Dangote Cement: 2014 Half Year Results
Dangote Cement Plc (Bloomberg ticker – DANGCEM:NL) is the most capitalized stock on the Nigerian Stock Exchange, with market capitalization of about N3.9 trillion. Last week, Dangcem released its half-year results for the period ended June 2014. We will analyze the financial statements to determine the profitability, and then conclude with its valuation to know if the stock is worth purchasing at current levels.
Dangcem grew its revenues by 5.3% between June 2013 and June 2014 from N198.463 billion to N208.908 billion. The company attributed the weak growth in revenues to a partial shutdown in one of their plants, and they expect this to come back upstream sometime in the next 12 months. The reality is that the revenue growth was weak, and we will not make any attempt to adjust for the plant shutdown because our investment strategy is based on current performance, not future promises. 42.5-grade cement, which is used for building houses accounted for 100% of their sales. Dangcem was able to grow gross profits by only 1.1% from N132.136 billion to N133.539 billion; the company also attributed the increased cost of sales to inadequate fuel supply, and that they expect the new coal facilities to improve the cost control in the coming years.
Profit from operating activities also increased by only 0.8% year on year from N111.090 billion to N111.984 billion; it is apparent that Dangcem continued to struggle with keeping costs under control in every way imaginable. The growth from operating activities was actually influenced by “Other Income”, which grew by 134.3% from N827 million to N1.938 billion. The footnote to the financial statement showed that a non-descript item named “Sundry Income” accounted for 82.0% of the “Other Income” in June 2014, growing by 336.5% from N364 million to N1.589 billion. No further comment was made about the “Sundry Income” or what it stood for. Apparently, this does not look like a recurring on an ongoing and stable source of income. If we adjust the operating profit for this “Sundry Income”, Dangcem would have experienced a reduction in operating profits from June 2013 to June 2014. However, given that this “Sundry Income” accounts for only 1.1% of net profits, after adjusting for taxes, we will keep this line item in the determining the valuation for Dangcem, but we remain skeptical about it.
The profit before tax dropped by 0.6% from N107.681 billion to N107.070 billion. This was due to a rise in net finance costs, which grew by 44.1% from N3.41 billion to N4.91 billion. Dangcem’s tax holiday is over and they paid income taxes in June 2014. This caused a further decline in profit after tax, which dropped by 11.4% from N107.681 billion to N95.440 billion within the period under review. Our conclusion is that Dangcem experienced weak revenue growth and then suffered increase costs in every imaginable way, and the relatively poor bottom-line was somewhat supported by an unexplained growth in “Sundry Income”.
Out of curiosity, we went a little further to determine which quarter Dangcem suffered the increased costs in 2014. The net profit margin in the first quarter ended March 2014 stood at 46.0%, while that of the second quarter (April – June 2014) stood at 45.4%. While doing this, we noted that the “Other Income” experienced the largest growth in the first quarter of the year. When the net profit margin was adjusted for this line item, the net profit margin in the first quarter dropped to 44.7% while that of the second quarter also dropped to 45.0%. It is therefore safe to conclude that despite increases in costs, Dangcem was able to improve its net profit margin in the second quarter of the year as against the first quarter.
The return on equity (ROE) for Dangcem dropped from 42.9% in June 2013 to 35.4% in June 2014. That could be a major source of concern, and we chose to determine what exactly caused this drop in ROE. The net profit margin, as we observed earlier, dropped marginally from 48.4% to 45.7%, but that was not enough to shave off over 700 basis points from the ROE. The asset turnover also dropped 0.56 to 0.48, which means that Dangcem’s efficiency has reduced. The company is not sweating its asset well enough; the partial shutdown could not have contributed to this, but it is not an encouraging sign. The leverage ratio increased marginally from 1.58 to 1.62 but this rise was not big enough to offset the drop in net profit margins and the asset turnover.
Now we will turn our attention to the cash management system. The inventory turnover dropped rose from 3.8 to 4.8; Dangcem is not tying cash down unnecessarily in inventories, and this is expected to free up cash that can be invested in the banks to make some returns for the company. The number of days of sales outstanding dropped from 12 days to 8 days; this means that if you buy goods from Dangcem, you have to pay for them in about 8 days. Not bad for a company that is already cash cow. Now given the fact that account receivables account for only 4.0% of revenues generated in 6 months, we strongly recommend that Dangcem tries to relax its credit policies a little bit. This is will invariable help the company boost sales. At the other end of the cash management spectrum, the number of days of payables outstanding rose from 198 days to 239 days! This simply means that if Dangcem owes you, well, you will get paid in about 8 months. We will also recommend that Dangcem relaxes this policy and pay their suppliers a little earlier. This company might be enjoying a huge market share but I doubt that suppliers are happy with keeping cash with them for so long while customers have to pay for goods in less than 10 days. Dangcem has a solid cash management system and it is apparently using its size and creditworthiness to squeeze out all available returns that can be generated from cash management.
From the analysis done so far, we do not think Dangcem is in trouble. This is a well-run company that has a very high profit margin despite the rising costs, especially from taxes and operations. There are two things that stand out as sources of concern. One is that the company is so engrossed in keeping its net profit margin high at the expense of improving efficiency. The asset turnover dropped from 0.56 to 0.48. The fact is that as competition increases in the industry, profit margins are going to reduce. The industry cannot remain as an oligopoly forever and the earlier the company recognizes that the better. The second source of concern is that the company is too strict with its cash management system. They should endeavor to make their suppliers and customers a little happier; Dangcem’s quality of earnings is already solid, and it will do them more good than harm if they relax a little.
Now to the question of valuation. Is Dangcem a buy, sell or hold? The stock, which is selling at N266.00 per share seems to be fairly valued at this point. It is selling at a PE of 20.2x, Price to Book Value of 7.3x and Dividend Yield of just 2.9%. Our valuation methodology, which combined both relative and fundamental factors showed that the stock has a fair price of about N235.36, which is just 4.1% from current price.
We have a hold recommendation on Dangote Cement at current pricing.