NIGERIAN CEMENT INDUSTRY

Transcription

1 NIGERIAN CEMENT INDUSTRY 14 September 2016 MATERIALS Contact: Jumai Mohammed Setting new profit margin levels In this note, we revise our earnings estimates and target price for our universe of Nigerian cement companies. We maintain our neutral stance on the sector on the basis of: (1) a downward revision of our earnings outlook over the medium term owing to the weak macro backdrop and intense competitive pressures; and (2) weaker profit margins and RoE trajectories. Moreover, we think the market has now incorporated what we believe to be a fair premium over peers for the sector multiples. Setting new margin levels. Core operating margins have been on a downward trend, declining 3ppt pa on average since FY12. This, in our view, is a result of persistent and under-appreciated structural forces, namely: (1) excess production capacity as companies continues to amass capacity ahead of the consumption growth curve. For context, consumption has only grown at a meagre 6% average over the past five years (FY10-FY15), while capacity has grown at a compounded annual rate of 24% over the same period; (2) weak selling prices which reflects the tense competitive landscape; and (3) mounting cost-side headwinds on the back of erratic gas supply and naira weakness. We expect that, within the context of such structural changes, margins will remain around their currently depressed levels with little room for improvement well into the medium term. But some positives Recovery in cement consumption. In spite of the challenging macroeconomic environment and fiscal position, cement consumption grew 15% yoy in H1 16 by our estimate, driven primarily by a rush to complete construction in fear of further hikes in building material prices, and the demand for inflation-protected assets such as real estate properties. We take the view that a gradual recovery in public sector spending and an improvement in retail presence could sustain the positive trend in consumption over the medium term. We update our key assumptions. We review our earnings estimates in light of the relatively weak sector fundamentals over the medium term. We cut sector earnings growth, estimating a 26% decline in FY16f net earnings (previously -11%) and our medium-term earnings growth estimate to 6% pa over FY15-FY18f (previously +10%). Similarly, we expect medium-term operating margins to trend lower at an average of 29.4% over FY15-FY18f, representing a sharp decline from the five-year historical average of 39.3%. We remain broadly neutral on cement stocks. Current sector multiples of 11.6x and 7.9x FY17f earnings and EBITDA respectively, are at a justifiable premium to SSA peers which trades on 8.6x and 6.9x FY17 earnings and EBITDA respectively. We reiterate our Sell recommendation on Lafarge Africa (NGN52.00/share TP) and maintain our Hold recommendations on Dangote Cement (NGN188.00/share TP), Ashaka Cement (NGN21.00/share TP) and Cement Company of Northern Nigeria (NGN7.00/share TP). If you must own a Nigerian cement stock, we recommend Dangote Cement, which we believe is the most resilient to current economic headwinds. Nigerian cement companies - equity ratings and target prices (9 September 2016) Company Ticker Rating Price. (NGN) New TP (NGN) Old TP (NGN) ETR Mkt Cap (NGN'bn) Dangote Cement DANGCEM NL Hold % 2,948,008 Lafarge Africa WAPCO NL Sell % 290,603 CCNN CCNN NL Hold % 7,540 AshakaCe ASHAKACE NL Hold % 44,677 Recommendations and opinions in this report, unless otherwise stated, are based on a combination of discounted cash flow analysis, ratio analysis, industry knowledge, logical extrapolations, peer group analysis and company specific and market technical elements (events affecting both the financial and operational profile of the company). Forecasting of company sales and earnings are based on segmented top-bottom models using subjective views of relevant future market developments. In addition, company guidance and financial guidance is taken into account where applicable. This report is on a stock under active coverage. All prices provided within this research report are taken from the close of business on the day prior to the issue date unless explicitly stated. Exotix Partners LLP is authorised and regulated by the Financial Conduct Authority. Please see disclosures on the last page of this document. Required Disclosures: 1

2 Sep-11 Jan-12 May-12 Sep-12 Jan-13 May-13 Sep-13 Jan-14 May-14 Sep-14 Jan-15 May-15 Sep-15 Jan-16 May-16 NIGERIAN CEMENT INDUSTRY Introduction The Nigeria cement sector has historically outperformed the broader Nigerian equities market. Over the last five years the sector returned 67% vs +31% for the broader market based on the NSE 30 index. This in our view has been a reflection of fairly resilient sector earnings, and excitement around aggressive sector capacity expansion and M&A which have recently reshaped the industry although not necessarily translated into value creation for investors. With the exception of the noise around corporate actions, performance has been persistently weak, evident in the broad-based decline in core operating margins and RoEs, down 7ppt and 11ppt respectively between FY12-FY15. More recently, however, the sector has underperformed the broader Nigerian market and Frontier materials alike (see Figures 1 and 2 below), down 22% YTD, as fundamentals prevail and performance begins to mirror the general economic cycle and the weakness in construction activities. Notably, the weaker margin trend has become even more pronounced recently,-12ppt yoy in H1 16. The key question facing investors today is whether this notable decline in profitability will persist into the medium to long term. In our view, the industry has now reached a new mean margin level, with little room for improvement within our forecast period. In light of this we remain broadly neutral on the industry over the medium term. We believe the market has now incorporated a fair value for the sector, evident in current trading multiples of 10.6x FY16f EV/EBITDA which we believe is at a justifiable premium to SSA peers which trade on a FY16f multiple of 8.8x and to its five-year historical average EV/EBITDA of 8.1x. Figure 1: Nigerian cement sector vs market share price trend 300 Figure 2: Stock performance, YTD (%) 0% % -10% -15% 50-20% 0-25% Nigeria cement SSA Materials Nse 30 FM Materials Source: Bloomberg Sector price index NSE 30 FM Materials EM Materials Source: Bloomberg, Exotix estimates In this note we evaluate the current themes shaping the Nigeria cement industry and their likely direction in the medium term. In so doing we find a number of underappreciated structural forces which suggest a persistent margin reversal, namely (1) excess capacity; (2) weak selling prices; (3) mounting cost-side headwinds; and (4) possible amendment of tax concessions. Accordingly, our analysis highlights a stabilisation of margins at currently depressed levels. Subsequently, we provide more detailed discussions on companies in our coverage see page 16. 2

3 NIGERIAN CEMENT INDUSTRY Key themes shaping the industry in the medium term The year has proved challenging for cement producers in Nigeria. Latest growth figures (-2.06% GDP growth in Q2 16) have indicated that the economy is indeed in a recession, presenting probably the toughest year for cement stocks in the medium term. This reflects the slump in oil prices and production above all else, but also a fallout from delays in fiscal and monetary policy response. As a result, growth expectations for the economy have deteriorated, evident in the IMF s recent downward revision of GDP growth estimates to -1.8% in FY16 (previously +2.3%) and +1.1% for FY17 (previously +3.5%). We anticipate that even under a benign recovery scenario in H2 16, the Nigerian economy will struggle to realise growth higher than -0.8% in FY16. We take the view that the economy will begin to recover in H2 16, and consequently expect an improvement in fiscal position which will provide support for cement consumption. However, we consider the sector s investment case over the medium term will be threatened by developments relating to: (1) excess production capacity; (2) weak selling prices; (3) mounting cost-side headwinds; and (4) possible amendments to tax incentive laws. Recovery in cement consumption We have observed an improved trend in cement consumption in recent quarters, up 15% yoy in 1H 16 (by our estimate), despite general economic weakness. In an effort to better understand the unexpected demand trend, we highlight two lines of demand for cement produced in Nigeria: (1) volumes consumed locally; and (2) re-exported volumes (volumes exported by distributors from neighbouring countries who are favoured by exchange rates and pricing in Nigeria). Focusing on local consumption, we observed that the key driver of growth in H1 16 was from demand for the completion of private construction projects hastened by inflationary pressures; we link this directly to inflationary pressures for two reasons: (i) we believe there was a rush by home-builders to complete construction in fear of further hikes in building material prices, and (ii) we suspect that there was an increase in demand for inflation-protected assets such as real estate properties. Other supporting factors are: (1) low base effect from weakness recorded in previous years; and (2) we suspect increased retail penetration could also be a driver, as cement players deepen route to market in an effort to counter competitive pressures in key markets, although we do not have enough evidence to support that view currently. Whereas most of these factors have begun to tail off given recent hikes in prices, our view is that the impact of an improvement in retail presence could be sustained in the coming periods. In addition to this, we expect a gradual recovery in public sector demand. Improving retail penetration Local cement producers have become more proactive in deepening their RTM in a bid to counter aggressive competition and have adopted unique approaches in doing so. Lafarge s approach has been to diversify its regional capacity to under-penetrated markets in the south-south through Unicem, and the north-east through Ashaka Cement. Dangote Cement, on the other hand, has recently revamped its distribution channels by initiating key distributor schemes and increasing its retail outlets. This is a strong positive for the company, in our view, given that there wasn t much of a relationship with its distributors in the past, which became evident when the company incentives such as price cuts never reached the end-users as intended. Even so, we believe Dangote s approach of transporting cement over hundreds of kilometres to depots or directly to end-users in other regions from the south, where it 3

4 F 2017F f 2017f 2018f 2019f 2020f NIGERIAN CEMENT INDUSTRY has amassed capacity, may not be sustainable into the long term due to high transport costs. We believe that regional players will increase capacity, thereby enabling them to dispatch cement to such markets at lower cost. Recovery in public sector demand We expect the government to increase its spending on construction in H2 16 in a bid to remedy waning economic growth. While we expect the implementation of capital projects to be low at just 50% as a result of the government s poor fiscal position, we are of the view that this level will still result in an improvement from the last months which saw a near stand-still in construction activities. Our estimate for total public sector consumption in FY16f is 2.5mt, significantly higher (+109% yoy) than public sector consumption in FY15, although FY15 was a low base. Our estimate is based on the following conservative assumptions: (1) 50% (NGN794bn) of capital expenditure allocations is released and spent; given that NGN400bn has been released so far; (2) cement accounts for c9% of the total project costs in Nigeria according to the National Bureau of Statistics; and (3) cement prices will average NGN28,400/tonne in FY16f. However, we note that the public sector accounts for c15% of total demand, and highlight that we expect growth from the private sector to slow due to increased constraints on consumer spending and higher cement prices. Cement volume outlook - we estimate 10% pa over the medium term Accordingly, we estimate that cement volumes will begin to recover at 10% pa on average over the medium term (FY15-FY18f) to 28.0mt by FY18f, slightly higher than our previous medium-term average of 8% pa due to better than expected growth in FY16f. Although we note that this contributes marginally to cement per capita consumption (PCC), which grows marginally to 144kg by FY18f vs similar middle income countries where consumption is expected to average 265kg per capita. Figure 3: Nigeria - capital expenditure budget vs spend Figure 4: Nigeria Cement - cement consumption and PCC 7,000 6,000 5,000 4,000 3,000 2,000 1,000-61% 50% 80% 56% 60% 52% 65% 50% 59% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% TOTAL EXP (actual) CAPEX budget (NGN'bn) CAPEX release (NGN'bn) Budget implementation (%) Local consumption PCC (Kg), RHS Source: National planning commission, Exotix estimates Source: Company filings, Exotix estimates Excess cement production capacity At an effective size of 41.3mt, production capacity for the Nigerian cement industry widely outpaces consumption (see Figure 5 below). The gap between capacity and demand has been widening since 2011 as cement producers continued to amass capacity ahead of the growth curve. To put this into perspective, we highlight that while capacity has grown at a compounded annual rate of 24% over the past five 4

5 NIGERIAN CEMENT INDUSTRY years (FY10-FY15), consumption has grown at a meagre 6% average over the same period. Based on our conservative capacity assumption of 44.1mt by 2018, cement consumption will have to grow 19% pa in the medium term, ahead of our 10% forecast in the same period, for local production capacity to achieve 80% utilisation. This is unachievable, in our opinion, given the challenges the industry faces which are discussed in a later section of this note. We narrow the core drivers of excess capacity to (1) latent demand, which remains untapped due to lack of commitment on the part of government to infrastructure development, and to a lesser extent higher price of building materials; (2) government protectionism and incentives in form of import bans and tax holidays; (3) cheap Chinese funding for plant construction in an effort to divert capital from its local over-invested industries; and (4) poor delivery by the cement companies on their export strategies. Figure 5: Nigeria Cement - production capacity (mt), dispatches (mt), utilisation rates (%) Figure 6: Nigeria Cement - actual PCC vs capacity implied PCC, kg f 2016f 2017f 2018f f 2016f 2017f 2018f Production capacity (mt) Utilization rates (%) Consumption (mt) Capacity implied PCC (kg) PCC (kg) Source: Exotix estimates and company data Source: Exotix estimates and company data The fallout of such excesses has manifested in increasing competition, the resultant volatility in cement prices and higher marketing costs to grow market share. Consequently, profitability measured by return on assets (RoA) has shown a downward trend. In the period between 2011 and 2015 RoA dropped 6ppt on average annually to 8.7% in We see little room for improvement in efficiency over the medium term; as such we forecast an average RoA of 7.4% over FY15-FY18f, a notable drop from the five-year historical average of 13%. Our estimate of 44.1mtpa capacity by FY18 includes existing infrastructure as well as expected capacity which we believe has been reasonably funded. Local cement producers, on the other hand, are more optimistic on bringing more capacity to the market by 2018, which worsens the investment case for the industry. The only cement companies we realistically see bringing on additional capacity before the end of 2018 are UNICEM, which is at quite an advanced stage of its 2.5mtpa expansion, and Ashaka Cement, via a debottlenecking programme on existing plant. 5

6 NIGERIAN CEMENT INDUSTRY Table 1: Nigerian cement industry - local production capacity builds ( ) Existing capacity Dangote Cement (Obajana & Gboko) Lafarge Africa (WAPCO) CCNN BUA Group (Edo cement) Purecem Atlas UNICEM Lafarge Africa (Lakatabu) Dangote (Ibese) Dangote (Obajana) Dangote (Gboko) Dangote (Ibese) Dangote (Obajana) BUA Group (Edo cement) Total existing capacity Additional funded capacity CCNN UNICEM AshakaCem (via debottlenecking) Existing+ funded Average utilisation 52% 56% 71% 53% 56% 70% 53% 50% 58% 62% 68% Announced (yet to be funded) CCNN 1.5 BUA Group (Edo cement expansion) 3.0 Dangote (Okpella) Dangote (Itori) Lafarge Africa (AshakaCem) 2.5 Lafarge Africa (Wapco) 2.5 Existing + funded + announced Source: Company presentations, Exotix Research estimates Weak selling pricing remains a key risk We continue to think that the weak pricing trend represents a significant downside risk in Nigeria over the medium term. As cost pressures intensify, we doubt that prices could increase enough to counter the effects, implying that margins remain at risk. We point to three observations in support of this: (1) deteriorating price-cost spread (see Figure 7), suggesting that cement prices more recently reflect the tense competitive landscape as opposed to input cost movements which they historically mirrored; (2) disruptive forces owing to aggressive capacity build despite large underutilised capacity; and (3) recent rising volatility in cement prices which indicates that the likely direction of prices in the medium term will be downwards. We estimate a 2% average yearly decline in prices over the medium term to NGN28,345/tonne by FY18f. H1 16 results indicate that cement prices have already declined by 24% yoy. We however expect that prices will start to inch upwards in H2 16 following recent price hikes (NGN100/bag in March, NGN50/bag in May, NGN50/bag in June and NGN600/bag in August). While we expect these increases to partly offset the low levels of H1 16, we also note that there could be an impending reduction in prices later in the year in the event of the following: (1) Unicem beginning to operate its new 6

7 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 NIGERIAN CEMENT INDUSTRY 2.5mt line, likely in October, and/or (2) Dangote completing its coal conversion and milling plant which is due in November In summary, prices will remain volatile but with a clear downward trend, and we therefore forecast a 5% decline in prices in FY16f to NGN28,400/tonne and a 2% average decline over the medium term to NGN28,345/tonne in FY18f. Figure 7: Nigeria Cement price/cost spread (indexed) Figure 8: Nigeria Cement- average selling price (NGN tonne) ,500 30,000 29,500 29,000 28,500 28,000 27,500 27,000 26,500 26,000 28,108 27,120 29,501 29,033 28,001 30,121 29,498 28,400 28,345 25, f 2016f 2017f 2018f Source: Company presentations, Exotix Research estimates Source: Company presentations, Exotix Research estimates Mounting cost-side headwinds Input cost pressure Input costs have risen sharply in recent quarters, and will continue to do so in the next months, in our view. For context, Nigeria s headline inflation accelerated for the seventh consecutive month in July, reaching 17.1% yoy. The core sub-index (housing, water, electricity, gas and other fuels) accelerated even more rapidly by 31% yoy to 16.9% in July. Input costs will continue to rise this year and next as producers realise the full extent of currency depreciation, down 56% YTD. Bear in mind that the currency was only floated in June, half-way through the year. The re-emergence of militant attacks on oil installations which has led to erratic fuel supply, particularly of gas, to companies has further compounded cost challenges. As a result, companies reported an unfavourable fuel mix towards more expensive alternatives in H1 16 and periods of production stoppage in some extreme cases. Exchange rate volatility - this represents one of the most significant downside risks to company earnings, which typically rely heavily on US dollar-linked cost components. Following the floating of the currency in June, the exchange rate has been volatile, leaving cement companies vulnerable to the depreciation of the naira. We estimate that cement producers went from settling the majority of their cash cost at NGN200/US$ as at end-2015 to NGN282/US$ as at end-q2 16, and even higher at NGN315/US$ currently. Compounding issues further is the low dollar liquidity in the FX market which could imply: (1) further depreciation of the currency; (2) inability to mitigate FX impact by stocking raw materials and fuel ahead of unfavourable FX movements; and (3) increasing dollar payables. It is due to these setbacks that we see a tick-up in cash costs, even under the assumption that gas supply stabilises from H2 16. Beyond the negative impact on costs, we expect the net impact of the depreciation of the naira to be positive in FY16f for some stocks within our coverage. This is due to exceptional gains that we expect them to record in the year from the revaluation of 7

8 Jan-15 Feb-15 Mar-15 Apr-15 May-15 Jun-15 Jul-15 Aug-15 Sep-15 Oct-15 Nov-15 Dec-15 Jan-16 Feb-16 Mar-16 Apr-16 May-16 Jun-16 NIGERIAN CEMENT INDUSTRY their dollar assets. However, we highlight that these gains might not be sustained in subsequent periods, depending on exchange rate movements. At the winning end of the spectrum is Ashaka Cement, whose fuel mix has gradually been enhanced by the use of local coal which could improve further by Dangote also stands out as a beneficiary of the naira devaluation, albeit to a lesser degree than Ashaka, due to the scale of its local operations, balanced pan-african spread and a relatively low US$ loan exposure. Conversely, producers with weak operating leverage such as CCNN and Lafarge Africa are negatively impacted by further devaluation. Lafarge Africa will be further pressured by its considerable dollar loan exposure. Re-emergence of militant groups: Energy supply in Nigeria has always been erratic due to poor infrastructure, however in the past six months this challenge has further intensified following several attacks on oil installations by new militant groups. Domestic gas supply dropped 15% yoy in June to a multi-period low (see Figure 9). As a result, cement producers have recorded an unfavourable fuel mix as the use of expensive alternatives rose. While producers were able to pass on cost pressures historically, we believe that they will have to shoulder the brunt going forward due primarily to increasing competitive pressures. Figure 3: Nigeria - domestic gas supply (mmscf), mom change (%) Figure 4: Nigeria Cement - energy cost profile (NGN per tonne) % 30% 20% 10% 0% 12,000 10,000 8,000 6,000 9,891 9,311 8,269 8,541 8,710 8,144 7, % 4, % -30% 2, f 2016f 2017f Domestic gas supply (mmscf) % change (RHS) Source: NNPC Source: Company accounts, Exotix research estimates Greater operating costs as companies deepen their route to market and continue to spend their way to defend market share and strengthen their brands in an increasingly competitive landscape. We estimate marketing and distribution costs to sales will increase by an average of 4% pa over FY15-FY18f for the companies in our coverage universe. Possible amendment to tax incentive laws In August 2016, the federal government set up a committee for the review and update of the national tax policy, supporting our view that there is considerable downside risk that the current administration will review the law granting tax concessions to cement producers who have over-invested in new capacity. We hold this view in light of pressing fiscal challenges and on the basis that the objective of such incentives, which was to spur local production, has been met. Contrary to our expectations, however, local cement producers are of the opinion that tax policies will remain unchanged. 8

9 NIGERIAN CEMENT INDUSTRY Changes to our earnings estimates and outlook In our last sector note (Nigeria Cement Industry - losing its charm over the medium term), we had forecast a considerable deterioration in the earnings of the companies in our universe over the medium term. The sector has however shown a weaker trend in recent quarters than anticipated, which highlights the pressures of a more challenging environment - we discuss this in greater detail later in the note. In light of the relatively weak sector fundamentals over the medium term, we cut sector earnings growth, estimating a 26% yoy decline in FY16f net earnings (previously -11%) and our medium-term earnings growth estimate to 6% pa over FY15-FY18f (previously +9%). Table 2: Nigerian cement companies changes to net income estimates (NGN bn) FY16f FY17f FY18f New old % New old % New old % Dangote Cement 181, , , , , ,359 5 Ashaka Cement 2,601 2, ,095 3,332 (37) 2,859 4,462 (36) Lafarge Africa (22,710) 24,695 nm 30,366 26, ,832 31,009 (33) CCNN 1,045 1,352 (23) 1,205 1, ,088 1,192 (9) Source: Exotix estimates Similarly, margins have been on a downtrend, stemming from increasing competition ahead of gains in efficiencies. We forecast a sharp decline in industry operating margin to 24.2% in FY16f, vs 33.6% in FY15, following the trend seen in H1 16 where margins declined 12ppt vs H1 15. In the same vein, we expect medium-term operating margins to hover at 29.4% over FY15-FY18f, representing a full 10ppt decline from the five-year historical average of 39.3%. Figure 11: Nigeria Cement - quarterly sector operating margins (%) Figure 12: Nigeria Cement - margins (%) Q12 4Q12 2Q13 4Q13 2Q14 4Q14 2Q15 4Q15 2Q f 2016f 2017f 2018f Operating margin Net margin Source: Company reports, Exotix estimates Source: Company reports, Exotix estimates On our estimates, the weakest performers from an earnings perspective over the medium term will be Lafarge Africa and CCNN, -10% pa and -3% pa respectively between FY15-FY18f due largely to their relatively high vulnerability to the changing competitive environment, cement prices and naira depreciation. Coincidentally, these represent areas that pose the greatest downside risk over the medium term, in our view. In Tables 3 and 4 below, we present the sensitivity of cement companies in our coverage universe to changes in prices and the exchange rate. We observe that both Lafarge Africa and CCNN fall within the bottom tier on operating leverage vs the rest of our universe. In addition, we note that Lafarge has a sizeable US dollar debt 9

10 NIGERIAN CEMENT INDUSTRY exposure which magnifies its losses. Conversely, Dangote Cement s relatively large scale helps it absorb some of the pressures, and also it enjoys a net positive impact from FX exposure due to its diversified regional exposure. Table 3: Nigeria Cement Companies earnings sensitivity to changes in FY16f prices % price change -15% -10% -5% 0% 5% 10% 15% Dangote Cement -33% -22% -11% 0% 11% 22% 33% Ashaka -94% -63% -31% 0% 31% 63% 94% Lafarge Africa -110% -73% -37% 0% 37% 73% 110% CCNN -131% -87% -44% 0% 44% 87% 131% Source: Exotix Research estimates Table 4: Nigeria Cement Companies earnings sensitivity to changes in exchange rate in FY16f Average exchange rate Dangote Cement -5% -2% 0% 2% 5% 7% 9% Ashaka -11% -5% 0% 5% 11% 16% 22% Lafarge Africa 97% 48% 0% -48% -97% -145% -194% CCNN 103% 52% 0% -52% -103% -155% -206% Source: Exotix Research estimates 10

11 Sep-11 Nov-11 Jan-12 Mar-12 May-12 Jul-12 Sep-12 Nov-12 Jan-13 Mar-13 May-13 Jul-13 Sep-13 Nov-13 Jan-14 Mar-14 May-14 Jul-14 Sep-14 Nov-14 Jan-15 Mar-15 May-15 Jul-15 Sep-15 Nov-15 Jan-16 Mar-16 May-16 Jul-16 NIGERIAN CEMENT INDUSTRY Valuation - Maintain neutral view on the sector More recently, cement stocks have lagged the market, due to recent weakness in earnings and muted construction activities, in our view. The cement aggregate index has significantly trailed both the broader market and material peers during the year, bucking historical trends (down 22% YTD vs NSE 30, down 4% YTD and MSCI frontier materials, down 3% YTD). Based on our estimates, we believe that the market now values the Nigerian cement sector fairly, as evidenced by the current trading multiples of 10.6x FY16f EV/EBITDA, despite a de-rating since the start of the year (-22% YTD). Current multiples represents a justifiable premium to SSA peers which trade on a FY16f multiple of 8.8x and to its five-year historical average EV/EBITDA of 8.1x. We feel the premium is justified owing to the better cash generation of the Nigerian cement sector. We would be unable to justify a much greater premium. Figure 13: Historical price trend, Cement stocks vs NSE 30 vs FM Materials Lafarge Africa AshakaCem CCNN Dangote cement NGSE30 Index FM Materials Cement sector index Source: Bloomberg Recently, there has been a deviation in PE and EV/EBITDA multiples. EV/EBITDA multiples were elevated until the start of the current year due to the depressed core operating performance of the cement companies. PE multiples, on the other hand, peaked in mid-2014 and have appeared cheap since then, reflecting market-positive sentiments around corporate actions. More recently, however, sector multiples have hovered closer to their historical average, as fundamentals prevail and performance begins to reflect the general economic cycle and the weakness in construction activities. In valuing companies in our universe using relative valuations, we have placed more emphasis on the one-year and two-year forward EV/EBITDA due to depressed earnings, which impair a PE-based valuation approach. 11

12 NIGERIAN CEMENT INDUSTRY Figure 14: Nigeria Cement - one-year forward PE Figure 15: Nigeria Cement - one-year forward EV/EBITDA Sep-11 Sep-12 Sep-13 Sep-14 Sep-15 Sector PE+1 5-year average Sector price index Source: Bloomberg, Exotix estimates Sep-11 Sep-12 Sep-13 Sep-14 Sep-15 Sector EV/EBITDA+1 5-year average Sector price index Source: Bloomberg, Exotix estimates

13 NIGERIAN CEMENT INDUSTRY Table 5: Nigerian Cement Companies - comparative valuation (FY) as at 14 September 2016 Price MktCap PE (x) EV/EBITDA (x) EBITDA margin (%) EPS growth (%) Name Country $ ($mn) 2016f 2017f 2016f 2017f 2016f 2017f 2016f CY15 - CY18f Dangote Cement Nigeria , Lafarge Africa Nigeria nm -16 CCNN Nigeria Ashaka Cement Nigeria Bamburi Cement Kenya Arm Cement Kenya EAPCC Kenya nm Tanga Cement Tanzania Tanzania Portland Tanzania Ciments Du Maroc Morocco PPC Ltd South Africa Nigeria SSA Vicat Cement FRANCE , Imerys SA FRANCE , Heidelberg Cement GERMANY , CRH Plc IRELAND , Buzzi Unicem ITALY , C. Portland SPAIN LafargeHolcim SWITZERLAND , Vulcan Materials Co US , Martin Marietta US , Average - DM China Resources C H HONG KONG 0.4 2, China Shanshui Cement CHINA 0.8 2, nm nm BBMG Corp-H CHINA 0.4 6, Cementos Argos sa COLOMBIA 4.1 5, Misr Cement (Qena) EGYPT Arabian Cement Co EGYPT Ambuja Cements INDIA 4.2 8, Ultra tech cement ltd INDIA , Holcim Indonesia INDONESIA Indocement INDONESIA 1.3 4, Holcim Maroc MOROCCO , Saudi Cement Company SAUDI ARABIA , Tokyo Cem. Co Lanka SRI LANKA , Asia Cement Corp TAIWAN 0.9 3, Taiwan Cement Corp TAIWAN 1.2 4, Siam cement public company ltd THAILAND , Akcansa TURKEY Hatien 1 Cement Jsc VIETNAM Average - EM Source: Bloomberg, Exotix research estimates 13

14 NIGERIAN CEMENT INDUSTRY Strategy and changes in target prices Strategy - Maintain a neutral view on the Nigerian cement industry We remain broadly neutral on the Cement sector over the medium term on the basis of earlier discussed headwinds - particularly the weaker earnings outlook. Moreover, we believe the market has now incorporated a fair value for the sector, and current multiples as we earlier noted represent a premium to both SSA peers and historical averages. While we feel the premium is justified owing to the better cash generation and size of the sector, we struggle to justify a much greater premium, hence our neutral view. However, should investors be inclined to hold a stock in the Nigerian cement sector, our preferred company is Dangote Cement. This is because the group has proven more resilient and adaptable in a challenging environment than local peers. We have therefore become more confident in its medium-term growth outlook as we believe that the group is poised to deliver high single-digit EPS growth over the medium term, towering above peers, although it is unlikely to accomplish this in FY16 (especially with cost headwinds). Furthermore, we think Dangote Cement continues to present an attractive dividend story. Summary of changes in target prices Below we present the companies in our universe in Nigeria along with our investment case. We maintain our previous recommendations on the stocks although at revised target prices. Table 6: Nigerian cement companies - equity ratings and target prices (9 September 2016) Company Ticker Rating Price (NGN) New TP (NGN) Old TP (NGN) ETR Mkt Cap (NGN'bn) Dangote Cement DANGCEM NL Hold % 2,948,008 Lafarge Africa WAPCO NL Sell % 290,603 CCNN CCNN NL Hold % 7,540 AshakaCem ASHAKACE NL Hold % Source: Bloomberg, Exotix research estimates Ashaka Cement we maintain our HOLD recommendation, based on a revised target price of NGN21.00, implying a +6.1% ETR. Our recommendation is based on (1) downward revisions of our core operating assumptions following recent earnings releases - particularly a weak performance in H1 16; (2) its bottom-tier return profile, below its cost of equity and; (3) relatively rich valuation as it trades at an unjustified premium to peers. Also we believe low liquidity in the stock could keep its share price range-bound. CCNN we reiterate our HOLD recommendation on CCNN based on a revised target price of NGN7.00 implying an 18% ETR. Our recommendation reflects concerns over its (1) weak earnings and RoE outlook over the medium to long term owing to its high sensitivity to FX and cement price movements; (2) weak operating leverage due to its uncompetitive cost base; and (3) lack of visibility over planned capacity expansion. Lastly, we do not believe the current cheap valuations reflect the weak fundamentals of the company. Dangote Cement we reiterate our HOLD recommendation based on a revised target price of NGN188.00, implying a +13% ETR. Our recommendation is on valuation grounds, which we consider fair and reflective of normalised returns. We are now more constructive on the group s earnings outlook owing to (1) its ability to 14

15 NIGERIAN CEMENT INDUSTRY sustain volume growth and consolidate market share; (2) its proactive cost engineering; and (3) its relatively superior profit margins and ROE, reflecting its market dominance and effective cost management. We believe that these will provide a cushion for the group s earnings in periods of volatility. Lafarge Africa We maintain our SELL recommendation, based on a revised target price of NGN52.00, implying a -10% ETR, on the basis of: (1) its weaker core operations impacted by the recent deterioration of the Nigerian operating environment; (2) lack of a coherent strategy to restructure the business in recognition of greater industry competition, the need to refinance outstanding dollar-denominated debt, and capacity expansion requirements; (3) debt overhang; (4) impending dilution of minority shareholders; and (5) its relatively rich valuations. 15

16 NIGERIAN CEMENT INDUSTRY COMPANY SECTION 16

17 ASHAKA CEM PLC 14 September 2016 MATERIALS Recommendation: HOLD Price Target price Expected share price return 5.3% Expected dividend yield 0.8% Expected total return 6.1% Market cap (mn) 44,677 Market cap (US$mn) 142 Avg. daily volume (US$mn) 0.00 Market performance in NGN YTD return (%) (19.6) 3-month return (%) (5.1) 1-yr return (%) (10.2) Share price performance Sep-15 Dec-15 Mar-16 Jun-16 Sep-16 Contact: NSE ASI Jumai Mohammed jumai.mohammed@exotix.com AshakaCem Trading ahead of fundamentals We maintain our HOLD recommendation on Ashaka based on a revised target price of NGN21.00/share (previously NGN22.50/share), implying an ETR of 6.1% (inclusive of 0.83% dividend yield). Our revision is based on (1) downward revisions of our core operating assumptions following recent earnings releases - particularly the weak H1 16 performance; (2) weak ROE profile, below its cost of equity; and (3) relatively rich valuation. At its current price, Ashaka trades on 19.0x and 8.3x FY17f PE and EV/EBITDA an unjustified premium to SSA peers which trade on FY17f PE and EV/EBITDA 8.6x and 6.9x respectively. Limited upside owing to low stock liquidity - Ashaka Cement s free float has now been reduced to 15% following a voluntary tender offer by Lafarge which saw an additional 2.5% of minority interest tendered. We fear the low liquidity of the stock could keep its share price range-bound, as it has been over the last five months. We revise our FY16f earnings upwards we raise our FY16f EPS by 4% to NGN1.16 (from NGN1.12), representing a decline of 6% yoy, stressing the tough operating environment in Nigeria. Our upward revision is aided by strong exceptional FX gains owing to a revaluation of its unutilised letters of credit. Excluding such gains we expect the company to record an operating loss of NGN46mn, due to (1) a weaker than anticipated pick-up in cement demand resulting from the weak economic environment and the slower rebuild in the north east region following several insurgent attacks; (2) lower price realisation, as Ashaka struggles to pass on cost-inflation to the market due to the weakness in the north-east region; and (3) surge in electricity and energy costs in the year, due to the +45% price hike in power implemented in February and higher diesel price in the year, +30% YTD. Our views on FY16f earnings estimates are consistent with the weak operating performance in H1 16 when the company recorded a loss of NGN575mn. However, we incorporate a slight improvement in operating profit in H2 16 aided by (1) an uptick in volumes as the company benefits from a low base effect and as public sector demand improves; and (2) higher selling prices following recent selling price hikes (NGN100/bag in March, NGN50/bag in May, NGN50/bag in June, and NGN600/bag in August) will slightly offset cost pressures. Medium-term outlook - we forecast EPS growth of 4% (previously 17%) pa over FY15-18f to NGN1.28, which compares to an average decline of 1% pa historically over the last five years. Our outlook reflects: (1) a rebound in volumes coming from a low base and a recovery in regional demand given the improved security, and (2) energy cost savings as the company continues to invest in power projects over the period, increasing its use of local coal over expensive grid electricity, diesel and heavy fuel. Year to 31 Dec f 2017f 2018f Revenue (mn) 21,134 17,415 16,300 19,683 22,438 Operating profit (mn) 3,984 2,911 (46) 2,172 3,190 Net Income (mn) 4,567 2,765 2,601 2,095 2,859 EPS EPS (Old) DPS P/E (x) EV/EBITDA (x) Dividend yield (%) 2.3% 0.8% 0.8% 1.2% 0.0% Recommendations and opinions in this report, unless otherwise stated, are based on a combination of discounted cash flow analysis, ratio analysis, industry knowledge, logical extrapolations, peer group analysis and company specific and market technical elements (events affecting both the financial and operational profile of the company). Forecasting of company sales and earnings are based on segmented top-bottom models using subjective views of relevant future market developments. In addition, company guidance and financial guidance is taken into account where applicable. This report is on a stock under active coverage. All prices provided within this research report are taken from the close of business on the day prior to the issue date unless explicitly stated. Exotix Partners LLP is authorised and regulated by the Financial Conduct Authority. Please see disclosures on the last page of this document. Required Disclosures: 17

18 Tanga Cement Bamburi GEM DangCem Twiga cement SSA average PPC Arm Ashaka Ciments Du Maroc CCNN Lafarge Africa DangCem Twiga cement Arm PPC Tanga Cement Bamburi GEM SSA average Ciments Du Maroc CCNN DM Ashaka EAPCC Lafarge Africa ASHAKA CEM PLC Weak return profile. With regard to RoEs, Ashaka has historically reported the lowest within our universe due to its high cash position, averaging 9% pa between FY10-15 vs the SSA peer average of 20% in the same period and notably below its cost of equity of 15.4%. We anticipate that this will decline over the medium term, averaging 5% pa, due to weaker earnings and as its cash balances grow. A caveat will be that management could deploy the cash on its books to increase capacity investment which should increase its operating leverage in the long term. In the event that capacity cannot be increased, perhaps due to escalated security challenges in the region, management could consider paying out excess cash as dividends to shareholders. Figure 5: Ashaka Cement - earnings outlook vs select peers (FY15-FY18f), % Figure 6: Ashaka Cement - RoAE vs select peers (FY16f), % (0.0) (3) (16) (17.0) (4.8) Source: Company accounts, Bloomberg, Exotix research estimates Source: Bloomberg, Exotix research estimates Table 7: Ashaka Cement - changes to estimates (NGN bn) FY16f FY17f FY18f New old % New old % New old % Revenue 16,300 18,139 (10) 19,683 21,114 (7) 22,438 25,337 (11) EBITDA 1,765 4,254 (59) 4,065 5,740 (29) 5,391 7,623 (29) PBT 2,827 2,911 (3) 2,793 4,628 (40) 3,812 6,375 (40) Net Income 2,601 2, ,095 3,332 (37) 2,859 4,462 (36) Net Asset 53,376 55,683 (4) 55,081 58,639 (6) 57,416 62,269 (8) EPS (NGN) (37) (36) DPS (NGN) (37) (36) EBIT margin % Net margin, % Source: Company accounts, Exotix Research estimates Rich valuations on our estimates, the company s valuations are relatively rich: currently trading on 2017F EV/EBITDA of 8.3x, which represents a considerable premium to the SSA peer average of 6.9x and its historical averages of 4.0x. We consider the premium unwarranted noting its weak profitability trend. 18

19 Price changes in Nigeria (2016f) ASHAKA CEM PLC Valuation We continue to use a combination of a DCF and relative valuation methodology, applying equal weightings to both. Our DCF yields a TP of NGN25.70/share, while our relative valuation based on one- and two-year forward PE and EV/EBITDA yields a TP of NGN16.61/share. Table 8: Dangote Cement - target price derivation (NGN) DCF Relative valuation Target price (weighted average) Source: Exotix research estimates Risks to our valuation Key risks to our forecasts, valuation and recommendation include: Greater than expected competition, resulting in greater than anticipated volume and pricing pressures. Heightened security challenges which could cause further delays in returning things to normality in the region. Sooner-than-anticipated delivery on expansion plans, which could be a driver for higher RoEs for the company. Sensitivity analysis In the table below, we present a sensitivity analysis of Ashaka Cement s FY16f earnings to changes in the NGN/US$ exchange rate and changes in cement prices beyond our FY16 estimates. Table 9: Ashaka Cement - sensitivity of FY16f EPS to changes in FX rates and cement prices Changes in US$/NGN exchange rate % change in rate 20% 10% 0% -10% -20% -30% Average exchange rate % 83% 89% 94% 99% 105% 110% 10% 52% 57% 63% 68% 73% 79% 5% 21% 26% 31% 37% 42% 47% 0% -11% -5% 0% 5% 11% 16% -5% -42% -37% -31% -26% -21% -15% -10% -73% -68% -63% -57% -52% -46% Source: Exotix estimates -15% -105% -99% -94% -89% -83% -78% 19

20 ASHAKA CEM PLC Table 10: Ashaka Cement - financial summary Income statement (NGN mn) FY14 FY15 FY16f FY17f FY18f Year-end: December Revenue 21,134 17,415 16,300 19,683 22,438 EBITDA 5,744 4,513 1,765 4,065 5,391 Operating income 3,984 2,911 ( 46) 2,172 3,190 Pre-tax income 5,251 3,209 2,827 2,793 3,812 Post tax income 4,567 2,765 2,601 2,095 2,859 Net income 4,567 2,765 2,601 2,095 2,859 Balance sheet (NGN mn) FY14 FY15 FY16f FY17f FY18f Cash and equivalents 11,053 6,923 4,436 4,441 6,554 Current assets 21,693 19,989 18,971 19,856 22,685 Non-current assets 49,834 50,387 52,651 55,088 54,682 Total assets 21,693 19,989 18,971 19,856 22,685 Current liabilities 8,129 7,397 8,282 9,899 9,987 Non-current liabilities 12,137 9,964 9,964 9,964 9,964 Long-term debt Minorities interest Shareholders' equity 51,262 53,015 53,376 55,081 57,416 Net debt/(funds) (11,053) (6,923) (4,436) (4,441) (6,554) Change in working capital (5,024) (5,019) (584) 738 (628) Cash flow statement (NGN mn) FY14 FY15 FY16f FY17f FY18f Funds from operating activities 190 (1,542) 955 4,105 3,810 Funds from investing activities (1,536) (1,173) (3,106) (3,709) (1,173) Funds from financing activities (941) (1,008) (336) (390) (524) Operating free cash flow (2,616) (4,065) (3,120) (226) 2,015 Net increase/(decrease) in cash (2,286) (3,723) (2,486) 5 2,113 Key metrics FY14 FY15 FY16f FY17f FY18f HEPS (NGN) DPS (NGN) BVPS (NGN) Revenue growth (%) (3) (18) (6) EBIT growth (%) 126 (27) (102) (4,777) 47 HEPS growth (%) 62 (39) (6) (19) 36 Margins and returns (%) EBITDA margin EBIT Margin Pre-tax margin Net margin ROIC ROE Valuation and leverage metrics P/E (x) EV/EBITDA (x) EV/Capacity (USD) Net debt/ equity Source: Company annual reports, Exotix research estimates 20

21 CEMENT CO. NORTHERN NIGERIA 14 September 2016 MATERIALS Recommendation: HOLD Price 6.00 Target price 7.00 Expected share price return 16.7% Expected dividend yield 1.3% Expected total return 18.0% Market cap (mn) 7,540 Market cap (US$mn) 24 Avg. daily volume (US$mn) 0.00 Market performance in NGN YTD return (%) (35.0) 3-month return (%) (14.8) 1-yr return (%) (27.9) Share price performance Sep-15 Dec-15 Mar-16 Jun-16 Sep-16 Contact: NSE ASI Jumai Mohammed jumai.mohammed@exotix.com CCNN Attractive valuations but weak fundamentals - maintain Hold In this note we reiterate our HOLD recommendation on CCNN based on a revised TP of NGN7.00 (previously NGN7.80) implying an 18.0% ETR inclusive of 1.3% dividend yield in FY16f. Although its current valuation seems attractive at 5.6x FY17f earnings and 2.8x FY17f EV/EBITDA vs SSA peers which trade on 8.6x FY17f earnings and 6.9x FY17f EV/EBITDA, we are not convinced that the company s fundamentals are robust enough to warrant a Buy, mainly on concerns over its (1) weak earnings and RoE outlook over the medium to long term owing to its high sensitivity to FX and cement price movements; (2) weak operating leverage due to its uncompetitive cost base; and (3) lack of visibility over planned capacity expansion. We cut our EPS estimate for FY16f by 23% to NGN0.83 (previously NGN1.08), representing a decline of 16% yoy to reflect a poor FY16f trend (-49% yoy in H1 16), broadly in line with local peers during the same period, and driven largely by weak volumes and pricing, underpinned by an adverse macro backdrop and increasing competition, although partly offset by a positive trend in operating costs in H1 16. Our adjustments to earnings capture such headwinds and our views are broadly consistent with H1 16 results. where we observed: (1) weak volumes and weak price realisation suggested by the 24% yoy decline in revenue, which more than offset price increases in the period; (2) issues relating to sourcing for fuel, as a result of disruptions to local production of LPFO that occurred in H1 16, and high costs of importing the fuel using funds sourced at the much weaker unofficial FX market; and (3) poor operating cost management. There was also a continued margin contraction, most notably gross margin which dropped 8ppt to 29.1% in H1 16. Medium-term (FY15-FY17f) earnings and RoE outlook we forecast a relatively weak earnings growth and RoE trajectory over the medium term, averaging -3% and 11% pa respectively over FY15- FY18f, placing CCNN in the bottom-tier of our universe of Nigerian cement companies. This also represents a significant deterioration relative to its historical average (FY10-FY15) EPS growth and RoE of -1% and 23% pa respectively. Headwinds driving our medium-term outlook are (1) lower cement prices, as we observe a declining trend across the industry on the back of increasing completion; although we expect it to command a premium over local peers; (2) vulnerability of its earnings to weakness in the naira, given its relatively large dependence on a single fuel source, LPFO, which is indirectly linked to the dollar. The company s insufficient operating leverage (discussed below) magnifies the impact of the aforementioned costs on earnings relative to peers. Notably, a 5% decline in our FY16f forecast for cement prices, all other things remaining unchanged, results in (continued overleaf) Year to 31 Dec 2014A 2015A 2016f 2017f 2018f Revenue (mn) 15,119 13,038 11,704 13,389 14,139 Operating profit (mn) 2,749 1,889 1,659 1,902 1,603 Net income (mn) 1,918 1,201 1,045 1,205 1,088 EPS EPS (Old) DPS P/E (x) EV/EBITDA (x) Dividend yield (%) 11.7% 5.8% 1.3% 4.8% 5.1% Recommendations and opinions in this report, unless otherwise stated, are based on a combination of discounted cash flow analysis, ratio analysis, industry knowledge, logical extrapolations, peer group analysis and company specific and market technical elements (events affecting both the financial and operational profile of the company). Forecasting of company sales and earnings are based on segmented top-bottom models using subjective views of relevant future market developments. In addition, company guidance and financial guidance is taken into account where applicable. This report is on a stock under active coverage. All prices provided within this research report are taken from the close of business on the day prior to the issue date unless explicitly stated. Exotix Partners LLP is authorised and regulated by the Financial Conduct Authority. Please see disclosures on the last page of this document. Required Disclosures: 21