We expect the announced sale of Lafarge Africa’s South African subsidiary, Lafarge South Africa Holdings (LSAH) to boost margins, while the use of the proceeds to repay all existing shareholder loans will result in a stronger balance sheet position, and support investments and growth. As the group successfully sheds off significant dead weight, management’s focus will be on efficiency and market share gains in Nigeria, in response to heightened competition.
Reiterate Buy with a TP of NGN25 (ETR of 86%). Our view is based on: 1) improvements in profitability following the sale of LSAH; 2) a sharp reduction in the group’s balance sheet leverage after the repayment of US$293mn in shareholder loans plus interest; and 3) further potential efficiency gains from the group’s energy and business integration initiatives in Nigeria. However, we highlight that the competitive environment and weak GDP growth could be a strain on margin expansion and volume growth over the medium term. Lafarge Africa currently trades at 5.4x FY 20f EV/EBITDA multiples versus a five-year historical average of 9.1x.
Divestment to support performance in the short term. Following the sale of LSAH (29% and 14% of FY 18 revenues and assets, respectively), we expect EBITDA margin to rise to 24.2% in 2019f, up 840bps yoy. In addition to Lafarge Africa’s NGN88.4bn rights issue (the second in less than 18 months), the sale should also help reduce its loans and borrowings by 77% yoy to NGN68bn by end-19. This should see its debt/equity ratio fall to 30%, versus 224% in 2018. The reduction in debt, with no short-term maturities left on the group’s balance sheet and 20% of the remaining debt borrowed at single-digit rates, should drive a 66% yoy decline in net interest expense, and a jump in interest coverage to 3.7x in 2019f, from 1.3x at end-18.
Management plans to focus on increasing efficiency and market share in Nigeria. This is largely due to the potential for price erosion over the medium term from increased competition. Building on a stronger balance sheet, lower debt service costs and tax savings from the recently acquired pioneer tax status for Mfamosing Line 2, management plans to: 1) enhance the energy mix by eliminating the use of expensive low pour fuel oil (LPFO) over the medium term; and 2) debottleneck the Ashaka plant over the next 12-18 months at a cost of US$20mn. As part of its energy initiative, the group aims to continue to increase the use of alternative fuels (which costs 50% less than gas) at all its plants over the medium term, from 10% at end-2018. The company also has plans to increase the use of local coal in the short term and alternative fuels over the medium term at the Ashaka plant, which currently runs on coal (80%) and LPFO (20%). While this should all be positive for efficiency and reduce the group’s exposure to currency risks, we may not see a significant medium-term improvement in margins if our expectations for further price reductions materialise. We currently expect the EBITDA margin to remain flat in FY 19-20f at c24%. The debottlenecking of the Ashaka plant, which could add up to 0.5mmtpa to the plants existing 0.95mmpta capacity, will likely add to the excess capacity in the market. As such, we see EBITDA margin remaining flat throughout FY 19-21f.
Volume growth is likely to slow over the medium-term. Despite management’s efforts to boost volumes by altering its route to market and increasing credit sales, we expect volume growth to slow, following a recovery in 2018, because of: 1) relatively slow economic growth; 2) heightened competition following a 10% increase in industry capacity to 45mtpa in 2016-18; and 3) weak consumer spending and lacklustre real estate and construction sectors. As such, we expect Lafarge Africa’s volumes to be relatively flat in 2019-20f, before seeing an uptick from 2021f. We highlight that there has been a noteworthy increase in the group’s trade receivable days, which offers more favourable terms of credit to drive volume growth as it battles for market share. However, the quality of these receivables has declined, with impairments as a percentage of net trade receivables averaging 5.2% 2017-2018, compared with 1.5% over 2014-2016.
Key risks. Downside risks to our outlook and valuation include: 1) increased competition and weaker macroeconomic environment, which could hinder volume growth; 2) sharp increase in balance sheet leverage; and 3) execution risk related to the company’s plans to improve its operating efficiency; and 4) volatile regulatory environment.