MASTERS IN FINANCE EQUITY RESEARCH BAMBURI CEMENT COMPANY REPORT. Enjoying the Ride CEMENT INDUSTRY 6 JANUARY 2016 STUDENT: GONÇALO RAMALHO

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1 MASTERS IN FINANCE MASTERS IN FINANCE EQUITY RESEARCH BAMBURI CEMENT CEMENT INDUSTRY 6 JANUARY 2016 STUDENT: GONÇALO RAMALHO 20612@novasbe.pt Enjoying the Ride Recommendation: BUY Grasping High Demand Opportunities Price Target FY17: KES The recent turmoil in oil prices has fostered the East African economic expansion, as the region is reliant on this commodity imports. Hence, there as been a higher demand for cement, which as been growing at a higher pace than GDP in both Kenya and Uganda. Furthermore, Kenya and Tanzania s strive to become the region s preferred gateway and the focus of other nations, such as Uganda, on developing its infrastructures, have positively contributed for the rally of this commodity. Price (as of 5-Jan-17) KES Reuters: BAMB NR, Bloomberg: BMBC KN 52-week range (KES) Market Cap (KES m) Outstanding Shares (m) Source: Bloomberg; Analyst Estimates Since Bamburi is close to its full capacity, the Group has launched an expansion plan that will improve their grinding capacity by the end of Nevertheless, despite higher future profits, the company will face excessive growth in imported clinker expenditures, which in turn will erode its margins. Bamburi Special Products (BSP) is a niche area that is expected to escalate in terms of its impact in Bamburi s total revenues over the years, as its sales are projected to grow at over 12% per year during our forecasted period. Furthermore, one should be aware of Bamburi s immense ability to distribute great amounts of dividends, which highly complements its strong balance sheet without withstanding debt. Under this context, our recommendation is for BPI to Buy. Company description Bamburi is one of the largest cement producers in East Africa. This segment represents the firm s core business, while at the same time the company is aiming towards the growing blocks and ready mix markets. It currently operates in Kenya and Uganda, and exports mainly to other regional East African nations. Source: Bloomberg (Values in KES millions) 2015H 2016E 2017F Turnover EBITDA Net Profit NOPLAT Net Debt EPS P/E Dividend Cover Return on Invested Capital 17.7% 14.6% 15.9% Source: Company Data; Analyst Estimates THIS REPORT WAS PREPARED BY GONÇALO RAMALHO, A MASTERS IN FINANCE STUDENT OF THE NOVA SCHOOL OF BUSINESS AND ECONOMICS, EXCLUSIVELY FOR ACADEMIC PURPOSES. THIS REPORT WAS SUPERVISED BY ROSÁRIO ANDRÉ WHO REVIEWED THE VALUATION METHODOLOGY AND THE FINANCIAL MODEL. (SEE DISCLOSURES AND DISCLAIMERS AT END OF DOCUMENT)

2 Table of Contents EXECUTIVE SUMMARY... 3 COMPANY OVERVIEW... 4 SHAREHOLDER STRUCTURE... 4 HISTORICAL FINANCIAL ANALYSIS... 5 MARKETS MACROECONOMIC CONTEXT... 7 EAST AFRICA... 7 KENYA... 8 UGANDA BUSINESS UNITS SEGMENTATION CEMENT BAMBURI CEMENT LIMITED HIMA CEMENT LIMITED BAMBURI SPECIAL PRODUCTS (BSP) VALUATION MAIN DRIVERS PROJECTIONS FINANCIAL STRUCTURE AND COST OF CAPITAL RISK ANALYSIS SCENARIO ANALYSIS FINAL VALUATION CONSIDERATIONS FINANCIAL STATEMENTS APPENDIXES DISCLOSURES AND DISCLAIMER PAGE 2/33

3 Executive Summary Nowadays, East Africa has taken advantage from the recent turmoil in oil prices to be considered as the fastest growing economy in the whole continent. Since the region is underdeveloped there is a special urge for infrastructure construction and also for the housing segment, as the inhabitants purchase power is increasing. Hence, Bamburi Cement has been reaping from the high demand for cement products. In fact, the latter operates essentially in two markets, Kenya and Uganda, where it holds a strong market share and from which Bamburi has seized the opportunity to continuously raise its yearly turnover. More particularly, this cement manufacturer has been enjoying from the contest between Kenya and Tanzania to become the region s preferred gateway into Africa, which in turn leads to high public expenditures in infrastructure, and from the Kenyan government s protectionist barriers to entry of competitors, which in turn allows for price stabilization. Moreover, the Bamburi Special Products segment, which sells premium concrete and blocks, has been growing at high margins and this trend is expected to continue for the future. However, Bamburi s position in each market is threatened by the lack of grinding capacity of the company to meet demand, since its plants in both countries are close to its full capacity, which in turn neglects any sales growth. In order to surpass this situation, the management of the firm has launched an expansion plan to increase both the capacity in Kenya and in Uganda, which is to be completed by the end of Additionally, the corporation faces two main challenges that concern competition and its erosion in margins. Firstly, the Ugandan cement prices in USD have been falling due to increasing competition and because prices are not getting to exports, whilst at the same time by 2019 Dangote Cement threatens to increase competition in the Kenyan cement market and to drag down prices, since it will have the ability to produce at much lower costs than Bamburi. Secondly, our model considers that the company s EBITDA margins are expected to be affected due to the fall in prices but also because Bamburi will incur in higher importation costs of clinker. Taking all of this into consideration, we have a Buy recommendation for a target price of KES , which is based on the Discounted Cash-Flow-to-Equity valuation method, thus providing a 23.85% upside in local currency. Furthermore, our valuation through the EV to EBITDA multiple sustains our price target as the latter is comprised between the defined range between the median multiple (KES ) and the average multiple (KES ). PAGE 3/33

4 Exhibit 1 Historical Total Sales by segment (million KES) Source: Company information ; Analyst Estimates Exhibit 2 Bamburi Cement Returns vs Competitors (Base 4 th January 2011) Source: Bloomberg Company Overview Bamburi Cement is a Kenyan corporation with headquarters in Nairobi that produces a comprehensive range of cement 1 products to be sold in the East African Market. In fact, the company is one of the leaders in the cement industry in both Kenya 2 and Uganda 3, which are the locations where the firm has itself in. Furthermore, Bamburi also exports its products to regional countries such as Tanzania and DRC, but it does so at a smaller scale than to its two main markets. Additionally, the company also comprises two other fully owned subsidiaries that in 2015 accounted for nearly 4.6% of its overall sales. The first is Bamburi Special Products (BSP), the largest supplier of Ready Mix Concrete 4 and Blocks 5 in Kenya, which are two markets that are growing at a fast pace, i.e. BSP s last 4- year average sales growth accounted for nearly 12%. Regarding Lafarge Eco Systems (LES) 6, the branch delivers services of reserve land management and quarry rehabilitation however, this company is threatened by the lack of demand, especially from tourists. Shareholder Structure Created in 1951, Bamburi Cement is currently owned by LafargeHolcim, which is one of the biggest players in the cement manufacturing industry worldwide. This partnership can create several synergies regarding the production process and innovation, whilst at the same time, the parent company s huge monetary power and will for the Kenyan subsidiary to succeed will provide for Bamburi if something goes wrong. In turn, this creates a competitive advantage for Bamburi regarding its Kenyan and Ugandan competitors since none of them is backed by such a strong parent company. 7 The company s stock is listed in the Nairobi Securities Exchange and accounts for 362,959,275 fully paid ordinary shares, which have a par value of KES 5, the right of one vote per share and are entitled to dividends. Additionally, LafargeHolcim s ownership is divided in two equal parts by two of its holdings, 1 Cement demand solid growth margins (Standard Bank estimates point to 13% and 11% growth in 2014 and 2015, respectively) have been fostered by the investment in infrastructure in East Africa. In Kenya, the individual home building segment has also had a solid 2 Kenya comprises the fully owned subsidiary Bamburi Cement Limited, which has factories in Nairobi and Mombasa. 3 Uganda comprises the fully owned subsidiary Hima Cement Limited, which has a single factory in Kasese. The company owns 70% of the firm, with the remaining allocated to minority interest. 4 The ready-mix concrete is a high quality product that has several advantages compared to site mix concrete, such as the elimination of storage and labor costing, thus being a premium product. 5 Blocks are segmented between precast blocks, drainage and edge restraints, fencing products and walling products. Hence, those products are mainly applicable for agricultural, roads, industrial, commercial and touristic purposes 6 LES accounts for 0.1% of Bamburi s overall revenues and, in our view, its revenues will decrease through time due to lack of demand, which will be emphasized by the political elections in Therefore, we will not mention it again during this report. 7 This information was taken from Bloomberg. Neither Tororo, Savannah Cement and Mombasa Cement are envisaged in this analysis since they are not public. PAGE 4/33

5 Exhibit 3 Bamburi Cement main shareholders Fincem Holding Limited and Kencem Holding Limited, each controlling 28.3%, whilst nearly 23% of the firm s shares are perceived as free floating 8. Such low liquidity may hurt the company s ability to raise capital in future seed rounds, nevertheless the benefits of such a strong parent company more than offset the latter evidence. Source: Company Annual Report 2015 Exhibit 4 Debt outstanding evolution (million KES) Source: Company Reports; Analyst Estimates Exhibit 5 Bank and Cash Balances evolution (million KES) Source: Company Reports; Analyst Estimates Historical financial analysis Bamburi Cement is well known for being a profitable organization with a strong balance sheet that pays a high amount of dividends. As a matter of fact, over the last four years the company has disbursed an average of 1.07 times its earnings to its shareholders, thus turning into an attractive investment in the African building materials industry. Moreover, after undertaking a debt reduction policy, the Kenyan organization managed to seize its debt levels to zero by 2014 i.e. in January 2011 it had KES 2,953m in outstanding debt and currently has none, which in turn demonstrates the group s liquidity, as the borrowings were repaid using Bamburi s excess cash. Since 2011, total operating revenues have been increasing (last 2-year average y.o.y growth of 7.5%), with exception of In that year, Bamburi enjoyed from relatively stable market conditions in the company s main markets, Kenya and Uganda, whose GDP had grown at 4.8% and 5.8%, respectively, and its interest rates had lowered, thus providing the opportunity for higher capital expenditures. Nevertheless, the cement industry suffered from Kenya s government divestment in infrastructure, which in turn negatively impacted Bamburi Cement Limited s turnover. In fact, public expenditures have had an historically increasing impact on the company s revenues, i.e. in 2015 the country s domestic sales, of which a major part comes from the government, accounted for 86% of Bamburi s total operating revenues. Furthermore, the Group s turnover also suffered from the higher market positioning costs and significantly lower inland Africa exports out of Uganda. By the end of 2015, total operating revenues accounted for KES 39,200m, in which the cement segment 9 represented 95.43% of total sales, with the remaining being allocated to BSP (4.47%) and LES (0.10%). If we break it down, we realize that Bamburi Cement Limited impact in sales has been rising from 49% in 2011 to 55% in 2015 compared to Hima Cement. Furthermore, this trend is expected to continue as the Kenyan government is expected to keep its infrastructure investment policy in order to turn the country into the primary regional transport hub, thus becoming the preferred gateway into East Africa. 8 Our free float criteria addresses investors whom own less than 1% stake in Bamburi. 9 In order to derive the cement segment s sales one should remove the intersegment amount of sales. This caption stands for inner Group exports of cement of Bamburi Cement Limited to Uganda Cement Limited. PAGE 5/33

6 Exhibit 6 Sales by country (million KES): Historical evolution Source: Company Reports; Analyst Estimates Exhibit 7 Group s cement segment: historical weights Source: Company Reports; Analyst Estimates Exhibit 8 Bamburi Cement EBITDA (million KES) and Margins Bamburi Cement s cost 10 efficiency is widely recognized in Kenya 11. In fact, the group s EBITDA margins accounted for nearly 23% of its sales in 2015, thus leading to a profit margin of around 15% in that same year. However, if we are to compare the Kenyan producer with Dangote Cement, the largest cement player in the African market in terms of volume of sales, we can perceive the discrepancy between both, as Dangote s EBITDA margin accounted for 53.4% in Furthermore from 2011 to 2014, Bamburi s EBITDA margins have shrunk from 26% to 19%, respectively, which had a direct impact in the profit margins that have fallen from 16% to 11%. This downward trend is predominantly explained by the rise of non-operating expenses, from KES 2,010m to KES 5,251m, thus attaining a CAGR of 21.3% during this time period. The underlying reason is the swelling amount of expenditures in technical fees, which constitute payments to LafargeHolcim, and administration expenses, with a CAGR of 28.7% and 15.7%, respectively. The first particular situation raises concern, as it might be the case that the parent company is being paid a special form of dividends to which the minority shareholders should also be entitled. Regarding Bamburi s operating expenses, there has been a yearly upsurge in the company s gross margin during 2013 to 2015, from 25% to 32%. Out of the most relevant costs of sales, one should pinpoint energy costs, which have the highest share in costs of sales (24% in 2015) but whose impact has lowered over the last 5 years, as in 2011 it accounted for 31.5%. In our view, this situation is mainly driven by the shift from heavy oil consumption to alternative forms of fuel in Kenya and Uganda 12, and more recently by the plummet in oil prices. Furthermore, the cost of raw materials used in production, the second most impactful cost (17% in 2015), has been lowering its impact in cost of sales, whereas imported clinker and additives (13% and 12% in 2015, respectively) have grown historically. Regarding the costs with clinker, the underlying reason is that there is not enough capacity for Bamburi to produce it, thus it has to recur to imports of this product, whilst the additives lump dwells on the fact that their incorporation in the manufacturing process is linked to increases in the cement output. Source: Company Reports; Analyst Estimates 10 Since the company only operates in one industry and that in the future both Hima and Bamburi Limited will have the same margins, it makes sense that we look at costs in consolidated terms. 11 From the available information for the players in Kenya, only ARM Cement rivals with Bamburi as in 2013 its EBITDA margin accounted for 20.8%. Moreover, in 2014 National Cement s presented negative EBITDA margins, whereas in 2015 Savannah Cement s EBITDA was 0.9% of the company s sales. Source: Bloomberg 12 The (...) installation of a new hot gas generator for the pozzolana dryer that uses biomass and has reduced heavy fuel oil consumption at drying stage from 100% to under 10% - source: Annual Report 2015 PAGE 6/33

7 Exhibit 9 Operating and Other Operating Expenses evolution (million KES) Source: Company Reports; Analyst Estimates Exhibit 10 Bamburi s main COGS evolution Source: Company Reports; Analyst Estimates Markets Macroeconomic Context East Africa Both Kenya and Uganda are an integrant part of East Africa, a region with a rising power in the continent s economic context. In fact, this is the fastest growing territory in Africa and the prospects are that their run will continue, since its last 3-year average growth in real GDP of 6.7% and projections for the end of 2016 and 2017 correspond to 5.7% and 6.7%, respectively. The recent turmoil in oil backs up this favorable economic environment since this is a highly dependent region in terms of oil imports 13, thus the consequent surplus provides an incredible opportunity for the region s development. This favorable growth outlook is expected to positively impact the FDI figures, which can lead to several development opportunities in the region. Nowadays, it seems that every constituting country is enjoying the ride, and if it were not for South Sudan s political crisis 14, East Africa would compete with South Africa as the continent s less risky region. Nevertheless, one must be aware of the recent developments in the OPEP, whose members finally seem to have found a middle ground, thus leading to a decrease in oil production and a lift in prices. The East African Community (EAC) 15 is a trade group that comprises Burundi, Kenya, Rwanda, Tanzania, Uganda, and, since 2016, South Sudan. Its main pillars reside in the establishment of a customs union 16, a common market 17, a monetary union 18 and of a political federation 19, thus promoting a vast economic partnership that leads to the development of its members. In fact, our view is that the community helped to broaden each country s demand base to a single one of 90 million at the time it was created, therefore turning the region into a more appealing, yet competitive market. Furthermore, we believe that the customs union offered a more predictable economic environment for investors, which led to the increasing figures in FDI that we see in exhibit 10. However, the EAC is not always united. In fact, Tanzania is refusing to sign an economic partnership with the European Union that would ensure that all nations 13 I.e. In 2015, the imported oil bill of Kenya fell by 37.9% compared to 2014, thus being the primary driver of the reduction in the country s total imports (decrease of 8.6% to KES 15.6bn in 2015). This means that the impact of oil in the overall imports fell from 20% to 16% in this period. Source: NKC 14 NKC Africa Report September All EAC information was retrieved from its website. 16 The Customs Union was established in 2005 with the objective of creating a free trade community over goods and services with low to none tariffs. 17 The Common Market was created in 2010 with the purpose of extending free movement to persons, labor, services and capital, as well the right to establishment and residence. 18 The Monetary Policy is in place since 2013 in order to progressively converge the currencies over time. 19 The Political Federation will be much harder to attain as it comprises the unification of the community as one, under common foreign and security policies, good governance and effective implementation of the prior stages of regional integration PAGE 7/33

8 Exhibit 11 Foreign Direct Investment in East Africa (billion USD) Source: NKC research except for South Sudan would export goods to the EU without incurring in quotas and tariffs, claiming that it will undermine their manufacturing base. Others, such as Uganda, have retracted their intentions on signing, as they do not totally perceive the benefits of such deal. Indeed, all countries apart from Kenya will not be affected because the EU perceives them as least developed countries. Therefore, Kenya stands as the main affected country since the country is classified in the class of wealthy developing country, so much so that it will face tariffs of , thus putting pressure in the nation s trade balance, which means that tens of thousands of jobs are at risk and, in our particular case, the government cement consumption may slowdown. Moreover, even though cement is still a protected market by the Kenyan government, this economic openness may pressure Bamburi s market share in the medium-term. Exhibit 12 Kenyan Gross Domestic Product evolution Source: NKC research Exhibit 13 Kenyan Government Debt (billion USD / % of GDP) Source: NKC research Kenya Kenya s steady economic growth constitutes the main feature of one of the bright-spots in whole Africa. The country s real GDP is expected to match last year s growth of 5.6%, with expectations that it will maintain this solid trend for the medium-term. In fact, the East African nation boasts all the positive characteristics of an emerging nation, including favorable demographics, increasing urbanization, rising incomes, and increasingly-sophisticated consumers. The country s real GDP expansion is supported by the construction sector, which recorded an admirable 13.6% 20 growth last year, and also the transport & storage sector, thus attaining a 7.1% 21 growth in Over the recent past, Kenya s government has engaged in an infrastructure investment program with the purpose of turning the country into the preferred gateway into East Africa, yet it faces tough competition of Tanzania and Mozambique, which in turn leads to an increasing amount of money borrowed to fund this program. This fact had contrasting implications in the country s outlook. On the one hand, investors must recognize the positive effect of this investment program on the upcoming years, which along with the recent oil discoveries and the country s solid GDP growth expectations supports the development of the cement industry. Furthermore, the acceleration of foreign direct investment in the country since 2012, with particular relevance for the year of 2014 when FDI doubled to USD 500m, helps proving our point. Looking ahead, this upward trend is expected to maintain, with FDI reaching around USD 1.2bn by the end of this year. On the other hand, the current account deficit is escalating mainly driven by Kenya s wide structural merchandise trade deficit, and projections anticipate that 20 NKC African Economics report 21 NKC African Economics report PAGE 8/33

9 Exhibit 14 Kenyan Current Account (billion USD) Source: NKC research by the end of 2016 real GDP will grow by 0.9% compared to the previous year, thus representing 7.7% of the country s real GDP. Over the last fifteen years, Kenya s population has grown at an average of 2.6% 22 per year. At the same time, we assist to a decrease of the population aged between 0-14 years old and to an enlargement of the youth base, which is getting more educated, with substantially higher life expectancy 23 and with a rising disposable income due to the economic development of Kenya. In our view, this situation has led to a greater housing demand thus contributing to the development of the construction sector. Henceforth, we believe that under this paradigm the growth margins and sustainability of the sector are ensured in the upcoming years, which in turn has a direct impact in the cement consumption levels. Additionally, there is a clear shift from rural to urban 24 in Kenya, which in turn leads to higher investment in infrastructures. Regarding the East African country s fiscal position, one can recognize that even though it has deteriorated throughout the years i.e. it recorded an average fiscal deficit of 3% of real GDP during period whilst the average deficit between 2009 and 2015 amounted to around 5.8% of real GDP, Kenya continues to possess a healthy level of foreign currency reserves. The country s debt metrics remain at sustainable levels 25 and shilling volatility remains limited, however, the continuous focus on expansionary budgets will further pressure the fiscal account deficit, which alongside with the recent downgrades from stable to negative for Kenya s economic outlook by the S&P Global and Fitch, may retract investors. 26 In fact, it is true debt levels have been rising along the years but have always been linked to a GDP growth that allows for the government debt levels as a percentage of GDP to be contained. Nevertheless, in our opinion, it is risky to keep up with this levering strategy since African economies tend to be unstable and there may be a series of events i.e. political, which can trigger a descent of GDP levels, thus increasing the debt levels of the country. The East African nation struggled to hold onto foreign currency in Most African currencies are and will remain vulnerable in the medium-term to the US dollar, and the Kenyan Shilling (KES) is no exception. The possibility of further increase in the US interest rates (under stress after Donald Trump s nomination), 22 In the period from 1982 to 1999, the Kenyan population growth diminished every year (3.82% to 2.46%, respectively). Since then it has slightly grown but it currently seems that has stagnated, with tendency to decrease. Source: World Bank 23 Whilst in 2000 the average Kenyan would live 50.8 years, estimates for 2015 are that life expectancy is close to 61.6 years. - Source: World Bank 24 World bank estimates suggest that by 2015 the urban population accounted for 25.6% of the overall population and that in every year since 1960 (urbanization rate of simply 8%) this indicator has grown. Hence, the slope indicates that the urban population is to increase in the future. 25 The NKC research team points to a consolidation of the government debt levels at close to 53% of the countries GDP in the mediumterm. 26 NKC African Economics report PAGE 9/33

10 Exhibit 15 KES currency fluctuation against USD Source: Bloomberg Exhibit 16 Inflation in Kenya Source: IMF Exhibit 17 Unemployment as % of the working aged population in Kenya uncertainties over the Brexit and the Chinese slowdown are the main threats to the region. Nonetheless, despite the strong depreciatory pressure in 2015, the shilling appreciated 10.3% against the Tanzanian shilling, 7.5% against the Ugandan shilling, and 13.6% against the South African rand. Hence, Kenya is expected to continue to accumulate foreign currency this year, with a more stable shilling exchange rate accompanied by a recovery in foreign currency inflows. Kenya s monetary policy objective is to contain inflation within the 2.5% - 7.5% range and has been successful throughout the years. In fact, 2016 inflation is expected to decrease by 30 basis points to 6.3% compared with 2015, which alongside the central bank s perceptions that there will be no excessive demanddriven inflationary pressures, led to a decrease of the Central Bank Rate by 100 bps to 10.5% 27 in May 2016, the first reduction since May Additionally, this was a measure that intended to stimulate the declining private sector lending in Kenya, where the country s growth in loans presented a nine-year low of 7.2 percent in July, a 14.2 percent decrease compared to the same month in Furthermore, in September 2016 the slowdown in interest rates continued since the Kenyan CB further cut down the CBR to 10%. 29 In terms of employment, especially youth related, figures are still concerning as over the years there as not been any real improvements. Expectations for the end of 2016 are that unemployment will affect close to 37.4% of the working aged population, which is quite similar to Currently, concerns arise over the possibility of further slowdown in credit extension to the private sector surge after President Uhuru Kenyatta s surprise decision to cap commercial banks lending rates at 14% (400 bps above the CBR) and to put a floor of 7% on interest bearing deposits (70% of CBR) 30. Furthermore, the upcoming elections may have a negative impact on growth if investors decide to keep a neutral position until the post-election period due to the instability lived during those periods or if the infrastructure investment policy suffers a setback. Source: NKC research Uganda Over the 1990s and 2000s, Uganda was amongst the fifteen fastest growing economies worldwide, with an average real GDP growth of 7%. However, in the last decade this East African country was subject to the global economic volatility, which negatively impacted the average growth in GDP thus dropping 2%. In fact, Uganda s Gross Domestic Product suffered a major downturn in 27 Financial Times Kenya bucks Africa s economic trend by John Aglionby 28 Financial Times Kenya cuts interest rates by 50 basis points to 10 per cent by John Aglionby 29 Financial Times Kenya cuts interest rates by 50 basis points to 10 per cent by John Aglionby 30 Financial Times Kenya cuts interest rates by 50 basis points to 10 per cent by John Aglionby PAGE 10/33

11 Exhibit 18 Ugandan GDP (Y.o.Y % changes) Source: Bloomberg Exhibit 19 Uganda s Current Account and Fiscal Deficit Source: Bloomberg 2012 when its year-on-year growth rate plummeted to 2.6%, which corresponded to a 4.2% decrease compared to Nevertheless, despite external shocks the country has been increasing the pace since in 2015 the growth in real GDP attained 4.8%. Additionally, expectations are that by the end of 2016 real GDP will grow at 5.1% whilst in 2017 it will overcome the precedent at 5.6%, mostly driven by industry, services and public infrastructure investment, as well as the government attempt to maintain macroeconomic stability and to tackle corruption. Much like in Kenya, the Ugandan positive GDP expectations support the government attempt to invest in infrastructure, which will provide several growth opportunities in the country thus developing industries such as the cement and boost services, especially tourist related. One key upgrade that requires special attention concerns roads, as 97% of the country s transport of heavy cargo is reliant on a poor quality road network, which directly impacts the costs of distribution of the products sold. Hence, a greater deal of consideration from the behalf of the government as been given towards this subject, as one can derive from the increase in the 2015/2016 budget attributed to this sector (UGX 3,328bn), which constitutes an increase of about UGX 753bn compared to the previous economic year. Moreover, the 2016/2017 budget will incorporate an extra UGX 499bn compared to the preceding budget to be allocated for the development of roads and key bridges 32. Over the past fifty years, the Ugandan population growth has been irregular 33 but in the previous four years it seems to have stabilized at 3.25%. Furthermore, with greater life expectancy 34 alongside to a wider population amongst years old and better economic conditions of the families leads to a higher demand for homes, thus creating a favorable environment for the construction sector. Additionally, there is clear evidence that people s willingness to move to urban areas 35 has grown, thus leading to higher infrastructure expenditures and stimulating cement consumption. Based on the premise of future economic growth, the infrastructure plan development was established under a period of credit expansion 36 with the objective of boosting consumption 37. Furthermore, the country is loosening its 31 World Bank 32 Deloitte Uganda Report The lowest point occurred in 1973 (2.65%), whilst its highest took place in 1988 (3.51%) Source: World Bank 34 Whilst in 1995 the average Ugandan would live 43.8 years, estimates for 2014 claim that life expectancy is 58.5 years Source: World Bank 35 The slope shows positive growth regarding the urbanization rate in every year since Nonetheless, Uganda s urban population is much lower than in Kenya, as in 2015 it accounted for 16.1%. 36 Credit concession increased by 16% in February 2015 compared to the preceding 12 months, which corresponds to more than the double of the February 2014 growth. 37 Financial Times Uganda cuts rates by 1 percentage point by Yukako Ono PAGE 11/33

12 Exhibit 20 Uganda s Debt to GDP Source: Bloomberg Exhibit 21 UGX currency fluctuation against USD Source: Bloomberg Exhibit 22 Inflation in Uganda Source: IMF monetary policy in order to further stimulate its economy through private agents, as the Ugandan Central Bank reduced its loans rate to commercial banks from 17% to 15% in June 38. All in all, those factors along with future oil prices fluctuation, have raised the investor s awareness on the East African country thus its FDI levels remained stable at US 1.3bn 39 in Nowadays Uganda s political and security environment is relatively stable but history shows that this path was hard. President Museveni won the elections in 2015 and is now on his way to his fifth mandate, which was only possible due to constitutional amendments that lifted the number of years that a president could be in power, from two to five years. Even though Uganda is now a pacific country, there are still several issues to be tackled that relate to corruption, underdeveloped democratic institutions and human rights related abuses. The recent outcome in the elections allowed the president to engage in programs that foster the economic growth of Uganda. Over the last three years, the Ugandan currency has been devaluing against the US dollar but it was in midst October 2014 that a more severe appreciation of the dollar was denoted, which continued up until the last months of Currently, it seems that even though there is still a devaluation tendency it is at a much slower pace than in the recent past, as the UGX shilling prepares to end the year close at 3,650 per US dollar in 2016, down from UGX 3,372 per US dollar in This downward pressure is expected to continue due to the substantial current account and fiscal deficits, which in turn will accentuate both of them. The underlying reasoning is that imports are getting more expensive, but are still required, mainly for continuing with the infrastructure investment plan, and exports are cheaper, thus distorting the trade balance. Since 2012, the current account as a percentage of real GDP has been decreasing and, according to Bloomberg estimates, it is expected to end 2016 at -9.1%, whereas the fiscal deficit is expected to account for 4.7% of real GDP and expected to slightly decrease over the next two years. Furthermore, the post-election period of 2011 was followed by high government expenditures, which led to a high inflation levels of 15.1% and to an aggravation of the government debt to GDP from 21.8% in 2010 to 27.1% in the subsequent year. Thereafter, efforts were made to control inflation measurable through its actual decrease during the following years. Currently, the projected CPI for the end of 2016 is 6.7%, with expectations of stabilization at 5% by Financial Times Uganda cuts rates by 1 percentage point by Yukako Ono 39 African Development Bank 40 Bloomberg data PAGE 12/33

13 On the other hand, the stable political climate, low oil prices, which have had a tremendous impact in the country s trade balance, and the steady foreign direct investments partially offset the devaluation of the Ugandan Shilling, thus decreasing its rate of depreciation. Moreover, the trade balance may even turn to surplus due to growing expectations on future oil production from Uganda after the announcement that a USD 4bn oil export pipeline 41 from Western Uganda will be constructed, passing through Tanzania. Exhibit 24 Bamburi Group s historical cement turnover (million KES) Business Units Segmentation Source: Company Reports; Analyst Estimates Exhibit 25 Bamburi s cement production capacity and utilization rates Source: Company Reports; Analyst Estimates Exhibit 23 Business Units breakdown Cement Historically, this has been the highest contributing segment for Bamburi s turnover and its sales have been rising, thus following the recent economic expansion in East Africa. Nevertheless, it seems that the company is reaching a point where they are operating close to its full capacity, as in 2015 the utilization rate of the firm was about 94% and will be quite hard for it to augment. Hence, Bamburi s cement sales will eventually stagnate, which in a market that is still increasing in volume could potentially lead to a loss of market share for the company. Taking this into consideration, last September the management of the firm informed its investors about an expansion plan to be finished in the end of 2018 that will increase the group s total grinding capacity 42. In order to obtain cement, the production requires the use of the so-called clinker 43. Both Bamburi Cement Limited and Hima Cement Limited have grinding 41 Deloitte Uganda Report 42 Exhibit 25 contains the expected changes in the capacity for both cement companies. Furthermore, it also presents information regarding the utilization rates of each firm, which were estimated through the information given by the company, an analyst that works for BPI and by our analyst. After the expansion project is in motion, the utilization rates will diminish and in the medium-term we expect them to grow close to the its previous rates. 43 Since 2013, the cement-to-clinker ratio is believed to be around , meaning that the production of 1.61 tones of cement requires 1 tone of clinker usage. PAGE 13/33

14 Exhibit 26 Bamburi s clinker imports (million tones) Source: Company Reports; Analyst Estimates Exhibit 27 Bamburi Cement Limited turnover (million KES) Source: Company Reports; Analyst Estimates Exhibit 28 Average yearly Kenyan cement price (in USD) and clinker capacity, nevertheless, the Kenyan branch has been successively in urge to import clinker since they do not have enough capacity to produce the required amounts for production. Furthermore, clinker prices have not changed much over the years 44 and are currently expected to remain at around USD 45/50 in the near future due the competitiveness of the industry 45. In order to better understand the cement segment and the effects of the expansion plan, we need to analyze both Bamburi Cement Limited and Hima Cement Limited, in terms of its performance, production capacity, the macroeconomic conditions of their market, as well as their competitors and competitive position. Bamburi Cement Limited Ever since inception Bamburi Cement Limited has been present in the cement market in which it is estimated that it owns close to 33% market share, thus being the country s major cement producer (Exhibit 30). The company owns two factories, one in Mombasa, which is fully integrated with both grinding capacity and clinker capacity, and one in Nairobi, which has only grinding capacity, meaning that it has to recur to collect clinker from the excess produced in Mombasa and to incur in importation costs to obtain this product. The cement manufacturer s cement revenues (excluding intersegment sales) have grown throughout the last five years 46, with exception of 2013, and are expected to slightly increase before achieving a steady state due to lack of production capacity. Furthermore, the biggest portion of sales is generated internally, as in 2015 only 14% 47 of the production was sold to Bamburi s foreign markets. In terms of its cost of sales, even though we use overheads in a consolidated basis and the Bamburi Group is perceived as cost efficient, the Kenyan branch s costs are more stable thus having less room to be improved when compared to the Ugandan peer. Nevertheless, there is a high focus in reducing energy costs and the Nairobi Grinding Plant is using more alternative fuel oil thus reducing its overall costs with energy. 44 CAGR ( ) accounted for 0.46%. 45 Clinker imports are mainly done from Pakistan and China. Prices are subject to conversion at the forward exchange rate (KES-USD). 46 CAGR ( ) accounted for 5.3%. 47 Company information PAGE 14/33

15 Exhibit 29 Kenyan cement demand projection Source: Standard Bank Exhibit 30 Kenyan cement market shares estimate Source: Standard Bank Internal Market Due to the infrastructure investment program engaged by the Kenyan government the cement market has strived and the tendency is for this trend to continue, even though some rating agencies voiced their concerns regarding the sustainability of the Kenyan public expenditures. Nevertheless, we believe that this will not impact the cement demand as this industry is directly linked to the Kenyan government main objective of becoming the main gateway into East Africa. The Kenyan cement market is highly regulated as foreign competitors face high tariffs to sell inside the East African country, thus protecting the six main cement players established in Kenya, which include Bamburi Cement Limited. Hence, as internal demand is satisfied and competitors face barriers of entry, the price of cement will remain stable for the foreseeable future at USD Nonetheless, Dangote Cement plans to have a cement plant in Kenya by 2019 jeopardizes the stability of prices over the last decade in the cement market. In fact, the Nigerian player aims to import cement from its Ethiopian plants, thus incurring in significantly lower costs of production, which in turn may drive down prices in the Kenyan market. They claimed that the cement exported into Kenya would be 40% cheaper 49 than locally manufactured brands and already incorporated transportation costs as well as taxes when applicable. Furthermore, Savanah Cement announced its plan to upgrade the Athi River grinding plant capacity at site from 1.2mt to 2.4mt by the middle of , thus expanding its range of cement, with special focus on its hydraulic road binder blend that is used in road construction, and ARM Cement has recently secured USD 140m in funding 51 from the CDC Group, in what was considered one of the largest equity deals in the history of Kenya, in order to increase their cement production capacity. Hence, if we incorporate this possible future fall in prices and the recent investments to expand capacity from current players in the Kenyan market, we realize that Bamburi s market position and future profits are threatened. External Market Nowadays, there is excess capacity in the Kenyan market, which in turn leads to an increase in exports that are essentially delivered to Uganda, Tanzania and 48 We have been able to estimate prices for Kenya in 2015, which corresponded to USD 100 per tone of cement sold. This was estimated by the weighted average price of the exported and internal sales, which considered the percentage on total sales of both as the weighing factor. After the conference call with an analyst he told us that the cement price in Kenya would round USD Daily Nation Dangote shakes Kenya s cement Market with Ethiopia imports by Victor Juma 50 Global Cement news Savananah Cement release details on cement plant upgrade 51 Global Cement news Arm Cement secures USD 140m from CDC group PAGE 15/33

16 Ethiopia, three regional countries. Those exporting markets follow the emerging trend of the East African global economy, and are expected to keep enforcing an infrastructure development policy. Ethiopia is one of the largest African markets for the cement industry that currently holds excess cement production capacity. However, forecasts on its future population growth, the fact that the country presents one of the lowest urbanization rates in the world at 19% and its government s recent commitment towards infrastructure projects, do make a case for the country s cement consumption rise. In fact, Dangote Cement, one of the biggest players in Africa has targeted a 25-30% market share over the upcoming years in Ethiopia as it expects cement demand to have increased to 8.88mt by the end of 2016 and a further raise to 10.56mt in Without further due, Derba Cement plans to invest $300m in the expansion of its plant in Ethiopia and PPC is expected to have its Habesha plant commissioned in the second quarter of 2017, thus increasing its cement production capacity by 1.4mt/year. Led by the country s relative political stability, the Tanzanian cement market is under expansion to which follows an annual average rate of 11.5% growth in the nation s construction GDP. In fact, the country s per capita annual cement consumption is relatively low at 65kg compared to the African continent and its urbanization rate is expected to accelerate from its scarce 31%. Supporting this trend are Heidelberg Cement s studies signaling an increase in cement consumption by 8-10% in the first two months of Hence, after the opening of an integrated cement plant in 2015, Dangote Cement already expects to have its cement production position reinforced by doubling its current 3mt capacity by 2019, which displays the increasing competition levels in the cement industry of Ethiopia. 52 Exhibit 31 Hima Cement Limited turnover (million KES) Source: Company Reports; Analyst Estimates Hima Cement Limited Acquired in 1999 by the French conglomerate Lafarge, Hima Cement Limited is a fully owned and incorporated subsidiary of Bamburi. The company is the second largest player in the Ugandan market with an estimated market share for the end of 2016 close to 12% 53, and owns a fully integrated factory located in Kasese. Equally to Bamburi Cement Limited, the Ugandan branch s operating revenues have grown in a yearly basis with exception of 2013 (-16.5%), and in 2015 accounted for KES 16,803m 54 (3.9% growth compared to 2014). Furthermore, there is clear evidence that its weight on total cement revenues has dropped since 51% in 2011 to 45% in Regarding the company s costs, one should 52 Bloomberg News 53 Standard Bank data 54 We estimated the Ugandan price per tone of cement at USD 214.7, which does not discriminate between exports and imports because there is no information on that matter. PAGE 16/33

17 Exhibit 32 Average yearly Ugandan cement price (in USD) acknowledge that the plant is not yet efficient in terms of energy expenditures mainly due to its high costs with fuel. If we consider the Kenyan factories we realize that fuel costs accounted for only 6.5% 55 of Bamburi Cement Limited s sales in 2015, whereas the Ugandan subsidiary s fuel costs represented close to 9% 56. The underlying reason is the higher use of heavy fuel in Kasese rather than the coal fuel oil or other alternatives like in Mombasa or Nairobi. Hence, one of the company s main objectives is to reduce Hima s dependency on heavy fuel and replace it by cheaper alternatives, as it is stated in the Annual Report of 2015, where the management of Bamburi claims to have reduced its heavy fuel oil consumption in the drying stage of the cement production in Hima from 100% to 10%. Internal market Exhibit 33 Ugandan cement demand estimates (million tones) Source: Standard Bank Exhibit 34 Ugandan cement market shares estimate Source: Standard Bank Uganda s government infrastructural development is considered to be a national developmental priority, thus positively impacting current and future prospects of the cement production industry. The sector continues its growing tendency has it holds a multiplier effect in both growth stimulation and development in Uganda. One of the most impacted segments is the road network, as it supports overall economic growth but mainly helps to reduce distance costs, which directly decreases the cost of doing business inside the East African country by diminishing distribution or time costs, as, according to BMI Research, the poor quality road network impacts 97% 57 of the transporting heavy cargo. Thus, the Ugandan government has established a plan that intends to upgrade its major roads and to construct key bridges, such as the Nile bridge located in Jinja, supported by a higher allocation of capital from its budget. As a matter of fact, according to Deloitte, the 15/16 government budget accounted for an investment of UGX 3,328bn, an increase of UGX 753bn compared to the previous year. Moreover, in 2016/2017 the budget increased to UGX 3,828bn in order to continue to act on the country s implemented strategy. Striving from this increasing demand is the cement sector, whose consumption has grown over the recent past and competition is getting fiercer, thus pushing down prices. Furthermore, the market has been slightly oversupplied in the recent past but expectations on future growth in cement consumption are driving several players from within and outside Uganda to increase their production capacity in the country. As a matter of fact, in 2015, National Cement launched its plan of opening its first cement plant 55 Company data 56 Company data 57 Deloitte Uganda Report PAGE 17/33

18 outside of Kenya by the end of 2016, which would add 1mt capacity into the Ugandan market. 58 Additionally, Tororo Cement expects to reinforce its position as the largest player inside of Uganda has in the end of July 2015 the company invested USD 25m to expand its integrated cement plant, thus improving its production capacity of 1.8mt per year basis to 3mt. Finally, DAO group announced a plan to develop an integrated plant with 1.5mt grinding capacity and 1.3tm clinker capacity. 59 External market Hima Cement sales are also directed to the three main markets of Uganda s cement exports, which are composed by Rwanda, Burundi and DRC. In a similar fashion to the remaining East African nation, Rwanda presents an ongoing infrastructure and construction development plans supported by GDP future growth rate expectations. 60 In recent news, PPC has claimed that its cement plant that was operating at close to 60% of its total possible production is expected to operate close to full capacity by mid-february 61, thus increasing competition levels in this country for Hima. On the other hand, there are some concerns regarding the sustainability of the cement market in the other exporting countries. Even though the International Development Association (IDA) conceded a USD 25m emergency support grant that will trigger investment in infrastructure in Burundi, the uncertainty on the country s political environment may affect the cement market. Moreover, DRC s increasing tension against president Joseph Kabila is driving down the country s economic activity, with GDP estimates for the end of 2016 of 5.2%, a 2.5% decrease compared to the previous year. Furthermore, its expected that the political turmoil pressures the government to reduce its capital expenditures, thus emphasizing GDP s decline. (NKC sources) Still, DRC remains as one of the most infrastructural challenged countries in the world and PPC reported that its new cement plant in the country is about 90% complete, expected to be commissioned and ready to start sales in early Global Cement News National Cement plans USD 198m plant in Uganda 59 Global Cement News Tororo Cement invests USD 25m in cement plant expansion % expected in 2017 compared to 6.4% in 2016 Deloitte Country report 61 Global Cement News PPC Cimerwa cement plant to reach full production by mid Global Cement News PPC reports progress of cement plant projects in Democratic Republic of Congo and Ethiopia PAGE 18/33

19 Exhibit 35 BSP turnover by segment (million KES) Source: Company Reports; Analyst Estimates Bamburi Special Products (BSP) Bamburi Special Product s blocks segment has been capturing a higher share of the firm s sales 63 since the market is becoming more competitive, whereas the ready-mix is experiencing high growth margins as well since it acts as an upgrade to the common site-mix concrete. Bamburi s management is focused on innovating through the creation of new products as well as in delivering measures that drive cost optimization to this segment. Additionally, they also seek to leverage on the sales force effectiveness program in order to upgrade its brand support. 64 This sector s sales have grown 1.45 times compared to 2011, however in 2015 there was big setback as revenues dropped hard. The underlying reasoning was that Bamburi was a key partner in several large infrastructural projects in Kenya that were on the verge of completion by Furthermore, the company closed one of its production sites in order to achieve operating efficiencies. Still, it seems that sustainable growth will return to this segment as the company has a solid pipeline of medium to large contracts that will positively impact revenues for Valuation Given that the majority of Bamburi Cement s segments are related to the cement manufacturing industry we chose to use the consolidated statements to value the firm s free cash flows. In fact, this method is accurate enough for our analysis for its Kenyan branch. Under this principle we discounted the group s free cash flows through the DCF method, which incorporates a Wacc of 17.4%. Furthermore, the company s final equity value was attained through a sum of the parts that considers the 2017 minority interests 65, the Employee Benefits and the company s Provisions, both of which were considered to be constant forever at the 2015 values. 66 Regarding the forecasting period length, since the African context is structurally riskier than the developed economies, mainly due to its substantially higher political and economic risks, we chose to perform the valuation accounting for the upcoming five years. Furthermore, we have forecasted a terminal value for Bamburi that condenses all future cash flows after , which contemplates a future growth rate of 6%. Our estimation on the latter undertook a study we have 63 From 2012 to 2015 the Blocks segment average sales growth accounted for 15.2% and during this period it increased its share of Bamburi s total operating revenues from 1.7% to 2.4%. 64 Bamburi Annual report Minority Interests were measured at fair value in Employee Benefits and Provisions have an implied charge for valuation purposes equal to its book value. 67 Formula used to determine TV, then discounted back: 2021 FCF (1 + g) / (WACC g) PAGE 19/33

20 developed on the construction sector historical yearly expenditures in South Africa, South Korea and Germany, since we find it to be a good proxy to the cement market evolution 68. As in any nation that undertakes the path towards development, the GDP growth, which is derived from sectors such as construction, tends to increase in larger scale in the beginning and tends to decrease as it progresses. Hence, we have weighted our terminal growth rate according to several scenarios that incorporate the different levels of future growth. 69 Additionally, we have further adjusted the future growth rate due the fact that we anticipate that in the future Bamburi will face the exact same problem of being close to its full capacity, which will lead to the inability to raise production, thus leading to increases in growth CAPEX. Furthermore, the declining in Ugandan prices and the possible entrance of Dangote Cement raise our belief that the growth rate in revenues during the upcoming years can be lower. 70 Exhibit 36: The road to development - 5 Year Moving Averages of the South Korean Construction Sector growth Source: Bloomberg; Analyst Estimates Main Drivers Projections a) Cement Segment - Sales Our projections are that cement sales will decrease in 2016 mainly driven by the reduction in the amount of cement sold driven and the decrease in prices per tone of cement in the Ugandan market. Up until 2018, Bamburi s cement segment turnover will grow due to the rise in prices derived from inflation in the 68 We have chosen South Africa because it is a developing country that resembles both Kenya and Uganda (Bamburi s main operating markets) in terms of the historical GDP growth and also because they are comprised in the same geographic area. Furthermore, we considered South Korea as it is a newly developed country, and therefore its data contains the evolution of its construction sector from when it was seen as a developing country (such as Kenya and Uganda) to its current developed state. Finally, we used Germany because it has long been developed country, with growth rates in this sector somehow stable over the last decades. 69 The scenarios incorporate a high growth opportunity which is the average of South Africa s last 23 years growth in the construction sector; the road towards a stable environment, which corresponds to the perceived stabilization of South Korea s construction sector, which has occurred during the last 24 years; and finally, we considered its average historical growth over the last 25 years in Germany as our perpetual rate. 70 We have considered Bamburi s last 5-year average growth rate in sales, which actually falls slightly under 2021 s expected turnover growth of 9.86%. To find out more about the weights used, please check appendix 1. PAGE 20/33

21 Exhibit 37 Cement revenues projection (million KES) US and depreciation of the Kenyan Shilling against the US dollar. Yet, the corporation will be under pressure of losing market share due to its inability to increase production, as both Bamburi Cement Limited and Hima Cement Limited are operating close to its full capacity. 71 Nevertheless, we project an upturn in sales starting in 2019, as according to the management of the firm, there is an investment plan in motion that will increase the grinding capacity of both countries plants, which is expected to be fully operational by the end of Hence, estimates point towards a significant increase in sales (16.93%) in the first year in which the new capacity is available, driven by a large increase in the tones of cement sold, which is directly linked to our expectations on the future utilized capacity levels 72. From this period onwards, revenues are expected to grow at a more moderate pace through time but we still expect two-digit growth average until 2021, with tendency to decrease in the future. Exhibit 39 Bamburi Cement Limited revenues projection (million KES) Exhibit 40 Projection of cement prices for Bamburi Cement Limited (USD). Exhibit 38 Future utilization rates projection a.1) Bamburi Cement Limited Based on the total available capacity of the firm at the forecasted year we had to estimate the corresponding utilization rate, which from is expected to be equal to the 2015 s rate of 95%. With the new grinding capacity installed that provided an increase from 2.3mt to 3.2mt, the company s production is anticipated to be immediately higher because not only is demand growing in its exporting countries but also the Kenyan demand, which has historically represented the greatest share of Bamburi s sales, is expected to keep growing close to nominal GDP growth expectations in the medium-term. Furthermore, we must acknowledge that utilization rates will be smaller, as it is not possible for production to be instantly close to full capacity. Therefore, we ran the assumption that in 2019 production would be of 2.4mt, implying a 75% capacity utilization, and presumed a 5% yearly increase until 2021, which we expect to be smoother over time since Bamburi Cement Limited will quickly reach what we believe to be its new maximum utilized capacity (90%). In order to estimate revenues we need to understand that prices are to remain relatively stable at USD 100 per tone for the forecasted period, but will increase with the yearly inflation and Forex 73. Thus, 71 Under this context, the firm s utilization rates are not expected to change until Estimated bv matching the percentual market growth expectations with the percentual increase in production derived from new utilization rates. 73 The exchange rate at which prices in USD are converted to KES accounts for the average between the projected Forex for n and n-1. PAGE 21/33

22 for every year forecasted we converted prices from USD to KES using the forward exchange rate 74. Exhibit 41 Hima Cement Limited turnover estimates (million KES) Exhibit 42 Projection of cement prices for Hima (USD) Until 2018F, the Kenyan cement sales are expected to increase at a CAGR of 4.7%. Nevertheless, once the new capacity is implemented the cement revenues are naturally expected to rise, so much so that in 2019F Kenyan turnover is expected to overcome its previous year by 7.8%, thus establishing itself at 19.2%. Thereafter, we anticipate that sales will slowly decelerate till 2021F, thus being slightly below the anticipated nominal GDP growth in Kenya. a.2) Hima Cement Limited In 2016E, revenues are expected to fall by 16% due to the decrease in the price of cement per year. This negative trend is expected to further continue since prices in Uganda are expected to decrease up to USD 165/ per tone of cement in the short term since the price is not getting to exports, and further reduce due the recent civil war in South Sudan, which can possibly mean the extinction of this market, thus pressuring prices to go down as there will be higher supply than demand. Furthermore we also believe that prices will fall due to the increasing competition in the Ugandan cement market. Furthermore, Hima is operating at 90% of its full capacity during this time window, which represents 0.77mt production in a possible total of 0.85mt. Once the expansion project is complete, the company s grinding capacity will increase to 1.65mt but, similar to Bamburi Cement Limited, we project that the Kasese plant will not be able to immediately exploit the best out of its new production capacity. Hence, we predict that the in 2019F, the overall sales of the firm will grow close to the country s cement market expectation 76, thus its corresponding utilization rate is 52%, which is anticipated to grow at 5% per year. Henceforth, Hima s 2019F turnover is expected to surpass its previous year by 13.3% and until 2021F we anticipate growth in turnover at an average of 6.8%. 74 Our estimations of the yearly Forex considered the following formula: Current spot rate x ((1+Infation_Kenya)/(1+Infation_US)) ^n, with n equalling the number of years after the spot rate year. The inflation considered was the estimated values from IMF for both Kenya and USA until 2018, whilst from 2019 to 2021 we have considered the inflation targets of the US FED (2%) and CBK (average 5%). 75. Information on overall price expectancies and on 2016 s cement price in Uganda was provided by an analyst, He claims that by the end of 2016, prices are anticipated to have fallen to nearly USD 180. Hence, taking into account the last 5-year average tumble of 7%, we have forecasted a 5% drop in prices in every year of analysis. 76 Standard Bank estimates point towards 11% growth of the Ugandan cement Market in 2021, which is very similar to the forecasts of IMF on the nominal GDP growth in Uganda for 2021 (11.9%) PAGE 22/33

23 Exhibit 43 BSP projected turnover by segment (million KES) b) Bamburi Special Products Based on the information provided by the management 77 regarding the strong prospects on the future of BSP and in Bamburi s investment in sales force effectiveness, brand building and operational efficiency, which in turn will drive performance in this business, we project that BSP will have a higher impact in overall sales of the Group troughout the forecasted years. Fostering this segment s expanision is the Blocks sector, which will grow by 15% until 2021F, and Ready Mix s sales with an 8.4% estimated growth rate until that same year. 78 c) Overall Operating Expenses Exhibit 44 Bamburi s cost structure 79 Exhibit 45 COGS projections (million KES) During our forecasted period, gross margins (which account for COGS only) are anticipated to grow until 2018 levered by the increase in sales and improvements in the production process regarding energy expenditures. Nevertheless, we anticipate them to slightly fall due to the expected decrease in the cement prices of Uganda and from the rising in the expenditures with imported clinker. On the other level, Bamburi s EBITDA margins (which account for other operating expenses as well) are projected to be on average 10% lower than the company s gross margins. It is worthwhile mentioning that other operating expenses reflect the so far mentioned technical fees 80, which are anticipated to account for close to 30% of its overall. Our analysis contains assumptions on every element of the operating expenses, which were mostly defined by linking them directly to Bamburi s turnover. Nevertheless, there are two main sources of costs that we must highlight due to its impact in the operating expenses of cement manufacturer, which relate to energy and imported clinker costs. 77 Source: Annual Report Our assumption is that both Blocks and Ready Mix will grow at its historical average growth rate from 2011 to Amongst operating expenses (or Cost of Goods Sold), other includes expenditures that are related to production, thus varying with it. The most relevant are the cost of raw materials, which we perceived to be 11.4% of the projected sales, and additives costs, that account for 8.5% of forecasted sales. Amid other operating expenses, it is worthwhile to mention that other costs are also directly attached to revenues. Its most relevant comprises administrative expenses (6.1% of sales) and distribution costs (2.8% of sales). 80 Technical Fees are fees paid to LafargeHolcim. This represents a risk to the minority shareholders, as there is no understanding on whether those represent a real service provided by the parent company or dividends distribution. PAGE 23/33

24 Exhibit 46 Fuel cost per tone estimate (KES) Exhibit 47 Fuel costs as percentage of turnover Exhibit 48 Total energy costs projection (million KES) c.1) Energy Costs Essentially, energy comes from two main sources, electricity and fuel, whose historical prices in KES were estimated by dividing each component s total costs by the production of both Bamburi Cement Limited and Hima Cement Limited. In our view, the Kenyan Branch is considered cost efficient, therefore its expenditures of electricity and fuel per tone produced will be the same as in 2015 for our forecasted period. However, it is our belief that the Ugandan plant is only efficient electricity wise, which in turn will ensure further economies of scale regarding fuel expenses. In order to estimate future fuel costs per tone of cement produced in Hima, we assumed that the total fuel expenses would represent a percentage of the company s sales over the years, that will match Bamburi Cement Limited s same percentage by 2021F 81, mainly due to a shift from heavy oil to alternative fuel options in the production process. However, up until that same year there will be a significant discrepancy between both firms, which will downward pressure the group s profit margins. In fact, by the end of 2016E we anticipate that Hima s fuel costs are to represent 9.1% of its total sales, meaning that it will be spending a higher share of its turnover compared to its peer (+2.5% beyond). Hence, taking into account that the synergy process and upgrades derived from the utilization of cheaper sources of fuel will take some time, we project that in each forecasted year the gap between the two cement producer s fuel costs as a percentage each firm s revenues is to narrow by 0.5%, thus implying that by 2021F those percentages will be fairly equal. Between 2016 and 2018F, the Group s overall energy costs are expected to plummet at an average of 2.1% per year due to the decline of fuel prices in the Ugandan plant, alongside its inability to produce more cement. After the expansion plan is fully operational the energy costs are expected to increase alongside to production, however, our forecasts contemplate that aggregated energy costs will continue to follow its descending historical trend as a percentage of total sales, averaging -0.8% per year in our projections. c.2) Imported clinker As it was previously mentioned, clinker is directly linked to production by the 1.61 cement-to-clinker ratio. Furthermore, each company has its own maximum clinker capacity of production, which has been historically insufficient to cover the 81 By 2021, the fuel costs of both Bamburi Cement Limited and Hima Cement Limited are expected to account for 4.7% of each firm s total sales. PAGE 24/33

25 Exhibit 49 Bamburi Cement Limited s projected clinker produced and imported (Mt) Exhibit 50 Hima Cement Limited s projected clinker produced and imported (Mt) Exhibit 51 Clinker price projections (USD) cement production, thus leading to clinker imports. In fact, this situation is expected to continue in the future but its impact is yet to accentuate as we project that from 2019 onwards, which is once the increase in grinding capacity is completed, cement production will substantially rise and a higher amount of clinker will be required. Nevertheless, since the expansion investment does not entail an increase of clinker capacity, there will be an enhancement in the imports of this material, which in turn will lead to higher expenses for the Group. One of the reasons that might have led to the decision of investing only in grinding capacity was that global clinker prices are expected to keep its downward trend until around USD 50, mainly due to increasing competition from China 82. Hence, there will be an offset effect between the rise in the need for clinker and the price paid for it, which in turn reduces the impact that imported clinker overheads will have in the outlook of the cost of sales of Bamburi. Our estimate was based on the assumption that over the upcoming two years, clinker will achieve its expected price and then remain stable until All in all, we expect that clinker imports impact in total sales will escalate from the moment the new capacity is in motion, as in 2019F it will represent 1.7 p.p. more than its previous year, thus accounting for 7.2% of the Group s sales, with tendency to further rise. Hence, our predictions are that clinker costs will grow at a fast pace in the time period between 2018 and 2021 (CAGR of 36.2%), which will reflect in the impact that clinker expenditures will have in Bamburi s future turnover 83. d) D&A and Growth CAPEX Regarding the depreciation of Property, Plant & Equipment (PPE), we have considered it constant as the five-year average expenditure in terms of percentage of PPE (3.4%), whilst the amortization of intangibles and prepaid operating leases was measured as its the estimated percentage for It is important to pinpoint that in 2017 the intangibles were fully amortized, thus the amortization did no longer occur in our forecasts, since we presume that there will be no more additions to this caption. Concerning future acquisitions of PPE (Growth CAPEX) we ran the assumption that it would be the same as the 2015 s as percentage of operating revenues (2.3%) for the entire valuation period, except for 2017 and During this time period Bamburi will invest KES 8.3bn to increase its grinding capacity and, since the project is foreseen to last 18 months and to be finished by the end of 2018, we foresaw that half of the investment would be made in 2017, with the 82 Conference call information. 83 By 2021, imported clinker expenses are expected to account for roughly 10% of the firm s operating revenues. PAGE 25/33

26 remaining being paid during 2018, which would all be fully funded by Bamburi s accumulated cash reserves. e) Operating FCF Operating free cash flows are expected to decrease over the next two years due to the steady production in both Bamburi Cement Limited and Hima Cement, and the fall in prices of Ugandan cement. Furthermore, it will be during this period that the investment in capacity will be made, thus negatively impacting the operating FCF up until the project is complete. In turn, the future intensification of production will lead to an abnormal rise in operational FCF (167% Y.o.Y) by 2019, which will then stabilize until 2021 (10% rise in 2020 and 7% growth during the last year of analysis). 84 Exhibit 52 Bamburi s dividend distribution policy Financial Structure and Cost of Capital In 2014 Bamburi completed the repayment of its outstanding debt in what was perceived as a clear signal that the company plans to fund itself through its own cash reserves. In fact, the cement producer s net debt 85 levels have historically been below zero and, after all the borrowings have been repaid, they have been getting more negative. Furthermore, Bamburi has historically paid a high amount of dividends 86, which in turn offsets the rising in excess cash but increases the dividend yield and, consequently, the total return for investors. We believe that over the next three years the firm will be more moderate in the distribution of dividends since it will invest out of its own pocket in the grinding capacity project, but by 2020 it will continue with its high dividend distribution policy, at least in the medium-term 87. Our cost of capital was therefore determined considering that the firm s capital structure will not shift during our forecasts, thus we have established a target debt-to-equity (D/E) equal to zero. In order to perform our analysis we have chosen the Weighted Average Cost of Capital (WACC) as our valuation method, which exactly corresponds to the estimated cost of equity due to our previously defined D/E target of zero. We defined the CAPM model as the best proxy for Bamburi s cost of equity, which accounts for 17.4%. The rationale behind this estimation relies on a risk free rate which considered the US 10 year treasury bond rate and a differential between the expected inflation rates at the end of 2017 of both Kenya and United States. Furthermore, we have conducted a study to determine the unlevered beta of the 84 The Net Working Capital considered Bamburi s accounts payable would represent the last 4-year average creditor position of 84 days, whereas it takes a maximum of 30 days for the firm to collect its sales. 85 The net debt deducts the excess cash from a company s outstanding debt. 86 The average dividend payout ratio from 2012 to 2015 accounts for 107%. 87 Bamburi has announced that dividends will be paid until the expansion project is in motion. Our assumption is that the company s dividend payout ratio will fall to 50% in 2017 and 2018, and grow by 25% in each year until PAGE 26/33

27 Exhibit 53 WACC estimation cement industry (0.6) that accounts for the weighted average between the African peers and Global cement manufacturers unlevered beta 88. The principle used undertakes the fact that, despite investors can invest in a global scale thus diversifying their risks, they also seek for higher risk-return trade-offs, consequently investing in companies such as Bamburi Cement. Furthermore, our cost of equity considered both a Market Risk Premium of 6% and also a Country Risk Premium of 7.07%, both of which based on the studies of Damodaran. The latter was used since investors must be rewarded for bearing the extra-risk of investing in the riskier economy of the African continent and, at the same time, we believe the CRP is a solid proxy that incorporates risky and hard to measure scenarios. ; Damodaran; Bloomberg Risk Analysis Investing in the African continent involves higher risks compared to the US or the European economies. In fact, throughout this research we have been able to uncover risks related to Kenya and Uganda as well as to Bamburi Cement itself. Country Risk On the one hand, the political risk in both countries as well as the higher probability of occurrence of civil wars is much higher than in any other continent, can severely impact the economy of a both these countries. Therefore, Bamburi s activity is in danger especially because this industry is highly dependent on the government s investment in infrastructure, which would be severally impacted by the collapse of a country s administration. Furthermore, those risks are incorporated in the currency s of both Kenya and Uganda, which alongside the general appreciation of the dollar in its post election period, lead to a devaluation of the KES and UGX, which is predicted to be further stressed over the upcoming years, thus having a greater impact in the company s turnover and cost of imported of clinker, which may impact the tones of cement sold and Bamburi s profits. Cement Market Risk Kenya has been protective over its current cement players, especially since it has created barriers on the imports of this commodity to the country. Nevertheless, Dangote Cement has started to export cement into Kenya from its Ethiopian 88 In order to compute the unlevered beta of each comparable, we took the adjusted betas of the African cement players and chose to regress them on the MSCI AWCI Index (which considers players from the emerging and developed countries) using data of the last two years, whilst the global peers were regressed on the MSCI World Index and have as well accounted for data of the last 2 years. The unleveraging was then performed using the capital structure (Debt/Market Capitalization) of each firm. Furthermore we assigned a weight of 605 for the African peers against 40% of the global competitors due to Bamburi s proximity in terms of geographic position to the first. In order to know more about the unlevered beta of the industry and what competitors were considered please check Appendix 2. PAGE 27/33

28 plants since its cement production costs are about 40% lower than in the Kenyan market, thus offsetting the tariffs imposed by the government 89. Furthermore, the company is to set its first manufacturing plant in Kenya by 2019, which will foster pressure on prices in the country, thus decreasing the margins of local manufacturers such as Bamburi Cement. Moreover, Ugandan prices are under pressure from increasing market competition. Bamburi Cement Risk We are concerned about Bamburi s inability to raise its production levels in the short term, which in turn can lead to a loss of market share since both the Kenyan and Ugandan markets are projected to keep growing at double digits in the next few years 90. Furthermore, our believe is that technical fees constitute a risk for minority investors since it looks like Bamburi is paying some extra dividends to its parent company and deducting it as a cost, which also reduces profits thus impacting the firm s stock price. Exhibit 54 Valuation Summary Scenario Analysis Even though the country risk premium was incorporated in our analysis and is expected to partially reflect the above mentioned risks, we have also established two scenarios that influenced our final target price output both positively and negatively. Expansion Project Delay One must acknowledge that not always do expansion plans take place during the time window initially defined. Furthermore, this situation is more prevalent when we consider that Bamburi is inserted in a context where it takes longer to get things done and where the uncertainty on the political environment can truly impact the operations of companies. Taking this into consideration, we have chosen to assign a 5% probability of a delay in the expansion project, which would postpone the project by one year, thus driving down our target price because only by 2020F would the new capacity be available for Bamburi. Ugandan cement market prices fall at lower rate We have created a scenario where the Ugandan cement prices in dollars would fall at a lower pace until 2021 rather than what we had previously defined in our base case scenario (-4% vs -5% growth rate) 91. In turn, this occurrence, to which we assigned a 20% probability, would boost the organization s turnover, thus 89 Daily Nation: Dangote shakes Kenya s cement market with cement imports by Victor Juma 90 Standard Bank projections 91 In the base case, the Ugandan cement price was falling at 5%, thus we assigned a 4% decrease instead in this new scenario that is likely to occur due to the fact that competition may not be as fierce as we have estimated in the base case. Furthermore, both growth rates are below the last 5-year average growth of -7% in those same prices. PAGE 28/33

29 increasing Bamburi s target price. Furthermore, our base scenario considers that the DCF accounts for nearly 29% of Bamburi s Enterprise Value of Operations, whilst the terminal value represents the remaining 71%. All in all, the East African cement producer target price outcome that incorporates all of our three scenarios corresponds to KES by the end of 2017, which guarantees a 23.85% upside. 92 Final Valuation Considerations At the end of our valuation we have decided to assess the reasonability behind our projections by conducting a study on value creation, developing a sensitivity analysis and performing a multiples valuation. Exhibit 55 ROIC vs WACC Value Creation Over our forecasted period, the firm s ROIC is expected to increase in every year, thus establishing itself at 24% by Nevertheless, those raw values do not provide a clear judgement on whether Bamburi is creating or destroying value. Hence, we developed a graph (Exhibit 54) that relates the company s yearly cost of capital (measured through the Wacc) with its corresponding ROIC. Our estimates point towards a value creation strategy since there is clear evidence of a ROIC higher than the Wacc in every projected year, with exception of Sensitivity Analysis Bamburi s enterprise value is mostly determined by our base case scenario, therefore we analyzed its target price sensitivity to the cement price pressure in Kenya due to the entrance of Dangote Cement in the Kenyan market in The impact of future changes in price were fitted alongside to altercations in the cement to clinker ratio, which will increase if the firm manages to achieve higher operating efficiencies, thus decreasing its requirements of clinker and increasing its COGS margin. Hence, evidence suggests that a decrease in prices derived from Dangote s entrance in the market would be harmful to Bamburi s stock price. However, we have chosen not to incorporate this analysis in the scenarios as the probability of occurrence is suspicious and its effects on prices are very hard to estimate. In a scenario where the 2019 s price keeps growing at inflation rates and in which Bamburi manages to grasp improvements in its operating efficiency (reflected by 92 Total return includes the 2017 s dividend yield of 4.5%. Please check Appendix 3 for the valuation waterfall. 93 The underlying reasoning is that, even though during this year the firm s revenues have increased, they are still insufficient for providing value creation, thus Bamburi is urging for an increase in capacity to lever up its turnover. PAGE 29/33

30 the cement-to-clinker ratio of 1.63), the total return would amount to 24.9%. However, the possible entrance of Dangote will drag down prices and negatively impact the upside i.e. in a scenario where the clinker-to-cement ratio maintains and prices lower to KES 90, the upside would amount to solely 3.1%. Exhibit 56 Target Price sensitivity to changes in 2019 Cement Price in Kenya / Changes in the overall Cement to Clinker ratio; Multiples Valuation Exhibit 57 Multiples Valuation (values in KES) ; Bloomberg Once our target price was unwrapped we decided to conduct an analysis through the multiples of several peers from the African continent, more specifically that operated in Nigeria, DRC and East African cement market, which are regions that entail solid growth prospects, whilst at the same time are similar part of the same region. Hence, we have defined the estimated EV-to-EBITDA at the end of 2017 and the Price-to-Earnings at the end of 2017 as the two multiples under analysis 94. Regarding the first, our target price is comprised within our defined range, thus proving itself to be a solid measure to define the price of Bamburi. On the contrary, the P/E ratio range does not contain our price target. Our belief is that the underlying reasoning for this situation concerns both the fact that the peers have different capital structures compared to Bamburi Cement, and also that the firm s earnings estimates for 2017 are significantly lower than what they would normally be due to its investment in grinding capacity. 94 Those multiples were estimated by Bloomberg. Furthermore, our range accounted for, on the one side, the median of the peers multiple (which removes the outliers), and on the other side, the average of that same multiple. (Please check Appendix 4) PAGE 30/33

31 Financial Statements Income Statement Sources: Analyst Estimates, Balance Sheet Free Cash Flow Map PAGE 31/33

32 Appendixes Appendix 1: Terminal Growth Rate estimation ; Bloomberg Appendix 2: WACC estimation ; Bloomberg Appendix 3: Valuation Waterfall Appendix 4: Multiples valuation (millions KES) ; Bloomberg (million KES) PAGE 32/33