9x for Lafarge (Bloomberg average: 8.8x). Overall, in line with its significantly smaller net debt position, we have upgraded our recommendation on the company to a STRONG BUY (vs. SELL in previous communication).
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