CSL Stockbrokers LTD NIGERIA Equity Research Rating: A268** BAGCO Nigeria Plc: NIGERIA Conglomerate Date: 30 Nov 2007. Opinion Rating: A268 Price Target: Offer Price: NGN4.03 NGN3.90 M. Cap @ offer price: NGN 24.2bn M Cap @ Target price:ngn25.0bn Estimated Net Proceeds: NGN6.952bn Use of Proceeds USE N (%) Loan repayment 6.26bn 90 Working Capital 0.69bn 10 Total Proceeds 6.95bn 100 Key Stock Data Share-holding Structure Shareholders No. of (%) Shares Flour Mills 4.35bn 70% Other Nigerians 1.865bn 30% Total no. of Shares outstanding 6.215bn 100% Free float: 30% Key financial Data FY 07 (Pre-Offer) Total Asset: NGN13.111bn Gross Earnings: NGN9.0bn Net Earnings: NGN931.9mn Shares Outstanding: 4.35bn Shareholders equity: NGN1.57bn Reason for the report: INITIATING COVERAGE The Nigerian Bag Manufacturing Company Plc (BAGCO) presents investors with an opportunity to participate in its heritage of excellence and market leadership through the roll out of its shares in an Initial Public Offering. Bagco is Nigeria s premier bag manufacturer with a solid reputation for innovation, strong management and good service to its customers. Currently the company is the dominant sack and bag manufacturing firm in Nigeria, providing the bagging needs of most of the leading cement manufacturing companies in the country. In terms of future growth, Bagco intends to leverage on already established customer relationships, its state of the art production facilities, and the Federal Government s import substitution policy with respect to cement production to maintain its market dominance and leadership in the industry. Industry Leader The Bagco group is regarded as the foremost suppliers to Nigeria s independent customers of woven Polypropylene products. Its market position is underscored by its significant market share which is estimated at 35% of the entire bag manufacturing market. Superior growth Prospects The Federal Government s policy stance that demand for cement in the country should be met by local manufacturers is expected to lead to increased demand for polypropylene sacks. Bagco s enhanced production capacity, places it in an ideal position to take up the anticipated rise in demand Valuation In pricing Bagco we used, a weighted average model comprising of earnings multiples of industry and peer group companies, and a DDM valuation model. We have used NAMPAK and Beta glass as comparables for Bagco because of all the companies listed on the Nigerian Stock Exchange; they are the closest to Bagco in terms of their operational processes. Our valuation was done based on forward P/E multiples of 28.96x, and P/B multiple of 1.48x, Our DDM model was based on a discount factor of 16.08% and sustainable growth rate of 7.25%. Our price computations based on a weighted average of these price outputs puts the fair value for Bagco at N4.03. In view of this we have assigned Bagco long term buy because of the enhanced growth prospect of the industry going forward and the company s positioning to take advantage of the anticipated increase in demand. Whilst we have assigned the stock a short term hold because we believe that key performance indicators are likely to decline in the short term due to the time lag between the acquisition of new capital and its deployment. SALES $MN PAT $MN EPS (NGN) TAX $MN DPS (NGN) D/YIELD P/E X 2005 A 43.92 0.43 0.21 0.18 - - 18.86 2006 A 65.65 7.81 3.72 0.48 - - 1.05 2007 A 75.99 7.83 3.73 1.19 - - 1.05 2008 E 104.69 9.0 0.17 1.26 0.04* 1.09 22.62 2009 E 129.85 14.0 0.27 2.53 0.17 4.44 14.52 2010 E 144.16 15.87 0.30 7.24 0.18 4.64 12.83 Source: Offer Prospectus, CSL Research. (*2008 DPS is for one quarter) ($1/N119)
Summary and Investment case Net profit margins to dip slightly in 2008 before rebounding to prior year levels. Profitability: The Company s profitability has been increasing in absolute terms over the years as Net profit over the period (2003-2007) recorded a CAGR of 110.3% and recovered from a negative position in 2003 to a high of over N900 million in 2006. This is aptly depicted by the ROE which rebound from a negative position in 2003 to a high of 141% in 2006. ROE however dipped to 59.3% in 2007. Analysis of the net profit margins shows an increase from 2.9% in 2004 to 10.3% in 2006. However, the company s forecast figures indicate that net profit margins will dip to about 8.6% before recovering to between 10 and 11% in 2009. ROE is also set to decline to about 12% in 2008 before rising to 17% in 2009. We are concerned about the company s ability to generate adequate returns on shareholders capital given that margins are expected to decline in the near future before recovering to normal levels. Margin Ratios 35% 30% 25% 20% 15% 10% 5% 0% 2005 2006 2007 2008E 2009 E 2010 E Gross profit margin Operating Profit Margin Net profit margin Declining operating ratio indicates ability to curtail costs. Efficiency: Operational efficiency as depicted by the asset turnover ratio declined from 1.12x in 2004 to 0.69x in 2007. This implies that the company was only able to generate sales of N69 on every N100 of assets it held in 2007, compared to sales of N112 on every N100 of assets held in 2004. However, examination of the company s forecast figures indicate that this ratio would improve to 0.85x, 0.94x and 0.97x in the years 2008 through 2009 respectively. The company has also been improving in curtailment of its operating expenses as its operating ratio has been on a pat of steady decline since 2003. Operating ratio (ratio of operating expenses to sales) declined from 21.9% in 2003 to 12.56% in 2007. The company s projections indicate that this ratio should decline to about 12% in 2008. Bagco s ability to curb operating expenses is commendable; however we are concerned about its ability to effectively sweat its asset in view of the new injection of capital. Efficiency Ratios 2010 E 2009 E 2008E 2007 2006 2005 0.00% 20.00% 40.00% 60.00% 80.00% 100.00% Asset turnover Operating ratio 2 CSL Stockbrokers
Short term assets were inadequate to meet current obligations. Liquidity: A glimpse at the Bagco s liquidity ratios, reveal that its current assets were lower then its current obligations during the period review period. Current ratios were 0.78, 0.83, 0.70, 0.95 and 0.90 respectively for the years 2003 through 2007. Likewise the quick ratio ranged between 0.27 and 0.53 during the period. An interpretation of these ratios suggests that the company s short term assets were inadequate to meet its short term obligations and substantial proportion of its working capital requirements had to be financed through bank overdrafts. 2005 2006 2007 Receivable days 20.00 14.79 21.16 Inventory Turnover 2.72 3.77 3.25 Payable days 77.30 67.81 69.80 Cash Conversion Cycle -54.59-49.25-45.39 Analysis of the company s cash conversion cycle (CCC) also reveals that the company receives cash form its customers at a faster rate than it pays out to its creditors. This is depicted in the average receivable days which were 20 days, 14.79 days, and 21.16 days respectively for the years 2005 through 2006, while its average payable days were 77.3 days, 67.8 days and 69.8 days respectively during the same time period. Thus we can infer that the company makes use of spontaneous financing to meet part of its working capital requirements. However, the company s liquidity position will be enhanced by the new injection of funds as about 10% of the offer proceeds will be committed to working capital needs. Leverage ratios indicate that Bagco is highly leveraged Leverage: Examination of the company s leverage ratios suggest that the company is highly geared. The company s proportion of balance sheet debt to equity declined from about 29x in 2005 to 7.34x in 2007. Likewise the total debt ratio which shows the proportion of interest bearing debt in a firm s capital structure declined from about 75% of total assets in 2005 to 57% as at the end of fiscal year 2007. The high level of leverage employed by the company was due to the negative position of shareholders equity from 2003 through to 2005. However, the Bagco s leverage status is set to make a dramatic recovery as about 90% of the offer proceeds will be used for loan repayment. Leverage Ratios 35 30 25 20 15 10 5 0 2005 2006 2007 2008E 2009E 2010E 80.00% 60.00% 40.00% 20.00% 0.00% Debt Equity Ratio Total debt ratio CSL Stockbrokers
Company Background Premier Bag manufacturing company in Nigeria The Nigerian Bag manufacturing Company Plc (Bagco) was incorporated in 1964 as a wholly owned subsidiary of Flour Mills of Nigeria Plc. Bagco s Pioneering spirit was firmly established when in 1972 it became the first company to introduce polypropylene bags into the Nigerian market. Over the next decade, the company enjoyed a period of growth and rapid expansion as its production base had to be increased in line with the growing demand of the domestic market. This resulted in the establishment of the Northern Bag Manufacturing Company limited (Bagco North) in 1990 with a view to meeting increased demand from that region of the country. The company s leadership role in the bags manufacturing landscape came to the fore again when in 1999 it introduced the versatile Adstar polypropylene cement sacks into the local market. Presently only three companies in Nigeria (of which Bagco is one) produce the patented Adstar block bottom valve bag with total industry output estimated at 37 million bags per month. The company s ability to exploit opportunities in the market place was again exhibited when it incorporated Bagco Morpack its newest subsidiary for the production of printed flexible packaging. Bagco Morpack will commence operations in the first half of 2008. Today the Bagco Group competes in all segments of the bag/sack manufacturing market, and its strategic investments in new production technologies has allowed it to emerge as one of the largest suppliers of polypropylene sacks in Nigeria and West Africa. Investment Thesis Strong brand equity Experienced managemtent team The company has a strong brand name that can be leveraged upon as a marketing tool. An experienced Management Team with a thorough knowledge of the Nigerian market and requisite skills and expertise, needed to actualize the underlying forecast. Experience curve developed over the years resulting in tried and tested logistics flows coupled with economies of scale that accompany volume production would ensure cost savings over its competitors. Efficient distribution network by virtue of its strategic factory locations; {Lagos (South) and Kano (North)} that gives it reach to all parts of the country. Strategic factory locations and distribution network The Bagco Group has unused capital allowances (over N3 billion as at March 2006) that would enable it pay corporate taxes at reduced rates for the next 2 years. In addition, Bagco-Morpack (its new subsidiary) has obtained pioneer status which will make it free from the payment of corporate taxes for the next 3 to 5 years. The combination of these two factors would have the attendant effect of enhancing the company s overall profitability with a view to maximizing shareholder value. Preferred suppliers to Burham Cement and UNICEM The company has entered into long term contracts (2 years) with major manufacturers of cement in Nigeria. In addition, it is a preferred supplier to Burham Cement and United Cement Company of Nigeria (UNICEM) which is billed to commence operations in 2008. This is in addition to its already established markets which include the agricultural markets which it supplies (Supersack and Kakaki) bags for the packaging of grains and vegetable; and the domestic market which it supplies strong durable shopping bags (Supersack, Heritage and Carry go). Bagco continues to embark on research and development initiatives aimed at ensuring that innovative products are constantly brought to the market. Furthermore its engineering workshops ensure that the production processes are not disrupted while awaiting imported replacement parts. 4 CSL Stockbrokers
The resumption of operation of Eleme Petrochemical Company in Rivers state has brought a local source of raw materials for Bagco. This has resulted in lower input costs combined with a reduced demand for foreign exchange for the company. SWOT Analysis Strengths Strong brand equity Established markets and supply relationships State of the art production facilities Efficient Distribution network Weaknesses Very high input costs, raw material inputs account for about 50% of production cost Opportunities Threats Increased local production of cement. Import restrictions on bags Growth of the construction industry Positive economic outlook Market share loss due to entry of smuggled products Raw material inputs are subject to Scarcity of world supply, import restrictions and high duty taxes. Moderately competitive industry with 3 primary participants High entry barriers Industry Overview The industry is a moderately competitive one with 3 primary participants (Bagco, Dangote Agro Sacks and Ibeto).Total installed industry capacity for the production of the patented Adstar polypropylene bags is estimated at 37 million bags per month. Bagco s dominance in the industry is underscored by its production capacity of 25 million bags per month. The Industry is characterized by High entry barriers by way of capital requirements, logistic chain for the importation of raw materials and effective distribution network for finished products. Production costs are high, as considerable funds must be expended on the importation of raw materials and energy as the production process is energy intensive. In addition import restrictions and tariff regime encourage local production of bags as opposed to importation. CSL Stockbrokers
Industry Analysis Porters Five Forces Model Suppliers Power Buyers Power Bargaining power of suppliers HIGH/ MEDIUM AND RISING: 2 High cost of raw material inputs in the global market. Inputs are also subject to price fluctuations, scarcity and high tariffs. High labour unionism Substitutes Threat of substitute products LOW/ MEDIUM AND STABLE: 4 Industry Rivalry Rivalry amongst existing firms LOW/MEDIUM AND STABLE: 3 Oligopolistic type of industry with players having defined customers. Bargaining power of buyers MEDIUM: 3 Mixed switching costs due to ability of buyers to switch to alternative suppliers. However, switching may be constrained by industry capacity Potential Entrants Threat of new Entrants LOW/MEDIUM AND STABLE: 4 Polypropylene bags have no perfect substitutes in the Nigerian market as High barriers to entry due to the significant level of capital requirements the packaging of cement products in non polypropylene bags has been restricted by the government. 5 4 3 Attractive competitive Forces Development of Logistic chain and distribution chain. 2 1 Unattractive Competitive Forces 6 CSL Stockbrokers
Valuation Dividend Discount Model; We have carried out our valuation of Bagco based on its forecasted dividend per share. According to the forecast, Bagco will pay dividend per share of N0.16, N0.17 and N0.21 respectively for the fiscal years 2008 to 2010. We have applied a discount rate of 16.08%, using the yield on 3 year FGN bond (8.88%) as risk free rate, an inflation premium of 4.2% and a default risk premium of 3%. We arrived at a present value of NGN2.84 Price to Earnings (P/E) ratio: Bagco s forward P/E ratios (at offer price) based on forecast earnings are 22.62x, 14.52x, and12.83x respectively, for the years 2008, 2009 and 2010. Combining our forecasted 2008 EPS with the industry trailing average PE of 28.96x gives us a value of NGN4.92 Price to Book (P/B) ratio: The company s P/B ratio at offer price stands at 0.62x, while forward P/Bs at offer price are 2.63x and 2.47x and 2.30x respectively for the years 2008, 2009 and 2010 respectively compared to peer average P/E of 1.71x. Combining the peer average P/B figure with the computed book value per share gives us a value of NGN2.53. In arriving at a fair value for Bagco we calculated the weighted average of all the values arrived at based on the different valuation models mentioned above. Based on our computations, the company s offer price is a 3% discount below its fair value of NGN4.03. Risks to our Valuation Macroeconomic Risk: Bagco faces a risk of the economy not meeting up with the Federal government s growth target. A declining level of economic activity may have an adverse impact on the company s business. The company s business is heavily reliant on the construction industry whose fortunes are inextricably linked to the economic progress of the country. Operating Risks: The Company operates in a competitive environment with lots of challenge from existing competitors. Furthermore there is always the threat of new entrants to the market. We believe that the relationships Bagco has built over the years with its suppliers and customers would give it a competitive edge. This is in addition to it s proven logistics chain and distribution network would be a source of competitive Foreign Exchange Risk: Bagco s primary production inputs are sourced from abroad, hence the company is exposed to fluctuations in exchange rate. This could affect the prices at which it buys inputs at the world market. However given the CBN s efficient management of exchange rate and the nation s huge foreign reserves, it is expected that the exchange rate between the Naira and other major currencies would remain stable in the short to medium term. Regulatory Risk: A key risk faced by the company is the endorsement of alternative packaging for cement products by Industry regulators. Paper packaging is the only viable alternative for cement products in Nigeria. However the packaging of cement in none polypropylene sacks is currently restricted in Nigeria. The risk that this restriction would be lifted in the near future is very low given the environmental implications of such an action. CSL Stockbrokers
BAGCO NIGERIA PLC INCOME STATEMENT 2005 2006 2007 2008 E 2009E 2010E Turnover 5,227,046 7,812,407 9,043,783 12,459,161 15,452,761 17,154,974 Cost of Sales (4,117,308) (5,386,271) (6,098,327) (9,148,703) (11,469,162) (12,206,851) Gross Profit 1,109,738 2,426,136 2,945,456 3,310,458 3,983,599 4,948,123 Other income 202,070 251,467 129,939 122,861 153,805 164,608 Distribution expenses (45,331) (95,057) (103,821) (136,315) (144,204) (151,071) Administration expenses (859,034) (963,519) (1,024,816) (1,370,508) (1,699,804) (1,887,047) Research & Development Cost (7,458) (5,507) (7,047) (6,663) (8,341) (8,927) Operating Profit 399,985 1,613,520 1,939,711 1,919,833 2,285,055 3,065,686 Interest payable and similar charges (326,365) (627,172) (865,433) (698,455) (314,538) (314,538) Profit before taxation 73,620 986,348 1,074,278 1,221,378 1,970,517 2,751,148 Taxation on profit on ordinary activities (21,935) (56,943) (142,333) (150,000) (301,305) (861,723) Profit after taxation 51,685 929,405 931,945 1,071,378 1,669,212 1,889,425 8 CSL Stockbrokers
Balance Sheet 2005 2006 2007 2008 E 2009E 2010E Fixed Assets 4,263,510 5,779,708 6,538,269 8,438,269 8,838,269 8,878,269 Investments 10,000 10,000 10,000 - - - Current Assets Stocks 1,922,132 2,074,335 2,780,754 3,986,932 4,944,884 5,489,592 Trade Debtors 286,382 316,624 524,332 747,550 927,166 1,059,747 Amount due from related companies 617,858 1,876,330 2,645,620 - - - Other debtors and prepayments 299,467 466,498 463,958 1,121,324 1,390,678 1,715,497 Cash and bank balances 5,684 13,432 148,687 404,038 259,845 490,632 Total Current Assets 3,131,523 4,747,219 6,563,351 6,259,844 7,522,573 8,755,469 Creditors: Amounts falling due within one year - - Trade creditors 871,995 1,000,656 1,166,213 1,495,099 1,854,331 1,887,047 Bank overdraft 2,708,090 2,669,074 3,785,237 1,370,508 1,545,276 1,372,398 Taxation 21,935 56,808 63,043 97,500 135,587 258,517 Dividend - - 10,000 - - - Term loans 281,251 211,824 1,137,438 124,941 127,764 148,235 Amount due to related companies 23,572 553,699 529,833 599,972 834,606 944,713 Other creditors 543,527 528,478 625,283 498,366 653,652 686,199 Current Liabilities 4,450,370 5,020,539 7,317,047 4,186,386 5,151,216 5,297,108 Net working Capital (1,318,847) (273,320) (753,696) 2,073,458 2,371,356 3,458,360 Total Assets 7,405,033 10,536,927 13,111,620 14,698,113 16,360,842 17,633,738 Total Assets less current liabilities 2,954,663 5,516,388 5,794,573 10,511,727 11,209,625 12,336,629 CSL Stockbrokers
Creditors : Amount falling due after more than one year Deferred Taxation (41,955) (41,955) (122,970) (127,500) (210,914) (473,948) Long term loans (2,845,604) (4,391,773) (3,672,215) (708,000) (724,000) (840,000) Provision for Liabilities & Charges : Gratuities (337,306) (423,457) (427,240) (469,964) (474,236) (482,781) Total Long term liabilities (3,224,865) (4,857,185) (4,222,425) (1,305,464) (1,409,150) (1,796,729) NET ASSETS (270,202) 659,203 1,572,148 9,206,263 9,800,475 10,539,900 Capital & Reserves Share Capital 125,000 125,000 125,000 891,376 891,376 891,376 Share Premium - - - 6,061,361 6,061,361 6,061,361 Revaluation surplus 2,391 2,391 2,391 2,391 2,391 2,391 Capital reserve - - - - - - Revenue reserve (397,593) 531,812 1,444,757 2,251,135 2,845,347 3,584,772 (270,202) 659,203 1,572,148 9,206,263 9,800,475 10,539,900 10 CSL Stockbrokers
KEY RATIOS Profitability 2005 2006 2007 2008E 2009E 2010E ROE -19.13% 140.99% 59.28% 11.64% 17.03% 17.93% ROA 0.70% 8.82% 7.11% 7.29% 10.20% 10.71% Gross profit margin 21.23% 31.05% 32.57% 26.57% 25.78% 28.84% Operating Profit Margin 7.65% 20.65% 21.45% 15.41% 14.79% 17.87% Net profit margin 0.99% 11.90% 10.30% 8.60% 10.80% 11.01% Liquidity Current ratio 0.70 0.95 0.90 1.50 1.46 1.65 Quick ratio 0.27 0.53 0.52 0.54 0.50 0.62 Cash Ratio 0.00 0.00 0.02 0.10 0.05 0.09 Efficiency Receivable Days (DSO) 20.00 14.79 21.16 21.90 21.90 22.55 Inventory days (DIO) 2.72 3.77 3.25 3.13 3.13 3.13 Payable Days (DPO) 77.30 67.81 69.80 59.65 59.01 56.43 Cash Conversion Cycle (CCC) -54.59-49.25-45.39-34.62-33.99-30.75 Operating ratio (operating expense to sales) 17.44% 13.62% 12.56% 12.15% 11.99% 11.93% Asset turnover 0.71 0.74 0.69 0.85 0.94 0.97 Fixed Asset turnover 1.23 1.35 1.38 1.48 1.75 1.93 Interest Cover 1.23 2.57 2.24 2.75 7.26 9.75 Leverage Debt Equity Ratio (28.41) 14.98 7.34 0.60 0.67 0.67 Total debt ratio 0.75 0.67 0.57 0.14 0.14 0.13 CSL Stockbrokers
Share Data Share Price 3.90 3.90 3.90 3.90 3.90 3.90 EPS 0.21 3.72 3.73 0.17 0.27 0.30 DPS 0.00 0.00 0.00 0.04 0.17 0.18 P/E 18.86 1.05 1.05 22.62 14.52 12.83 BV/Share (N) -1.08 2.64 6.29 1.48 1.58 1.70 P/BV -3.61 1.48 0.62 2.63 2.47 2.30 Sales/Share (N) 20.91 31.25 36.18 2.00 2.49 2.76 P/Sales 0.19 0.12 0.11 1.95 1.57 1.41 Dividend Yield - - - 1.09% 4.44% 4.64% Dividend payout 0.00% 0.00% 0.00% 24.73% 64.40% 59.54% Retention Rate 100% 100% 100% 75.27% 35.60% 40.46% Growth rate -19.13% 140.99% 59.28% 8.76% 6.06% 7.25% Price Ratios Market Cap (N000') 975,000 975,000 975,000 24,238,500 24,238,500 24,238,500 Market Cap (US$000') 7,800 7,800 7,800 193,908 193,908 193,908 EV (N000') 3,814,920 5,353,341 4,498,528 24,542,462 24,702,655 24,587,868 EV (US$000') 30,519 42,827 35,988 196,340 197,621 196,703 12 CSL Stockbrokers
CSL Ranking: A-Fundamental Long Term Buy 1- Short Term Buy 4- High Dividend 7- Low Volatility B-Fundamental Long Term Hold 2- Short Term Hold 5- Dividend (Moderate) 8- Moderate Volatility C-Fundamental Long Term Sell 3- Short Term Sell 6- Low Dividend 9- High Volatility DISCLAIMER: This article is based on information available to the public but its accuracy or completeness cannot be guaranteed. This is not an offer to buy or sell or a solicitation to buy or sell the securities mentioned herein. Opinions are expressed in good faith but are subject to change without notice. CSLS Limited may effect transactions in securities of companies mentioned herein and may also perform or seek to perform investment-banking services for those companies. CSL Stockbrokers
For further enquiries, please contact the Investment Research Dept. (cslresearchandstrategy@firstcitygroup.com 14 CSL Stockbrokers