ASHAKACEM. Vetiva Research. Q3 10 Earnings Release. Margins under pressure? 4 November Fair Value Range N21.76 N24.05

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1 Q3 10 Earnings Release Margins under pressure? We maintain our neutral rating on AshakaCem despite its unimpressive performance in its Q2 and Q3 quarterly earnings this year. Since our last Earnings Release update on Ashaka s H1 10 earnings when we had an Accumulate rating on the stock, it has appreciated by c.19%. With a YTD gain of 98.9%, the stock has been the best performing among the cement producers and in the entire stock market mainly because the share price came from a low- base at the beginning of the year. The increased conservative stance on the expected improvement in the company s operating efficiency has necessitated a reduction in our fair value mid-point to N Slowing sales in line with expectations Ashaka s top-line reflects broad expectations for cement producers this year in view of the declining sales that generally characterised the industry in Q3 10 (July September). Nonetheless, Ashaka s top line appears to have been hit considerably as turnover declined by c.29.5%, in comparison to a marginal decline of c.3.5% observed in Q2 10 (April June) turnover on a QoQ basis. As expected, management attributes the decline to the seasonality caused by the heavy rainfalls during the period. Margins however disappointing: In our previous updates on Ashaka, we had stated an expected rise in profitability margins in view of its new coal plant which enables the use of coal fuel rather than Low Pour Fuel Oil. This had been the basis of our key investment case for Ashaka given the anticipated cost savings expected from such conversion. However, the company s profitability margins have been on a declining trend since Q1 10, dipping to 12.5% in Q3 10 (July to September) from c.20% and c.26% in Q2 10 (April to June) and Q1 10 respectively, despite the completion and the use of coal this year. According to management, the decrease in turnover took toll on pre-tax profit and profitability margins. Though Ashaka is gradually substituting LPFO with coal, the company still utilised Low Pour Fuel Oil, which had been bought at significant highs earlier in the year, for production during the quarter. Thus, the reduction in pre-tax profit margin is adduced to the higher costs of sales associated with Low Pour Fuel Oil. Management however expresses confidence that there would be major impacts of the use of coal on profitability margins from next financial year Expansion would improve prospects: In line with management s guidance, Ashaka s kiln expansion project is still on-going. We expect new 400,000 tonnes kiln to become operational by 2012, thus increasing the company s capacity to 1.25 million tonnes. With the additional capacity the company would be able to drive higher volumes, which is critical to sustaining turnover growth given the low possibility of price increases in the medium to longer term. Analyst Tosin Oluwakiyesi t.oluwakiyesi@vetiva.com Stock Data Symbol: NSE: Bloomberg: Reuters: ASHAKACEM ASHAKA.NL ASHAKA.LG Current Price (N): Trailing EPS (N): 0.74 Trailing P/E (x): P/E (x): Shares Outstanding (Bn): 2.24 Market Cap (Nbn): Market Cap ($ Mn): 338 Year High (NGN): Year Low (NGN): Share Price Performance 30 Days (%): Days (%): weeks (%): Ownership Structure: Lafarge 52-week S.A share (%): price performance (Rebased) Others (%): Vetiva Research 4 November 2010 Fair Value Range N21.76 N24.05 Ashaka NSE ASI Build. Mat. Index 2-Nov 2-Feb 2-May 2-Aug 2-Nov Vetiva Capital Management Limited Plot 266B Kofo Abayomi Street Victoria Island Lagos, Nigeria Tel: Fax: research@vetiva.com 1

2 Key Headlines Q3'10 Q3'09 Chg 2010F Q3 as % NGNbn % NGNbn of 2010F Turnover PBT Tax (0.82) (0.59) (1.19) PAT Performance highlights Ashaka s quarterly performance in % 25% 20% % % 5% 0.00 Q1 Q2 Q3 0% Turnover PBT PBT Margin Source: Company Filings, Vetiva Research Increasing receivables; incentive to stimulate sales? We observe the 334% jump in Ashaka s trade debtors account to N382 million at the end of Q3 10 from N88 million as at FY 09, which is quite unusual for Nigerian cement producers as the business has historically been cash-based. In fact, the entire N294 million increase in accounts receivables came in Q3 (July September). This, in our view, suggests that the company relaxed its credit policy in order to accommodate more sales given the sluggish demand for cement during the period. In view of expectation of better economic recovery and real sector spending next year, we do not expect such steep rise in account receivables to continue. Fixed asset balance soars on capitalized coal plant: We would begin to see a sharp rise in Ashaka s depreciation charge in view of the significant rise in fixed asset balance as at Q3 10. Ashaka s management has revealed that the 177% jump in its fixed asset balance (to N billion from N5.218 billion) at the end of Q3 10 is due to the capitalisation of its coal plant investment, which before then has been classified as work-in-progress, and not depreciated. 2

3 While we expect the depreciation expense to reduce operating profit margin, the expected reduction in energy costs from the increasing use of coal, in our view, would be more significant than the implicit reduction likely from higher depreciation expenses. Therefore, the net effect as we anticipate would be an overall gradual increase in operating profit margin. FY 10 forecasts revised slightly downwards: Ashaka s lower-thanexpected bottom-line performance has called for some downward revisions to our forecasts. We therefore revise our average capacity utilisation rate assumption by FY 10 downwards to 86.5% from 92% and consequently FY 10 turnover and PAT forecasts are also scaled down by 6% and 17% to N18.19 billion and N2.53 respectively. Our initial FY 10 PAT is particularly revised downwards by a higher percentage to capture the declining profitability margins observed QoQ for Ashaka this year, reflecting the fact that for this year, we are not likely to see any significant impact of the of the company s use of coal on its profitability margin as previously anticipated. In all, we still hope to see a better FY 10 performance in comparison to FY 09. Valuation Our valuation is based on the Discounted Cash-flow Method which spans through a period of 6 years, capturing our expectation on the company s expansion. We assumed that the additional 400,000 metric tonnes production line being built by the company would become operational by Using the company s cost of equity of 15.63% as our discount rate since Ashaka has no long term debt; we arrive at a fair value range of N21.76 N The discount rate is obtained using a risk free rate of 10%, equity risk premium of 5% and beta of Our fair value range implies a midpoint of N22.91, which translates into a upside potential of 1.1% relative to its current price of N Thus, we maintain our Neutral rating on the stock. Forward (2010) Comparables valuation Local peers Valuation multiples P/E (x) EV/EBITDA (x) Div Yield ROE (%) EBIT Margin (%) Ashaka Cement Lafarge WAPCO CCNN DCP Source: Vetiva Research 3

4 Appendix Ashaka Cement Financials: Actual and Forecasts (N million and USD Million) INCOME STATEMENT (N'Mill) F 2011 F 2012 F Turnover 16,772 16,473 21,378 17,194 18,189 21,025 23,358 Cost of Sales (8,794) (10,868) (14,039) (11,771) (11,846) (12,058) (11,528) Gross Profit 7,978 5,605 7,339 5,423 6,343 8,967 11,830 Selling and distri. Expenses (2,408) (1,486) (1,437) (432) (1,137) (1,472) (1,635) Core Operating Profit 5,570 4,120 5,902 4,991 5,207 7,495 10,195 EBITDA 5,948 4,452 2,697 3,785 1,533 4,115 5,603 Depreciation & Amortization (436) (514) (519) (526) (604) (630) (659) EBIT/Operating Profit 4,016 2,183 3,265 1,007 3,512 4,973 7,433 Interest Payable & Charges Profit Before Taxation 4,952 2,513 3,430 1,324 3,512 4,973 7,433 Taxation (1,574) (1,361) (911) (1,422) (983) (1,641) (2,379) Profit After Taxation 3,378 1,153 2, ,528 3,332 5,055 BALANCE SHEET (N'Mill) F 2011 F 2012 F Non-Current Assets Fixed Assets 2,685 3,811 5,686 5,218 19,840 20,262 20,771 Work in Progress 5,333 8,891 10,901 13,849 2,981 3,030 3,031 Current Assets Inventories 4,931 4,220 4,706 4,707 5,017 5,107 4,883 Debtors 1, Bank and cash balances 3,798 2,137 1, ,929 6,131 Other Receivables and Current Assets - 2,785 1, ,200 1,388 1,542 Total Current Assets 10,403 9,528 8,440 6,552 6,678 9,539 12,684 TOTAL ASSETS 18,421 22,230 25,027 25,618 29,499 32,831 36,485 Current Liabilities Creditors & Accruals 887 1,151 1,921 2,296 1,315 1,986 2,206 Other Creditors 3,341 6,164 7,269 5,967 4,892 5,655 6,283 Short Term Loan Taxation 1,661 1, , ,641 2,379 Total Current Liabilities 5,890 9,971 10,117 9,648 7,191 9,282 10,867 Non-current Liabilities Long-Term Loans Provision for Gratuity ,648 2,862 2,505 2,039 Deferred Taxation ,144 1,181 1,921 1,621 1,349 Total Non-Current Liabilities 934 1,546 2,125 2,829 4,783 4,126 3,388 TOTAL LIABILITIES 6,824 11,518 12,242 12,477 11,974 13,407 14,255 Net Assets 11,598 10,713 12,785 13,142 14,085 15,488 17,337 Source: Annual Report, Vetiva Research 4

5 INCOME STATEMENT (USD'Mill) F 2011 F 2012 F Turnover Cost of Sales (75) (92) (113) (80) (79) (78) (74) Gross Profit Selling and distri. Expenses (20) (13) (12) (3) (8) (9) (11) Core Operating Profit EBITDA Depreciation & Amortization (4) (4) (4) (4) (4) (4) (4) EBIT/Operating Profit Interest Payable & Charges Profit Before Taxation Taxation (13) (12) (7) (10) (7) (11) (15) Profit After Taxation BALANCE SHEET (USD'Mill) F 2011 F 2012 F Non-Current Assets Fixed Assets Work in Progress Current Assets Inventories Debtors Bank and cash balances Other Receivables and Current Assets Total Current Assets TOTAL ASSETS Current Liabilities - - Creditors & Accruals Other Creditors Short Term Loan Taxation Total Current Liabilities Non-current Liabilities Long-Term Loans Provision for Gratuity Deferred Taxation Total Non-Current Liabilities TOTAL LIABILITIES Net Assets Source: Annual Report, Vetiva Research 5

6 Key financial ratios: Actual and Forecasts F 2011F 2012F Growth Turnover growth -2% 30% -20% 6% 16% 11% 13% Growth in Core Operating profit -46% 50% -69% 249% 42% 49% 17% EBITDA Margin 27% 16% 18% 9% 23% 27% 35% EBIT Margin -49% 36% -61% 165% 42% 49% 17% PAT Margin -66% 119% -63% 168% 32% 52% 17% Profitability Return on Equity (AVG) 10% 23% 8% 19% 24% 33% 33% Return on Equity (END) 29% 11% 20% 7% 17% 20% 26% Return On Asset (AVG) 19% 6% 11% 4% 10% 12% 16% Return On Asset (END) 18% 5% 10% 4% 10% 11% 15% Share Metrics EPS (N) DPS (N) NAPS (N) EBITDA per Share (N) Sale per Share (N) Shares Outstanding (N) 1,991 1,991 1,991 1,991 2,240 2,240 2,240 Production data Capacity(million tonnes) Production (million tonnes) Utilization (%) Price/Tonnes (N) 22,881 24,332 24,686 26,452 26,500 25,500 25,500 Cost of sales/tonnes (N) 8,900 12,989 12,549 21,599 17,150 14,367 13,163 EBITDA/Tonnes (N) 6,074 3,984 4,370 2,358 5,996 6,796 8,835 Source: Company Financials, Vetiva Research 6

7 INVESTMENT RECOMMENDATIONS Vetiva uses a 5-tier recommendation system for stocks under coverage: Buy, Accumulate, Neutral, Reduce and Sell. Buy/Overweight +25% expected absolute price performance Accumulate +10% to +25% expected absolute price performance Neutral/Hold +/-10% range expected absolute price performance Reduce -10% to -20% expected absolute price performance Sell/Underweight -20% expected absolute price performance Definition of Ratings Buy/Overweight recommendation refers to stocks that are highly undervalued but with strong fundamentals and where potential return in excess of or equal to 20% is expected to be realized between the current price and analysts target price. Accumulate recommendation refers to stocks that are undervalued but with good fundamentals and where potential return of between 10% and 25% is expected to be realized between the current price and analysts target price. Neutral/Hold recommendation refers to stocks that are correctly valued with little upside or downside where potential return of between +/- 10% is expected to be realized between current price and analysts target price. Reduce recommendation refers to stocks that are overvalued but with good or weakening fundamentals and where potential return of between -10% and -25% is expected to be realized between current price and analysts target price. Sell/Underweight recommendation refers to stocks that are highly overvalued but with weak fundamentals and where potential return in excess of or equal to - 25% is expected to be realized between current price and analysts target price. 7

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