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    Nigiraa vetiva research-cement-sector-study Nigiraa vetiva research-cement-sector-study Document Transcript

    • Nigerian Cement Sector Unbundling Potentials January 4, 2011In this report, we update our views on the Nigerian cement industry, Analystassessing the sector’s long term potentials from a global standpoint. On Tosin Oluwakiyesi t.oluwakiyesi@vetiva.coma company-specific level, we upgrade our rating on Nigeria’s biggestcement producer – Dangote Cement to “Accumulate” whilst downgradingour rating on Ashaka Cement to a “Reduce”. Market Cap: N2,060bn (US$13.7bn) Slight price cuts likely in the short term… In view of the recent % of NSE: 26.2% inventory build-up in the industry, we envisage some reduction in prices, albeit in the short term. In our view, cement producers, in a bid to clear out Forward 2011 P/E: 10.1x accumulated inventory, may further reduce prices directly or indirectly through bonuses and rebates. In contrast to our previous views, we are not likely to see EV/2011 EBITDA: 9.0x the anticipated boost in private sector lending till late Q2, hence strong demand 2011 Div Yield: 6.5% would only resume in the latter half of 2011 into 2012. Whilst sluggish demand persists in the short term, we believe maintaining lower prices at current or YTD perf: 38.81% higher capacity utilisation rates is a better option, compared to reducing Recommendations list capacity utilisation, in view of the huge operational gearing of the industry. Dangote Cement: ACCUMULATE …Notwithstanding, mid to long term fundamentals remain impressive: The need to meet Nigeria‟s huge infrastructural deficit cannot be Lafarge WAPCO: ACCUMULATE overemphasized. Despite its large population and rapidly growing urbanisation, Ashaka Cement: REDUCE Nigerias roads network significantly lags comparable African countries and emerging markets countries (30% paved, in comparison to North Africa average Cement Co. of North. Nig: UNDERWEIGHT of 68%, BRIC average of 64%). Housing deficit has been widely reported as 16 – 18 million units, with an estimated N60 trillion (more than twice Nigeria‟s GDP) needed to bridge the gap. It is evident therefore that the sector‟s long 52-week share price performance (rebased to Dec ‟09) term potential is unquestionable; nonetheless, we believe the potentials are 1.8 gradually unfolding. 1.6 Pivotal to SSA‟s infrastructural development: With the bigger global 1.4 players (Lafarge, Heidelberg, CEMEX) focusing on deleveraging, there would probably be little on-going investment in cement plant expansion in Africa. 1.2 Thus, given the inherent possibility of exports to other African countries in the 1 medium to long term, the Nigerian cement sector can potentially become a 0.8 dominant player within the continent. Furthermore, the planned expansion of 31-Aug 30-Apr 31-Oct 31-Dec 31-Dec 28-Feb 30-Jun Dangote Cement in southern, central and western Africa shows the important role Nigeria‟s cement sector is set to play in sub-Saharan African. ASI Building Materials Index Valuations: On a relative valuation basis, the cement producers are cheap; Source: NSE, Vetiva Research Nigerian cement producers are trading at a 2011 weighted P/E and EV/EBITDA of 10.1x and 9.0x relative to emerging market peer average of 14.2x and 8.9x Vetiva Capital Management Limited respectively. Our valuations for the cement producers are based on an 80/20 266B Kofo Abayomi Street Victoria Island, Lagos weights of Discounted Cashflow and EV/EBITDA valuation methodologies respectively. Thus, we upgrade our rating on Dangote Cement to an Tel: +234-1-46175213 “Accumulate” (11% upside to our fair value), maintain our “Accumulate” Fax: +234-1-4617524 Email: research@vetiva.com and “Underweight” rating on Lafarge WAPCO and CCNN respectively but downgrade our rating on AshakaCem to a „reduce‟ (11% downside to our fair value). Nigerian Cement Sector: Unbundling Potentials I January 2011 I
    • Nigeria I Building Materials I Equities Table of Contents Summary ................... 1 A global perspective .................... 3 Nigerian Cement Sector: The Value Proposition................... 4 Industry Outlook ................... 8 Industry Structure .................. 13 Demand Dynamics .................. 19 Changing Landscape of Supply ................... 21 Pricing dynamics ................... 23 Regulatory Perspective ..................... 26 Investment Summary .................... 28 Quoted Companies ................... 34  Dangote Cement Plc  Lafarge WAPCO Cement Plc  AshakaCem Plc  Cement Company of Northern Nigeria Plc Non-quoted Companies ................... 90 Disclosures ................... 91Nigerian Cement Sector: Unbundling Potentials I January 2011 I 1
    • Nigeria I Building Materials I EquitiesA global perspectiveTimes are changing for global cement producers as they struggle to grow earnings More global cement producers areunder a weight of debt and slowing demand in developed economies. The focus of shifting focus to deleveraging andglobal players on minimising costs and debt exposure, and slowing down on cost cuttingexpansion and investment may make them lose out on the growth prospectsexpected in frontier markets in sub-Saharan Africa. Among the global cementproducers, Lafarge is perhaps the only one well poised to benefit from theongoing and expected economic growth in Africa and the Middle-East, as theregion has the second highest contribution to its global revenue, unlike Holcimand Heiderberg which have very little presence in these regions. The five keyplayers dominating the global cement industry - Lafarge (France), Holcim(Switzerland), Heidelberg (Germany), CEMEX (Mexico) and Italcementi (Italy),account for c.20% (Industry HHI* is 6,685) of global cement sales in 2008,indicating the highly concentrated nature of the industry. Furthermore, the Apart from Lafarge, other globalmature state of most of the global players, has been compounded by the recent players are not likely to embark on any major expansion in Africadownturn in global economy, thus there is considerable pressure on the growthpotentials of the global players, especially in developed economies. Figure 1: Market Share (mill. tonnes of top five global cement producers) 2008 data 220 205 194 165 155 143 103 110 96 89 87 77 63 55 0 Lafarge Holcim Heidelberg Cemex Italcementi Cement Sales Capacity Source: CemNet In Western Europe, where the global players have a major market share, Decline in construction activities in construction activities have been on a decline since the onset of 2010. The Europe considerably affected the eurozone debt crisis further slowed down recovery as the affected earnings of the key global players governments embarked on fiscal cuts, thus reducing the spend on new infrastructural and non-residential public projects which should have stimulated construction activity. Regional split of sales for the producers (as at half year 2010) shows declining sales in Europe, with slight pick-ups in North- America, Asia and Africa. * HHI means Herfindahl HirschMan Index, calculated as the sum of the squared market share of industry players. It‟s a measure of industry concentration.Nigerian Cement Sector: Unbundling Potentials I January 2011 I 2
    • Nigeria I Building Materials I Equities Figure 2: Regional Split of Sales (based on interim quarterly results) of the top three global cement producers Lafarge Africa/ Africa/ Middle Holcim Middle Heidelberg East: East: Africa/ 5.3% 1% Middle Asia East: Pacific:2 Europe: Europe: 27% 1% 36.0% 29.40% Europe: 37% Asia Pacific: Latin 37.40% America Asia North : 13% Pacific:1 Latin America North 5% North America : America America : 12.50% : 28% Latin 15.40% :17% America : 5% Sources: Company‟s websites, Vetiva Research While we still see some potential in less developed eastern european countries, we believe the expected slow-down in growth in more developed western europe would cause an overall strain on earnings growth from the european Global cement producers with market. Apart from Lafarge, who virtually had presence in almost all the significant presence in Africa are better poised to grow earnings in African sub-regions – North Africa (Lafarge Ciments – Morocco, Orascom - the long term Egypt), East Africa (Bamburi Cement – Kenya), West Africa (Lafarge WAPCO and Ashaka Cement - Nigeria) and Lafarge S.A (South Africa), the other global players at best only operate in one or two sub-regions. Therefore, based on the current low level of social and physical infrastructure penetration in Africa, and the boom expected from increasing discovery of mineral resources and commodities, we make a case for Africa as the next frontier of global economic growth, with Nigeria‟s cement sector strategically positioned to drive the expected growth in physical infrastructure. The African story: the next frontier of growth With the growth in the developed economies expected to slow-down Though the African continent still lags significantly in infrastructure, we believe over the next decade, whilst SSA‟s the next pioneer of global economic growth would be Africa. Asia, aided by the growth trends up, Africa can be the very rapid growth of China, India, Singapore, Malaysia, Indonesia, Thailand, next pioneer of global growth which are classified by the International Monetary Fund (IMF) as Newly Industrialised Asian Economies (NIAE) over the last two decades, has been the propelling force of global economic growth.Nigerian Cement Sector: Unbundling Potentials I January 2011 I 3
    • Nigeria I Building Materials I EquitiesHowever, economic growth in Asia would gradually slow down over the nextdecade; thus we expect growth in Africa, especially SSA (excluding south Africa)to gradually trend up on the back of increasing discovery of mineral resources,strong commodity prices and improving political landscape. Figure 3: Economic growth of some regions1 of the world (2000-2015E) 10.00% 8.00% 6.00% 4.00% 2.00% 0.00% 2010E 2011E 2012E 2013E 2014E 2015E 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 -2.00% -4.00% Advanced Economies NIAE MENA SSA Sources: IMF, Vetiva Research 1 MENA: Middle East and North Africa, NIAE: Newly Industrialised Asian Economies, SSA: Subsaharan Africa In our view, there‟s an increasingly lesser potential for infrastructural Africa‟s infrastructure deficit development in advanced and fast growing Asian economies. Thus, Africa has portends significant growth the highest untapped potential for economic growth and infrastructural opportunities in the longer term development. According to a recent World Bank report – Africa Infrastructure: Time for Transformation, Africa is estimated to have an infrastructural deficit of $93 billion out of which we estimate that about a third, c.$31 billion would be used for electric power and about $25 billion for the construction of physical infrastructure (roads, bridges, ports and rails). Based on the same report, most African cities face the challenge of acute housing shortage. In most African countries, real estate and government agencies are only able to meet at most one quarter of housing demand, leaving three-quarter to the informal market. Based on UN Habitat estimates, as much as 70 percent of Africa‟s urban population reside in slums. However, the infrastructure deficit is not evenly spaced across the African sub-regions. For instance, countries in the Northern Africa region particularly Egypt, despite its inherent minor challenges, is way ahead of others in cement consumption, housing delivery and other physical infrastructure.Nigerian Cement Sector: Unbundling Potentials I January 2011 I 4
    • Nigeria I Building Materials I Equities The major deficits in housing and other phyiscal infrastructure in Africa is more concentrated in West, Central and East African sub regions. In view of Nigeria‟s enormous population (a sixth of Africa‟s population), we see the highest prospects for infrastructural development in Nigeria. Hence, we believe the Nigerian cement sector offers a very robust growth potential. Nigeria‟s cement sector: The value proposition Among the top five major markets in Africa (South Africa, Egypt, Algeria, Given Nigeria‟s massive Morocco and Nigeria), Nigeria offers the highest growth opportunity in the population and fast-paced cement sector. Using cement consumption patterns, Nigeria‟s cement urbanisation, Nigeria offers the highest growth in the cement consumption per capita significantly lags that of the remaining top four sector among the top markets in markets. Egypt has the highest cement production capacity on the continent Africa (as at 2008). Owing to the impact of the rapid development of the Middle East region on North Africa, the sub-region generally leads in cement consumption pattern on the continent. Average cement consumption per capita for North Africa is slightly above 300 kg, the highest on the continent. Given Nigeria‟s heavy cement supply deficit and historically low local production capacity, Nigeria‟s cement consumption level is significantly lower at about 105 kg per capita. The dynamics of Nigerian cement production is however changing tremendously since the entrant of key players like Dangote Cement. We present the following as the Investment thesis for Nigeria‟s cement sector. Based on our estimates, c.112m Robust Housing Deficit: According to estimates from industry experts, tonnes of cement would be Nigeria has an estimated deficit of 16 million to 18 million housing units. In required to meet just half of 2009, the Presidential Committee on Implementation of Affordable Housing Nigeria‟s estimated housing has estimated that about N60 trillion would be needed to bridge the deficit. deficit Assuming that federal, state governments, and private sector makes very Africa significant efforts, within the next 10 years to provide cheap and affordable ideal housing stock (at least a 2- bedroom apartment) to meet half of the estimated deficit (c.9million housing stock), cement consumption based on this premise would be c.112 million tonnes. With expected rise in local manufacturing capacity to c.28 million tonnes by 2012, it would take 5 to 6 years to provide half of the estimated housing deficit. On a more realistic stance, we believe it would take longer than 6 years to at least provide half of the estimated housing deficit. However, with the Federal Housing Authority‟s 2009 – 2013 action plans to provide 100,000 units of houses annually, the increasing mass of private real estate developers and state governments‟ participation in housing delivery; we expect Nigeria‟s housing deficit to shrink considerably over the next 10 years.Nigerian Cement Sector: Unbundling Potentials I January 2011 I 5
    • Nigeria I Building Materials I Equities Figure 4: Comparison of Nigeria‟s housing deficit 120 90 60 30 0 South Africa Nigeria Egypt India Brazil China Housing Deficits(Mill units) Housing deficit per capita(1/1000 units) Sources: Nationsencyclopedia, National housing ministries websites, Vetiva Research estimates Roads: Another major case for the strong potential of Nigeria‟s cement sector is the current insufficient and inadequate road transportation network. With the shift of the global construction industry to concrete and steel (from the more primitive stone and mortar) in construction activities, cement demand Nigeria‟s total road network is only 30% paved compared to has occupied a pivotal position in the construction industry. According to the North Africa average of 69% and Federal Ministry of Transport, Nigeria has a road network of c.195,000 km “N-11” average of 63% with only 30% paved in comparison to 63% average for emerging N-11 countries and 69.7% average for Egypt, Algeria, Morocco and Tunisia, based on data from World Bank and International Road Federation (IRF), see figure 5 below. Based on IRF definition, paved roads refer to length of roads that are surfaced with crushed stone (macadam) and hydrocarbon binder or bituminized agents, with concrete or with cobblestones. Therefore, the use of concrete in road construction implies a concurrent use of cement.Nigerian Cement Sector: Unbundling Potentials I January 2011 I 6
    • Nigeria I Building Materials I Equities Figure 5: Comparison of Nigeria‟s paved road network 100% 80% 60% 40% 20% 0% Egypt China Germany UAE South Korea Libya Italy Morocco France Japan Nigeria N/Africa Average Algeria Tunisia India Malaysia N-11 average Russia Czech Republic Sources: World Bank database, World Road Federation, Vetiva Research  Rail and ports construction: The increasing use of concrete ties in railroad construction (rather than wood), has meant a significant surge in cement Nigeria‟s 3,505 km rail network ranks lowest amongst highly demand globally. Thus, in Nigeria, the current abysmal state of railroad populated countries network portends a major opportunity for continuing growth in the cement sector. With a total rail network of 3,505 km (from Federal Ministry of Transport), Nigeria‟s rail network ranks among the lowest for highly populated countries. In line with the Federal Ministry of Transport‟s 25 year National Ports Master Plan, several port development projects including sea- ports expansion, rehabilitation of facilities and channel towage development have been embarked upon. If the master-plan would be diligently followed, more investments in ports development and maintenance are underway, even into the longer term.  Vast raw material deposit: Apart from the expected boom in physical infrastructure, which would be the key propeller of growth in the cement sector, the presence of limestone and other additives used in the production Infrastructural boom and of cement in vast quantities, is an additional plus for Nigeria‟s cement sector. abundance of raw materials would also encourage cement Nigeria has an estimated 837 million tonnes of limestone deposits in 22 out production of 36 states, but currently has cement plants in only 6 states. Gypsum, the major binding substance used in the final stage of cement production is also present in commercial quantities in some Nigerian states, even though it is not being mined or produced in commercial quantities; leaving producers to import the substance. According to China‟s leading cement equipment supplier – Jiangsu Pengfei Group Co. Ltd, the high purity level and shadow- buried depth of Nigeria‟s limestone deposits are characteristics which make it easily exploitable and desirable. Limestone is mined in just about half of West African countries, but then not as major economic activities.Nigerian Cement Sector: Unbundling Potentials I January 2011 I 7
    • Nigeria I Building Materials I Equities Hence, cement production is significantly low in West Africa and the region‟s countries rank among those with lowest cement consumption per capita on the continent. Nigeria‟s vast limestone deposits therefore potentially place the country at an advantage in the sub-region if it can harness the opportunities.  Potential FX earner: Nigeria depends almost entirely on crude oil as the main government revenue and foreign exchange earner. Like the developed Asian countries – China, Japan and Thailand which are top exporters of Cement deficits in African cement globally, Nigeria can also become a net-exporter of cement through countries drive potential for continuous investment in local production. The cement deficits across West export, as local production is expected to exceed demand in and Central African countries present Nigeria with immense opportunity for the longer term export when local production exceeds demand. We predict that this would likely occur by 2013 at which point local production, estimated at 28 million, would slightly surpass demand (estimated at 27.5 million tonnes). In our view, more investments in local manufacturing would be needed beyond this point for the sector to contribute meaningfully to the country‟s exports.  Government‟s Medium term Fiscal Commitment: We view government‟s recent medium-term budgetary frame-work (based on National Improved efficiency of Implementation Plan for NV2020) as a catalyst for sustained spending on Government‟s short-term plan for capital projects. Whilst noting that NV2020 has been flawed with criticism in projects is expected to boost view of Nigeria‟s poor history of implementation of national goals, the physical infrastructural projects, medium term frame-work offers a more realistic expectation in government‟s hence demand for cement commitment to achieve the goal, and also presents a shorter-term frame work to examine and monitor performance and progression. Therefore, with government being the biggest spender on physical infrastructure and perhaps the largest consumer of building materials, one can readily project cement demand, at least in the short to medium term. More important in the recently launched medium term National Implementation Plan (NIP) is the fact that emphasis is placed on capital expenditure (CAPEX) in the development of critical infrastructure. Industry Outlook Cement consumption hinged on government‟s revenue We restate that Nigeria‟s investment case for the cement sector and the broader building materials industry is quite attractive, thus we reaffirm our long term optimistic outlook for the industry. Our outlook on cement demand is hinged on expected government revenue from crude oil (since crude oil constitutes c.90% of government‟s revenue), the proportionate spending of the revenue on physical infrastructure while drawing historical correlation between federal government‟s physical infrastructural spending and cement consumption.Nigerian Cement Sector: Unbundling Potentials I January 2011 I 8
    • Nigeria I Building Materials I EquitiesFigure 6: Federal Government Revenue assumptions 2010 2011 2012 2013 Crude Oil Production (mbpd) 2.4 2.5 2.5 2.5 Crude Oil Price (US$) 60 60 60 60 Real GDP Growth rate (%) 8.2 10.9 11.8 13.1 Population Growth rate (%) 2.8 2.8 2.8 2.8 Source: NIP implementation plan In our view, projecting cement consumption this way presents a fundamental Poor economic conditions argue basis for the expected boom, especially because with the vast majority of against domestic demand by the Nigeria‟s population living below the poverty line, it is difficult to justify that masses, putting the spotlight on the expected rise in cement production can be absorbed by the rather weak the government purchasing power of the of the citizenry. Thus, a base case assumption for cement consumption that is directly linked to government‟s expected revenue, in our view, provides a more fundamental backing for our outlook on cement demand. We note however, the increasing involvement of the private sector through Public Private Partnerships and the rising spate of debt issuance by governments (both state and federal) to fund major capital projects. Thus, we reiterate that our outlook represents a base case on which higher expectations can be built, in view of other possible sources of funding for physical infrastructure. Medium term outlook on cement consumption Following from our overall expectation of government revenue being the key However, fundamentals still point driver of cement consumption, we expect, based on the analysis of a little in the direction of the governments‟ (both states and federal) medium term CAPEX on housing and Private sector contribution road construction, that cement consumption will increase at 4-year CAGR of through Public-Private projects 16.7% to 27.54 million tonnes by 2013. Over the four year period, 2010 – . 2013, we expect cement consumption to sum up to c.70 million tonnes. Figure 7: Estimated CAPEX on housing and transportation infrastructure (2011 – 2013) State Government (N‟Trn) 3.55 Federal Government (N‟Trn) 1.68 Total (N‟Trn) 5.23 Cement Consumption (000 tonnes) 69,088 Sources: National Planning Commission, Vetiva ResearchNigerian Cement Sector: Unbundling Potentials I January 2011 I 9
    • Nigeria I Building Materials I Equities Figure 8: Federal and State government CAPEX on housing, roads, rail and ports (N‟bn) and cement consumption construction (million tonnes) 2006 – 2013E 30000 2000 24000 1500 18000 1000 12000 500 6000 0 0 2006 2007 2008 2009 2010E 2011E 2012E 2013E Cement Consumption Government CAPEX Sources: CBN, Ministry of National Planning Vetiva Research estimates As seen in the table above, we arrive at an estimated sum of N5.2 trillion (c.US$35 billion) for housing, road, ports and rail transportation CAPEX Estimates show N5.23 trillion in (including only projects which based on our view are directly correlated to government spending on cement consumption while adjusting for outliers). Following from minister of Infrastructure with 50% implementation and a potential to finance recent affirmation of about 50% budgetary implementation for 2010, ramp up in subsequent years we assume about 60% execution of physical infrastructure projects (relating to housing and transportation only) for 2010 and while gradually scale percentage . execution upwards to 75% by 2011, 85% by 2012 and 95% by 2013. We also assume that unspent allocations on these projects would be automatically rolled over to the following year. Potential for export in the medium term? Based on the medium term outlook presented for cement consumption above, Actualizing the export potential the potential for export in the sector may not be realized prior to or by 2013. might take more than 2 years Exports of about 4 million tonnes of cement would only be feasible by 2012 if due to the ramping up associated we make an aggressive assumption that all existing and new cement plants with cement plant expansion would operate at full capacity by 2012. While this might be possible, we consider it very unlikely in view of the usual ramping up phase for most . cement plants. Historically, based on Dangote Cement‟s Gboko Plant expansion (former Benue Cement Company) in 2008 and Obajana Cement Plant built in 2007, we believe that it will take a minimum of 2 to 2.5 years before a new cement plant or line can reach full capacity utilisation.Nigerian Cement Sector: Unbundling Potentials I January 2011 I 10
    • Nigeria I Building Materials I Equities Figure 9: Aggressive case: Cement production vs Figure 10: Normal case: Cement production vs consumption (million tonnes) consumption (million tonnes) 30000 30000 22500 22500 15000 15000 7500 Production outstrips 7500 Production lags consumption; exports likely consumption; exports unlikely 0 0 2009 2010E 2011E 2012E 2013E 2009 2010E 2011E 2012E 2013E Consumption Production Consumption Production Sources: Industry, Vetiva Research estimatesLonger term outlook – Where will it swing?The outlook for the cement industry in the longer term is strongly correlated to In the long run, economiceconomic and population growth. From the development pattern of most prosperity and population growthdeveloped economies and emerging markets, the link between GDP growth and would be the major drivers of thecement consumption is well established. (Figure 11 below shows the correlation of demand for cementthe two) . Figure 11: G-20 countries: Cement Consumption Vs GDP per consumption 1400 S/Arabia 1200 China S/Korea 1000 800 Italy Turkey 600 Japan Mexico Germany 400 Russia Canada Australia Brazil S/Africa Argentina France USA 200 Indonesia United Kingdom India 0 Nigeria 0 10000 20000 30000 40000 50000 60000 Cement Production Per Capita Sources: Industry, Vetiva Research estimatesNigerian Cement Sector: Unbundling Potentials I January 2011 I 11
    • Nigeria I Building Materials I Equities In our view, the potential for strong economic growth in Nigeria is Nigeria‟s economic growth is largely dependent on government‟s ability to intensely increase its strongly linked to increased revenue and the success of its medium term (2010 – 2013) power funding and the success of the sector reform. We highlight the following as the reasons undergirding this power sector reforms view. . Government‟s oil revenue is not sufficient to cater for all its long term investments; hence the private sector is pivotal to the achievement of these goals. However, the power sector reform must be successfully implemented to Diversification of sources and encourage sustainable private sector investment. Notwithstanding, we believe private sector participation are government can achieve more if its revenue base becomes substantially expected to back up Crude oil proceeds in boosting revenue diversified to reduce the heavy dependence on crude oil revenue. Agriculture and Manufacturing are two key sectors that can help Nigeria achieve the . desired diversification. The growth prospects in the Agriculture and Manufacturing sectors are almost entirely dependent on the success of the power and banking sector reforms. Stable power supply would significantly minimize overheads and encourage large scale private sector involvement in these sectors. Furthermore, re- structuring of the banking sector to enable Small and Medium Scale Enterprises (SMEs) access credit facilities is imperative. If these are achieved, the effect on the broader economy would be higher revenue to government, lower unemployment and a significant improvement in the purchasing power of the citizenry. Government spending has historically been the major driver of cement A slight shift off the Government consumption in Nigeria. While we believe government‟s expenditure would still in cement consumption may help close the cement deficit faster as account for a sizeable portion of cement consumption in the medium to longer effective demand grows term, a more rapid growth could be achieved in the longer term if purchasing power becomes less concentrated in government‟s hands. Currently, there‟s . still a huge deficit in Nigeria‟s cement consumption despite the inventory build-up which had plagued the industry in the last few months as a result of lower effective demand (demand backed by purchasing power). Barring failures in Government‟s Assuming a successful implementation of government‟s medium term plan on infrastructural programs and local critical infrastructure and steady strengthening of commodity prices, demand boom, cement particularly crude oil, cement consumption would continue to rise beyond consumption would soon outpace 2013 and would soon out-pace local capacity except new capacities are local production capacities added. . In line with this, we assume a base case outlook of cement consumption continuing to rise at a constant CAGR of 13.5% beyond 2013. However, cement consumption may grow at a much quicker pace if there is massive influx of the private sector in real estate development, higher purchasing power and stronger government revenue base.Nigerian Cement Sector: Unbundling Potentials I January 2011 I 12
    • Nigeria I Building Materials I EquitiesHomogeneous product - prospects for integration?Competition gradually rising...In our view, the Nigerian cement sector isbecoming increasingly competitive. Industry players have attributed the slower While manufacturers blame waning sales on odd rains andsales that characterised the industry for most part of this year to heavier-than- lack of funding, facts point tousual rainfalls and strained credit flow. While this is partly valid, we believe increased competition especiallycompetitive pressures are gradually increasing in view of rising surplus. Recently, in the citiesLafarge WAPCO launched a new brand of its cement - “Elephant Supaset”- whichportrays, as explained by the company, that the brand would harden or set faster .under water compared to the usual Portland cement. As we have alwaysmaintained, this buttresses our view that Lafarge WAPCO would be facing intensecompetition from Dangote Cement and would gradually incur higher marketingexpenses to defend its market share. We expect the competition to heighten,especially in the Lagos and Abuja regions when the on-going expansion projectsfrom Dangote Cement and Lafarge WAPCO are completed next year....Vertical integration possible in the longer term: We believe the Nigeriancement industry would move towards vertical integration in the longer term, as Product homogeneity and marketobtainable in developed countries and emerging economies. Cement is relatively structure are bound to encouragehomogenous in physical attributes and little brand differentiation can be achieved, vertical integration in the longtherefore, as it has historically being in Nigeria, competitive effects relating to term as profit margins eventuallypricing arise more from market structure rather than product alterations. For softensinstance cement is usually cheaper in areas closer to plant or depot locations. .Eventually, in the longer term, profit margins would either start reducing orremain constant, if prices decline or at best remain constant. We believe playerswho generate huge volumes would have the upper-hand, until a saturation pointwhen volume increases might create a glut, and vertical integration wouldbecome imperative to achieve some cushioning in revenue base.Dynamics of vertical integration in the cement industry: The most commonform of vertical integration in the cement industry involves the acquisition or Common integration involvessetting-up of ready-mix concrete, aggregate businesses and production of obtaining ready-mix andgypsum. Construction activities in most developed countries have been quite aggregate business units; thesesimplified with the use of ready-mix concrete and aggregates. Ready-mix would help simplify constructionconcretes (also referred to as customised concrete), which have significant and accelerate permeation ofadvantages over site-mix concrete in terms of labour costs and wastage, would be low-cost housingneeded to achieve faster and cheaper housing delivery in Nigeria. .Industry StructureHigh concentration: The Nigerian cement industry (importation and localproduction) is highly concentrated. Based on available data for 2009 cementconsumption from industry sources, the cement industry had a HHI of about2,840 which based on global standards on anti-thrust policies implies a highly With a HHI of 2,840, the Nigerianconcentrated and less competitive industry. According to US anti-thrust policy an Cement Industry is quiteindustry with a HHI of less than 1000 is considered a competitive market; HH1 of concentrated1000 – 1800 is considered moderately competitive, while HHI greater than 1800implies a highly concentrated and less competitive industry. The higher the HHI,the closer the industry is to being a monopoly. Using FY‟09 data from industrysources, Dangote Cement controls c.50% of the Nigerian cement industry (bothlocal production and importation).Nigerian Cement Sector: Unbundling Potentials I January 2011 I 13
    • Nigeria I Building Materials I EquitiesThough 2010 cement consumption data are unavailable, we guesstimate from theinterim earnings announcement of publicly listed cement producers that industryconcentration has increased with Dangote gaining market share, as most otherproducers recorded YoY decline in sales. In view of the much anticipatedcompletion of Dangote Cement and Lafarge WAPCO‟s expansion next year, theconcentration level of the industry would rise further as we expect DangoteCement‟s market share to rise to c.70% by end of 2011. Figure 12: Current market share of Nigerian Figure 13: Expected market share at the cement producers completion of on-going expansion 4.4% 6.2% 8.8% 18.3% Ashaka Ashaka 14.8% Dangote Dangote 1.8% CCNN CCNN 14.7% Lafarge WAPCO Lafarge WAPCO Unicem 57.1% Unicem 70.3% 3.7% Sources: Industry, Vetiva Research EstimatesWide variations in operating efficiency: The different fuel types and energy/cost dynamics of Nigerian cement producers have translated into variedprofitability margins in the industry, with big producers like Dangote Cementhaving PBT margins slightly in excess of 50% (based interim Q3‟10 earnings),whilst that of small-scale producers like Cement Company of Nigeria andAshakaCem Plc are as low as 11% and 20% respectively. Figure 14: Industry Average PBT/tonne (N) and Figure 15: Industry Average PBT/tonne (N) and PBT margin (%) with Dangote Cement PBT margin (%) without Dangote Cement 10000 40% 8695 10000 40% 8304 34% 7286 32% 7500 30% 7500 30% 26% 6284 6357 5537 5544 24% 23% 5000 20% 20% 5000 4447 20% 18% 16% 2500 10% 2500 10% 0 0% 0 0% 2009 2010E 2011E 2012E 2009 2010E 2011E 2012E PBT/Tonne PBT Margin PBT/Tonne PBT Margin Sources: Annual, Vetiva Research EstimatesNigerian Cement Sector: Unbundling Potentials I January 2011 I 14
    • Nigeria I Building Materials I EquitiesEven with the least profitable producer having a PBT margin in the low double- Though technology sets Nigeriandigits, the cement industry, having an average PBT margin (based on latest cement players apart, the sectorinterim results) of 28%, is still more attractive than the food/beverage, is profitable on the overall,conglomerates and breweries sectors of the Nigerian Stock Exchange, which has outclassing the local FMCG‟s andaverage PBT margins of 12.4%, 11.6% and 21.0% respectively. matching continental counterparts. Figure 16: Average Pre-tax profit margins of key sectors on the Nigerian Stock Exchange (based on latest interim earnings) . 30% 28% 21% 23% 19% 15% 12% 12% 8% 5.4% 0% Petroleum Banking Breweries Conglomerates Food/Beverage Building Materials Marketing (Cement) Sources: Company Filings, Vetiva ResearchOperational gearing: Given the huge fixed asset base of the industry, Manufacturers would aim tooperational gearing is high and producers can only reduce its impact through soften gearing effects by uppinghigher sales. Overall, the bigger players have the best opportunity to minimise sales, tipping the scales the wayoperational leverage at higher volumes. of the big players.Domination by local players: In comparison to bigger cement markets in Africawhich are still dominated by global players, the Nigerian cement industry haswitnessed a radical shift with the entry of the Dangote Group into cementproduction. Suez group, the biggest cement producer in Egypt is owned by the Dominated by Dangote Cement,Italcementi group – the fifth largest cement producer globally. Other global local influence is strong in theplayers like Lafarge, Holcim, and Cemex also have major presence in other North Nigerian cement market, asAfrican countries. In a similar vein, the Lafarge Group has a significant presence against trends in other Africanin South Africa. Although, the Lafarge Group (through its subsidiaries – Lafarge countries.WAPCO and Ashaka Cement) is the second largest producer in Nigeria, its marketshare of c.13% significantly lags behind Dangote Cement‟s 50%.Prior to 2007, Lafarge WAPCO dominated cement production in Nigeria with amarket share of c.60%. Whilst the Dangote Group has always had a significanthold on cement importation, its backward integration which culminated in thecommissioning of the Obajana plant in 2007, pushed its dominance to localproduction, hence displacing Lafarge WAPCO. Germany‟s top cement producer -the Heidelberg group, until 2009, had a minute exposure to Nigerian Cementindustry through the Cement Company of Northern Nigeria (CCNN).Nigerian Cement Sector: Unbundling Potentials I January 2011 I 15
    • Nigeria I Building Materials I EquitiesPerhaps due to inability to compete adequately as a result of the small productionscale of CCNN (0.5 million tonnes annual capacity) and its obsolete state, theHeidelberg group pulled out of the Nigerian cement industry, selling its stake inCCNN to a local conglomerate – the BUA group, in 2009. The Holcim group, whichentered the Nigerian cement industry in 2005, operates through the Unicem plantin Calabar (South-South Nigeria). The company is a Joint Venture with Flour Mill,and Lafarge. Figure 17: Dominant Cement Producers in some African Countries (put companybefore parent) Production1 Country Company Parent Capacity Egypt Suez Italcementi 12.0 Morocco Lafarge Ciment Lafarge 7.0 ** South-Africa PPC Barloworld 8.0 Kenya Bamburi Lafarge 2.5 Ghana Ghana Cement Heidelberg 2.4 Nigeria Dangote Cement Dangote 8.0 Source: Vetiva Research** PPC - Pretoria Portland Cement, 1Current Production Capacity onlyNigerian Cement Sector: Unbundling Potentials I January 2011 I 16
    • Nigeria I Building Materials I EquitiesFigure 18: Emerging market cement producers‟ comparable metrics EBITDA (Mkt Mn EBIT Margin ROE (%) EV/EBITDA P/E (x) Dividend yield Company Margin USD) Country 2010E 2011E 2010E 2011E 2010E 2011E 2010E 2011E 2010E 2011E 2010E 2011E Pret. Portland S/Africa 2,715.5 38% 38% 33% 34% 112.9 99.3 8.7 7.8 13.1 11.5 5.9 6.7 Cement Anhui Hong Kong 13,400.2 26% 26% 20% 20% 15.4 16.5 12.1 9.9 21.5 17.8 0.9 1.1 Ambuja India 4,771.3 28% 26% 21% 21% 19.6 18.0 9.4 9.1 15.9 15.1 1.8 1.9 Bamburi Kenya 885.5 30% 33% 32% 32% 26.6 29.0 7.1 5.5 12.9 9.9 4.7 6.3 Cement ACC Limited India 4,191.8 25% 24% 22% 19% 20.4 17.9 8.4 8.0 14.1 13.7 2.2 2.3 Gulf Cement UAE 359.8 18% 26% n/a n/a 5.3 12.0 8.5 5.5 24.8 11.5 n/a n/a Sib Cement Russia 714.0 30% 33% 22% 22% n/a n/a 7.5 5.1 15.0 7.0 n/a n/a Huaxin China 1,098.9 17% 19% 8% 9% 6.8 9.5 10.7 7.8 23.6 14.9 0.7 1.0 Cement Siam Cement Thailand 12,842.1 17% 17% 11% 12% 22.9 23.9 10.9 9.2 14.7 12.2 3.1 4.0 Holcim Phillipines 1,561.7 33% 33% 27% 27% 23.9 24.9 7.9 7.1 15.0 13.1 3.8 5.5 Phillipines MISR Cement Egypt n/a 52% 50% 46% 44% 45.2 41.7 n/a n/a 7.3 7.6 11.7 11.0 Sinai Cement Egypt 588.9 51% 49% 45% 47% 36.6 32.4 3.7 3.9 5.0 5.1 12.1 13.1 Tai Shan China 4,182.1 20% 26% 20% 21% 18.0 20.0 12.8 9.9 18.3 13.9 0.7 1.0 Jidong Ashaka Nigeria 358.5 25% 34% 23% 32% 20% 25% 10.8 7.4 15.8 11.5 2.3 3.2 Lafarge Nigeria 860.2 35% 29% 26% 22% 14% 18% 9.9 7.8 18.2 12.9 0.6 1.2 WAPCO Dangote Nigeria 13,553.40 58% 61% 51% 56% 59% 83% 18.3 11.1 20.9 12.7 3.7 5.9 CementNigerian Cement Sector: Unbundling Potentials I December 2010 I
    • Nigeria I Building Materials I EquitiesDemand Dynamics – What drives consumption?Government‟s expected spend on the built environment- Government, As capital expenditure grows,both at state and federal levels, would still be the major driver of cement government spending ondemand in the medium term, as it has been historically. The expected CAPEX on Infrastructure follows suit, eveninfrastructural development as detailed in the medium term National Plan would as new road constructionbe the boost for demand in the next three years, if adequately implemented. techniques use to cementCement constitutes about 7% to 15% of concrete-(a mixture of cement and .other aggregates), a key material in construction; thus an increase inconstruction activities naturally means a rise in demand for cement as well. As apointer to the fact that increasing government spending on housing and roadconstruction has been a key driver of the upswing seen in demand for cement inNigeria, the federal government‟s capital spending rose by c.212% between2004 and 2008. In the same vein, state governments (Federal Capital Territoryinclusive) CAPEX on housing and transportation infrastructures have also peakedsignificantly over the last five years. According to figures from CBN‟s 2008annual reports, state governments and FCT capital spending on housing and roadconstruction rose to N388.3 billion in 2008, from N50.2 billion in 2004. Weexpect an additional 144% rise in federal and state governments CAPEX onhousing and transportation (road, rail and port construction) between 2009 and2013 (See figure 19 below). Figure 19:Actual and forecast Government (state and federal) CAPEX (N‟Bn) and yearly growth (%) on housing and physical infrastructure in transportation 2000 104% 100% 1500 76% 78% 60% 1000 23% 21% 500 17% 17% 20% -8% 0 -20% 2006 2007 2008 2009 2010E 2011E 2012E 2013E Government CAPEX Y-o-Y growth Sources: CBN, Vetiva Research EstimatesApart from government‟s CAPEX, recurrent expenditure on road maintenanceand housing are key contributors to the increase seen in the demand for cementover the years. Recently, the chairman of Dangote Group, Alhaji Aliko Dangoteproposed the use of concrete, rather than bitumen, in road maintenance. Whilstsome local government roads in major cities like Lagos are already being re-constructed using pre-cast concrete, the suggestion may cause stakeholders tointroduce more of concrete in road maintenance, as it is the case in South Africa. Nigerian Cement Sector: Unbundling Potentials I December 2010 I 18
    • Nigeria I Building Materials I EquitiesIf the use of concrete in road maintenance receives increased acceptance,cement consumption would considerably rise faster than our forecasts, whichhave been solely based on expenditures on capital projects.Public-Private Partnerships (PPPs) in real estate development: Thegrowing involvement of public-private partnerships in real estate development With about 600,000housing unitsacross the country would also continue to contribute substantially to cement expected from PPPs, close todemand. In 2009, the federal government signed partnership agreements with N105 billion would be spent onten private sector real estate developers and investors, to increase national housing provision in the next 3housing stock by 1,694 units in Osun, Adamawa, Ondo and Niger states, and the yearsFederal Capital Territory. According to the erstwhile minister of works, housingand urban development - Dr Muhammed Lawal, the federal government hadsigned 80 partnership and Development Lease Agreement to spur developmentof affordable housing in Nigeria. Also in the government‟s national developmentplan on housing, increased emphasis is placed on forming more PPPs to helpdrive the national plan on housing delivery. Thus, the federal government plansto deliver 600,000 housing units under Public Private Partnerships (PPPs)arrangement, estimated at cost of c.N105 billion over a three year period from2011 to 2013.Growth in private sector real estate development: Whilst admittinggovernments‟ (at State and Federal levels) efforts on housing delivery to its While the Private sector plays acitizenry, one should note that the complexities surrounding the effectiveness of growing role in housing provisionthe land use regulations in Nigeria, and the fast rate of urban migration in for Nigerians, funding challengesNigeria have continued to promote the growth of private sector in housing have limited delivery in 2010delivery. We conclude therefore, that the private sector (either at organized levelas real estate development companies, or through individuals) is increasinglybecoming the major provider of housing to Nigerians. This year however, theslow-down in credit to the private sector has adversely affected overall cementconsumption. Figure 20: Credit to Government vs Credit to Private Sector (% growth over 2009 levels) 70 Credit to Government 60 Credit to Private Sector 50 40 30 20 10 0 -10 Jan Feb Mar Apr May Jun Jul Aug Sept Oct Source: Central Bank of Nigeria, Vetiva ResearchNigerian Cement Sector: Unbundling Potentials I January 2011 I 19
    • Nigeria I Building Materials I EquitiesPrivate real estate developers became quite pivotal in housing delivery in thecountry after federal government‟s housing reforms of 2003/2004. We note also Private real estate developerssome key features of the reform which catalysed the rapid growth seen in the benefitted from the 2004 housingnumber of private estate developers between 2004 and 2008. Some of these reforms, riding on the 2008features include; assignment to government of primary infrastructure for new economic boom to boost demandestate development, an amendment of the Land Use Act, development of a for housing ergo cementsecondary mortgage market and a five-year tax holiday for developers. In linewith the general economic boom of the 2007/2008 era, real estate developmentalso witnessed a significant boom during this period, translating therefore intohuge demand for cement and other building materials.Changing landscape of supplyCement glut…possible? The dynamics of cement supply in Nigeria is graduallychanging from being predominantly dominated by imports to local production. In Local manufacturing is growingline with the additional supply expected to come from new capacities by 2012, fast, significantly cutting importswe believe imports would gradually shrink within the next 2 to 3 years. Whilst wedo not expect the slow-down in cement demand this year to persist, we are notoverly bullish on cement demand rising significantly next year for politicalreasons, as development projects typically slow-down during election years inmost African countries. Furthermore, credit to the private sector is not yet at thedesirable level after last year‟s shake-up of the banking sector.Further compounded by the Central Bank‟s rising concern on inflationarypressures and its somewhat weariness to continue to stimulate banks to lend tothe real economy as indicated by recent rate hikes, credit extension to the We expect minimal improvementsprivate sector is not likely to witness any significant improvement in the short over this year‟s consumptionterm, at least until after the April 2011 polls. This implies that the slow-down seem likely, in view of the slow-seen in demand this year may only improve slightly in 2011, if weather down in new infrastructure spendconditions (heavy rainfalls) are not as adverse as they were in 2010. In our view expected pre-electionstherefore, supply would likely still outstrip effective demand next year and bigproducers like Dangote Cement and Lafarge WAPCO, which expect additionalcapacities next year, must begin to seek creative means to sell their product.Dangote Cement which is currently planning to commence exports, would likelysee its revenue cushioned by exports to other West African countries. Thealternative for Lafarge WAPCO and other smaller producers might be to reducecapacity utilisation rates.Post-elections, especially by 2012, we believe there would be majorimprovements in demand and purchasing power, especially in view of theexpected improvements in power supply, coupled with stability and increased As availability of power, politicallending to the private sector. With our expectation of increasing implementation stability and access to loansrate of the medium term National Development Plan, local demand would likely converge in 2011; demand forsurge again to fully absorb cement supply. Prior to 2010, cement demand had cement is bound to increasesignificantly outstripped supply and the resultant supply deficit made Nigeria thethird largest importer of cement in the world. Between 2004 and 2008, importsaccounted for about 64% on average of cement supply, while local productiononly accounted for 36%.Nigerian Cement Sector: Unbundling Potentials I January 2011 I 20
    • Nigeria I Building Materials I EquitiesSupply dynamics however changed in 2009 as Dangote Obajana and BCCrecorded higher utilisation rates. We note that local production now accounts for With the expected up-shoot inthe larger proportion of cement supply in Nigeria. Industry estimates for 2009 local supply, companies haveput production at c.59% and importation at c.41% of total cement supply. In developed more frameworks forview of the bulky nature of cement which posts significant problem in distribution, with Dangote cementtransportation over long distances, supply is typically localised to the immediate running the broadest networkregion of cement manufacturers. The south west region has historically beendominated by Lafarge WAPCO‟s Elephant Cement, Flour Mill‟s Burham Cementand Dangote Cement. In a similar vein, the north-west region is dominated byCement Company of Northern Nigeria - CCNN‟s Sokoto Cement while the north-east region is largely controlled by Ashaka Cement. Benue Cement Company andObajana Cement - both owned by Dangote Industries (before the Merger of thetwo entities), accounted for the larger portion of local production and cementsupply in 2009. Dangote Cement is however able to penetrate most regions ofthe country because of its extensive depot network.Tighter importation policy: In line with the changing dynamics of cementsupply in Nigeria, government policies on cement imports have become tighter. Regulations favour local production as conditions forThe new cement import policy announced by the federal government in August importation have become more2010, involves re-stating the 20% import duty on bulk cement and the stringentimposition of a 15% levy on the cost, insurance and freight price of bulk cementto substitute the existing N500 per tonne, which would be utilised in thedevelopment of the Cement Technology Institute. Also, as a part of the newcement import policy, the federal government cancelled all existing un-utilisedcement import quota between 2002 and 2008, and stated that an annual reviewof local production would be carried out going forward, to determine the need forcement imports.Figure 21: Cement import terminal operators and import quota (Jul.-Dec. 2010) Capacity Import Company Location („tonnes) Quota2 Eastern Bulkcem P/Harcourt 600,000 225,000 Ibeto P/Harcourt 1,500,000 245,000 BUA Floating terminal, Lagos 1,051,000 225,000 Flour Mill Apapa Port, Lagos 2,000,000 600,000 Dangote Cement P/Harcourt, Onne 3,000,000 895,000 Apapa, Tincan & Aliko 3,000,000 terminals, Lagos Lafarge: Atlas P/Harcourt 2,000,000 160,000 Sources: Media, Industry sourcesLocal manufacturing capacity and utilisation rates: Besides the expected Apart from new plants, rampingrise in volume from the new cement plants which would be commissioned next up of utilisation by older plantsyear, existing plants will continue to ramp up capacity. Based on our estimates, would also increase supplyaverage capacity utilisation in the industry as at Q3‟10 in 2010 was about 62%,even though Obajana Plant‟s capacity utilisation was c.90%.Nigerian Cement Sector: Unbundling Potentials I January 2011 I 21
    • Nigeria I Building Materials I EquitiesAccording to the Nigerian Bureau of Statistics, Nigeria‟s average utilisation ratefor the cement manufacturing sector stood at 53.39% between 2002 and 2007.Owing to the gradual ramp up of the Obajana plant and Gboko (former BenueCement Company), which were commissioned in 2007 and 2008, capacityutilisation dropped to 47% in 2007, but steadily rose to 59% in 2009, usingavailable data from industry sources. Based on our estimate, average capacityutilisation in the cement industry stood at 66% as at Q3‟10. However, we projectthat average industry capacity utilisation would dip slightly to 65% in 2011, butrise again in 2012 when most of the new plants would have ramped upcapacities. Figure 22: Actual and forecasts of production volume („000 tonnes) and capacity utilisation rates (%) from local manufacturing 25000 90.0% 82.1% 82% 20000 64.7% 58.8% 60.0% 15000 54.5% 10000 30.0% 5000 0 0.0% 2008 2009 2010E 2011E 2012E Production Volume Utilisation Rate Sources: Annual reports, Vetiva Research Estimates Pricing Dynamics: Likelihood of crashing? Notwithstanding the significant increase in cement capacity anticipated nextyear, we do not see major cuts in cement prices in the mid to long term. Tostimulate sales in 2011 in view of the inventory build-up witnessed by producers We believe cement prices wouldthis year, a slight cut in prices next year is likely. In our view, once producers be kept relatively stable by volume adjustments despiteclear up built-up inventory, the alternative would be to reduce capacity utilisation foreshadows of changes in supplyto minimize production rather than embark on aggressive price cuts to stimulate and demandsales. We however believe that it would be more profitable for cement producersto maintain higher capacity utilisation given the huge operational gearing of theindustry. By Q4‟11 we believe demand would increasingly become stronger, asthe newly elected government settles in, and continue the pursuance of themedium term National Development Plan on infrastructure development.Nigerian Cement Sector: Unbundling Potentials I January 2011 I 22
    • Nigeria I Building Materials I EquitiesDespite our expectation of a resumption of strong demand at this period, we do The excessive cost of cementnot see producers hiking prices; we believe volume play would be a core production in Nigeria is expectedstrategy, as new plants gradually reach higher utilisation rates to remain to fall with improvements incompetitively profitable. We reiterate that cement prices would at best, power and political stability in theremain constant. The following are factors that underpin our view that Niger Deltacement prices are not likely to crash in the medium term:Huge cost of production: With an industry average of $102 per tonne, the costof producing cement in Nigeria is one of the highest globally. Figure 23: Comparison of production cost (USD per tonne) of cement 120.0 103 90.0 60.0 54 55 45 40 32.2 32 33 26.2 24 30.0 23 15 0.0 Egypt Oman Jordan S/Arabia China UAE Iran Nigeria Ave.MENA India Algeria Ave. Europe Sources: CEMNET, Vetiva ResearchExcluding Dangote Cement (which has the least cost of production per tonne of$58) from the industry would even raise industry cost of production further to$117 per tonne (based on FY‟09 figures). Whilst we expect some reduction in Average cost of production perproduction costs for most Nigerian cement producers with the increasing tonne for Nigerian cement producers is $103, quite higherpopularity of using coal as an additional fuel alternative, and the relative stability relative to most emergingin the Niger-Delta region, the expected decline in production cost would not be economiessignificant enough to warrant a crash in cement prices. A producer like DangoteCement has a significantly lower cost of production relative to others because itpredominantly uses gas, which is the cheapest fuel source locally, in its 5 milliontonnes, Obajana Cement Plant. However, due to the usage of Low Pour Fuel Oil(LPFO) at its Gboko plant, Dangote Cement‟s production cost of $58 per tonne,despite being the lowest in the Nigerian cement industry, is quite higher thanwhat is obtainable in other emerging economies in Africa and Asia like Egypt($33), India ($32) and China ($26). The comatose state of electric power inNigeria is another contributing factor to the high production costs of Nigeriancement producers, as more cement plants virtually run on generating plantswhich mostly run on diesel, LPFO or gas in some cases.Nigerian Cement Sector: Unbundling Potentials I January 2011 I 23
    • Nigeria I Building Materials I EquitiesTransportation costs: According to industry sources, the cost of transportingcement from the plant to distributors can increase production cost by an Given the lack of a functionaladditional 25% to 30%, given the practically non-existent railway transportation railway system, inefficient meansin Nigeria and the bad state of most Nigerian roads. Expectedly, the additional of transport are used translatingcost incurred on transportation is passed on to consumers in form of higher retail to costs laid on the finalprices; thus, Nigeria has one of the highest cement prices globally. consumer Figure 24: Average selling price and production cost (N per tonne) for publicly quoted cement producers 30000 15% 25000 10% 20000 15000 5% 10000 0% 5000 0 -5% 2007 2008 2009 2010E 2011E 2012E Price per tonne (N) Production cost per tonne Y-o-Y Growth in Price (%) Sources: Annual reports, Vetiva Research EstimatesCement Imports: Owing to the high costs associated with cement imports, inthe form of actual cement costs, as well as freight and shipping costs, the pricing Cement import dynamics havedynamics of imported cement is significantly different from locally produced been set even further apart fromcement. On the average, the cost of sale of cement import terminal operators local production by recent hikes in import duties80% - 85% of cement sales. Apart from the cost of cement and freight charges,the recent hike in import duties (to 35% from N500 per tonne) wouldsignificantly cause a surge in the overall cost of imported cement, therebyputting pressure on retail prices going forward.Nigerian Cement Sector: Unbundling Potentials I January 2011 I 24
    • Nigeria I Building Materials I Equities Figure 25: Components of production costs for an import terminal (2009 Estimates using Dangote Cement) 3.7% 3.2% 3.2% 3.1% Cement cost Demurrage Packaging Direct Factory Overhead 86.7% Fixed costs Sources: Company, Vetiva ResearchRegulatory Perspective: impact of governmentpolicies... Having re-introduced backwardThrough its recent policies, government has demonstrated its support for the integration in the cement sector arapid investments seen in the cement industry. As an industry with very huge while back, government hascapital outlay, the Nigerian cement industry is highly regulated. Following a re- followed up with incentives tointroduction of backward integration in the sector during President Obasanjo‟s sustain investments in theadministration, government had since then paid close attention to investments in industrythe sector, putting various incentives in place to protect the industry andencourage potential investments in cement production.In line with this policy, we have seen significant investments in the cementindustry in the last three years culminating in the addition of three cement plants(Dangote Cement‟s Obajana and Gboko- former BCC-plant and, Holcim and Flour Policies have as well been aimedMill‟s Unicem plant) having a combined annual capacity of 13.2 million tonnes. In at retarding importation while encouraging local production,recent time government has re-introduced policies, which in our view, would through selective taxing and bansprotect local manufacturers at the expense of cement importers. The recentmeasure involve an increase in duties on imported cement as summarisedbelow;  Re-instatement of 20% import duty on bulk cement and an additional 15% duty on cost insurance and freight price of bulk cement. The 35% import duty would replace the existing N500 per tonne  Cancellation of all existing unutilised import licenses issued between 2002 and 2008  Annual review of local production to ascertain the need and extent of imports  Banned importation of bagged cementNigerian Cement Sector: Unbundling Potentials I January 2011 I 25
    • Nigeria I Building Materials I EquitiesOther existing government incentives available to investors in the industryinclude;  Removal of restrictions on the importation of gypsum  Reduction of the duration for obtaining exploratory and mining licenses to 18 and 6 months respectively  The reinstatement of tariff incentives for imported spare parts and machineries for the production of cement for 2-3 years.  The duty free period is to cover the plant building phase and the first two years of commencement of production  The approval of tax deductible incentives on investments in system conversion to coal  The approval of concessional pricing and special allocation of LPFO to the sector  Delinking the price of gas for cement production from the price of LPFOApart from policies that are directly linked to the cement sector, the federalgovernment through its Nigerian Investment Promotion Commission (NIPC) hasencouraged new investments in the sector. One of such incentives is the PioneerTax Status from which players like Dangote Cement and Unicem which investedin new capacities through brown-field and green-field projects are benefitting. NIPC incentives in form of tax reliefs have also encouragedApart from the Pioneer Tax Status, tax relief for Research and Development is investments in the cement sectoralso available for industry players who engage in active research and and the overall economydevelopment for the improvement of their industrial processes. Most companiesin the cement industry however are yet to exploit this tax relief incentive as littleResearch and Development activities are carried out locally. Cement companieslike Lafarge WAPCO and Ashaka mostly rely on the Research and Developmentcarried out at the parent (Lafarge) level.The cement industry is also poised to benefit from government‟s export policies,especially those relating to free trade within the ECOWAS region. With the Free trade policies among Westexception of CCNN which sometimes embark on minimal export to Niger Republic African countries are also policiesto reduce the impact of sluggish sales locally, no other player in the industry that would evidently favourcurrently embarks on cement exports. With the indication that cement export cement export in the long runmight be feasible in the medium term, players are poised to benefit fromECOWAS incentives on exports to West African countries. Some of theseincentives are as follows;  Manufacture-in-Bond Scheme  Export Expansion Grant (EEG) Scheme  Export Development Fund Scheme  Trade Liberalisation Scheme of ECOWAS  Nigeria Export Processing Zones (Free Zone Law)Nigerian Cement Sector: Unbundling Potentials I January 2011 I 26
    • Nigeria I Building Materials I EquitiesParticularly, we believe Dangote Cement, the biggest producer in the industrywill be the most suited to benefit from these export incentives, given itsaggressive business strategy to commence cement export to West Africancountries.Industry RisksEnergy costs/supply: Since the major input (apart from Limestone) in Despite the global use of coal ascement production is energy, the key risk facing industry players relate to a more prominent fuel in theenergy cost and supply. In the Nigerian cement industry, the major fuel types cement industry, its use inused to power cement kilns include Low Pour Fuel Oil (LPFO), gas and coal, with Nigeria is still largely limitedcoal being the newest fuel substitute in the Nigerian cement industry, graduallygaining more acceptances among producers. We highlight the following as themajor risks relating to each type of fuel:  Low Pour Fuel Oil: Possible scarcity and hike in fuel price since the product is largely imported; local refinery capacity is limited (at 60% utilisation). The Kaduna refinery which mainly produces LPFO has however been shut down due to technical hitches, despite resuming operation in May 2010.  Gas: threat from militant activities in the Niger-Delta and possible disruption of gas supply; possible hike in prices  Coal: The key risk relating to the use of coal relates to its potential as a major source of environmental pollution, especially in view of the rising Despite expected stability, global emphasis on the “green evolution”. persistence in the current weakness in purchasing power Pricing: Although we broadly maintain our view that a crash in cement prices is could drive prices down unlikely, we do not completely eliminate the possibility of major price reductions if the wane in purchasing power observed for most of this year is prolonged beyond expectation. Investment Summary Stock Market performance Cement stocks are among the best performing on the Nigerian Stock Exchangeyear to date. As measured by the Vetiva Building Materials Sector Index, thesector has recorded a YTD appreciation of 39%, ahead of the NSE All ShareIndex which has recorded a gain of 19%. The sector reached its peak Stocks in the sector haveappreciation of 60.5% in April, the period when the stock market posted the progressed over the yearhighest gains. Prior to the listing of Dangote Cement Shares and delisting of (outperforming the ALSI)BCC, the strongest movers of the sector‟s performance were Lafarge WAPCO and especially prior to the listing ofBenue Cement Company (BCC) as they predominantly dominated the sector‟s Dangote Cementmarket capitalisation. On an individual basis, Ashaka Cement, with a YTD gain ofc.116% is the biggest gainer in the sector, followed by WAPCO (YTD gain ofc.30%) and CCNN (YTD appreciation 18%). Following the listing of DangoteCement Shares, the stock became, the major determinant of the buildingmaterials sector performance as it accounts for c.91% of the sector‟ s marketcapitalisation. The declines seen in Dangote Cement Price post listing (the stockhas lost 11%) has further eroded the gains in the sector, bringing it down to39%.Nigerian Cement Sector: Unbundling Potentials I January 2011 I 27
    • Nigeria I Building Materials I Equities Figure 26: Share Price Performance Year Open to 15th December 2010 (Rebased) 2.25 Ashaka: +132% 1.75 BMIndex:+39% WAPCO:+35.7% 1.25 ASI:+19% CCNN: 19% DCP: -11% 0.75 28-Aug 27-Sep 30-Apr 29-Jul 31-Dec 31-Mar 27-Oct 26-Dec 30-May 1-Mar 29-Jun 26-Nov 30-Jan ASI BMIndex Ashaka WAPCO DCP CCNN Sources: Company, Vetiva Research Q3‟10 Earnings UpdateFor most cement producers, the Q3‟10 earnings came in with weak top-lines, but Even as extended rains andrelatively improved bottom-line performance. Cement sales took a double blow dearth of loans have loweredfrom the prevalent slack in lending from the banking sector, and the protraction earnings, a rebound in demandof the rainy season. Reports from industry sources have indicated that there is by H2‟11 is expected to restoreas much as 500,000 tonnes of clinker piled up across the industry as at growth in the sectorOctober/November 2010. Earlier at the beginning of Q3, Lafarge WAPCO hadexpressed concerns about the wane in demand the possibility of shutting one ofits plants temporarily if the situation does not improve. Accordingly, its Q3‟10earnings came in with weak top-lines. Whilst the build-up may have somewhatcaused some surplus in the industry, we maintain our view that it is only atemporary glut which we believe would cease latest by Q4‟11.Dangote Cement Plc: Closing Up on ExpectationsDangote Cement Plc is the only cement producer that recorded a YoY growth insales in the Q3‟10 earnings season. Reported figures (see figure 26 below) show As against the trend, Dangotean impressive 60% growth in turnover, quite laudable in a period when all the cement grew its earnings through effective product distribution andcement producers reported decline in sales. Whilst noting that Dangote Cement incentives to loyal customerswas not immune to the slow-down in general demand across the sector as it hadto embark on slight price cuts, the sales growth achieved was possible byaggressively pushing volumes through its extensive distribution network, as wellas granting bonuses and credits to loyal customers. More importantly, thecompany‟s Q3‟10 earnings show EBIT and PBT margins of 52.9% and 52.5%,quite in line with forecasts of 54.2% and 53.7% respectively. The company alsopaid an interim dividend per share of N2.00.Nigerian Cement Sector: Unbundling Potentials I January 2011 I 28
    • Nigeria I Building Materials I Equities Figure 27: Dangote Cement Plc Q3‟10 Results Key Q310 Q309 Chg 2010F Q3 as % Headlines NGNbn % NGNbn of 2010F Turnover 146.56 91.3 60.47 197.25 74.3 EBITDA 87.97 58.21 51.12 114.25 76.99 EBIT 77.37 49.56 56.11 100.83 76.73 PBT 76.93 46.93 63.92 99.83 77.06 Tax -1.63 -1.79 8.93 - - PAT 75.29 45.14 66.75 99.83 75.42 Sources: Company Fillings, Vetiva ResearchLafarge WAPCO Cement Plc: Tough Quarter, Earnings Growth StrainedIn line with the trend observed for Lafarge WAPCO‟s Q1‟10 and Q2‟10 earnings,Q3‟10 earnings came in with a decline of 5.8% in revenues but strong growth of Notwithstanding waning sales,41% in after tax profit. Notwithstanding, the results are somewhat in line with Lafarge WAPCO results showedour Q3‟10 revenue and profit after tax forecasts of N32.20 billion (variance of continuing improvement in+2.6%) and N5.32 billion (variance of +6.9%). Relative to the prior two quarters operating efficiencyhowever, the company recorded a more pronounced decline in sales on a QoQbasis as its Q3‟10 (July – September) revenue dipped by 9.2%. Despite lowersales, Lafarge WAPCO has been able to sustain the improvement seen in itsprofitability margins at the beginning of the year. Figure 28: Lafarge Cement WAPCO Plc Q3‟10 Results Key Q310 Q309 Chg 2010F Q3 as % Headlines NGNbn % NGNbn of 2010F Turnover 33.04 35.09 (5.80) 42.86 77.09 PBT 9.02 7.21 23.40 11.08 81.39 Tax (3.34) (3.29) 1.50 (3.99) 83.71 PAT 5.68 4.02 41.40 7.09 80.11AshakaCem Plc: Margins under Pressure?Notwithstanding being in line with general expectations for cement producers,Ashaka‟s Q3‟10 numbers came in shy of our estimates for revenue and after tax Ashaka‟s Q3 performance fell short of our forecasts though itearnings by 8.5% and 15.9% respectively. On a quarterly basis, Ashaka took a stood in line with the averagesignificant hit in both top and bottom line performance in Q3‟10 (July to industry expectationsSeptember) as revenue and pre-tax profit plunged by 29% and 55% respectively.In view of the faster rate of decline in Ashaka‟s Q3‟10 pre-tax profit, the companyrecorded the lowest profitability margins in the quarter as pre-tax profit marginfell to 12.5% in Q3‟10 (July to September) from 19.9% and 25.5% in Q2‟10 (Aprilto June) and Q1‟10 respectively. The drop in efficiency and margins in the quarterwhich had been contrary to our expectations as higher gains in efficiency has beenexpected to accrue from the company‟s coal investment. Ashaka‟s managementhowever adduced the poor bottom-line numbers to LPFO costs (which had beenpurchased at high price levels of 2009) and the lower substitution of coal in itsfuel mix.Nigerian Cement Sector: Unbundling Potentials I January 2011 I 29
    • Nigeria I Building Materials I EquitiesFigure 29: AshakaCem Plc Q3‟10 Results Key Q310 Q309 Chg 2010F Q3 as % Headlines NGNbn % NGNbn of 2010F Turnover 13.57 12.71 6.80 18.19 74.60 PBT 2.73 1.77 53.75 3.73 73.19 Tax (0.82) (0.59) 39.76 (1.19) 68.91 PAT 1.91 1.19 60.64 2.54 75.19Cement Company of Northern Nigeria: Laggard in the PackThough falling short of our turnover forecast by 12%, CCNN‟s Q3‟10 top-lineearnings reflect the general industry theme of slowing sales for the quarter. Theresult however was considerably disappointing in bottom-line earnings as pre-tax Despite aligning with generaland after tax profit fell by 51% and 61% respectively, making CCNN the least industry trend in terms of top-lineefficient amongst the cement producers. CCNN is perhaps still having challenges earnings, CCNN seems to lag othersin getting around its rising energy costs to remain profitable. Whilst noting that in the sector given its significantlyCCNN‟s management had indicated at various times its plans to expand weaker bottom-line performanceproduction capacity, our major concern regarding its expansion cost reductionstrategy relates to the lack of clarity regarding the expected kick-off/completionof these projects as well as funding considerations. Without specific steps on itsexpansion and cost reduction plans, CCNN would increasingly become grosslyincapable of matching up with the rising competitive pressure from DangoteCement depots in its region. Figure 30: Cement Company of Northern Nigeria Plc Q3‟10 Results Key Q310 Q309 Chg 2010F Q3 as % Headlines NGNbn % NGNbn of 2010F Turnover 8.39 8.91 (5.8) 11.54 72.71 PBT 0.93 1.89 (50.6) 1.14 82.01 Tax (0.36) (0.43) 17.1 (0.36) 98.90 PAT 0.574 1.46 (60.6) 0.774 74.16Nigerian Cement Sector: Unbundling Potentials I January 2011 I 30
    • Nigeria I Building Materials I EquitiesDangote Cement PlcEntrenching Market Dominance ACCUMULATE Matchless organic value: In our view, Dangote Cement‟s ability to Stock Data drive growth organically is quite enormous, given the anticipated Bloomberg Ticker: DANGCEM:NL increase in its production capacity by an additional 11 million tonnes Market Price (N) 120.00 before the end of 2011. This presents Dangote Cement Plc the Shares Outs (bn) 15.494 opportunity to consistently drive higher growth through increasing Market cap (N‟bn) 1,859 volume and capacity utilisation, at least over the next 7 to 8 years. Fair value range (N) 131.5 – 142.5 Rating ACCUMULATE On-course with Pan-African expansion: With Dangote Industries Limited‟s recent increase of its stake in Sephaku Cement South Africa to a controlling position, the Dangote group is pushing strong in its Pan- Price Perf. Dangcem NSE African expansion drive. Dangote Industries is currently making 12-month (%) n/a 19.2 arrangements to transfer other African assets to Dangote Cement Plc at 6-month (%) n/a -5.0 cost. According to management, we expect the transfer, which would Post listing (%) -11.0 -2.0 bring Dangote Cement‟s total capacity to c.46 million tonnes, to be completed in 2011. Financials 2009A 2010F 2011F Global Offering in the offing: In compliance with NSE listing Turnover (Nbn) 189.62 208.50 346.33 guidelines of having at least a 25% free-float, Dangote Cement Plc has EBITDA (Nbn) 77.85 120.61 206.52 announced plans for a Global Depository Receipt (GDR) offering, PAT (Nbn) 61.39 102.86 186.94 through which Dangote Industries would reduce its holdings in Dangote EBITDA Marg (%) 41.1 57.8 59.6 Cement by 20%. Dangote Cement Plc shares, through the GDRs to be PBT Margin (%) 33.6 50.9 55.1 issued in the offering would subsequently be listed on the London Stock PAT Margin (%) 32.4 49.3 54.0 Exchange. Valuation and Recommendation: We use a blend of DCF and Valuation 2009A 2010F 2011F EV/EBITDA for our valuation and arrive at a fair value range of P/E (x) 0.98 18.08 9.95 N131.50 - N142.50. Dangcem currently trades at a forward (2011) P/BV (x) 0.83 9.81 7.73 P/E of 9.95x relative to sector average of 12.70x and average of our EV/EBITDA (x) 23.88 15.41 9.00 universe of emerging market peers of 11.8x. Div. Yield (%) 1.7 4.1 7.3 Figure 31: Post-listing Share price performance vs. ASI and sector index (Rebased); Shareholding Structure 1.1 Others 1.0 5.3% 1.0 0.9 0.9 DIL 94.7% 0.8 26-Oct 2-Nov 9-Nov 16-Nov 23-Nov 30-Nov 7-Dec 14-Dec ASI Dangcem BMIndex Source: NSE, Vetiva ResearchNigerian Cement Sector: Unbundling Potentials I January 2011 I 31
    • Nigeria I Building Materials I EquitiesInvestment ThesisDominant market share: Through its 5 million tonnes Obajana Plant, 3 With a current annual productionmillion tonnes Gboko (BCC) Plant and 6 million tonnes import terminals in capacity of about 8 million tonnesLagos, Port/Harcourt and Onne, Dangote Cement controls close to 60% of the and an additional 11 million tonnesNigerian cement market and it‟s unarguably the giant of the industry. almost completed Dangote cement isDangote Cement‟s Obajana plant is the biggest cement plant in Nigeria and set to increase its market share tothe second largest in the Africa. (See chart below). This is indeed a big mile c.70%stone for an indigenous business in a continent where the cement industryhas historically been largely dominated by foreign multinationals some ofwhich include globally known names like the Lafarge group of France,Heidelberg group of Germany, Italcementi group of Italy and Holcim group ofSwitzerland. Of more importance is Dangote Cement‟s aggressive expansiondrive to entrench its dominant position in the Nigerian cement industry. Asbroadly stated by Dangote Cement‟s management, an additional 6 milliontonnes cement plant in Ibese, which is billed to be completed by Q1‟11 andObajana‟s 3rd and 4th lines, also billed to be completed by H1‟11, would pushDangote Cement‟s market share to c.70% of the market, giving the companya relatively monopolistic advantage based on accretion of huge benefit ofeconomies of scale relative to others in the industry. Figure 32: Total production capacity (million tonnes/annum) of DCP 25 6 20 Current manufacturing and import capacity of 14 million tonnes 15 5 26 6 10 Additional 11 million tonnes (Obajana 2 + Ibeshe) expected by 2011 5 5 1 3 0 BCC Obajana Import Obajana2 Ibese Expected Total terminals Sources: Annual Reports, Vetiva Research EstimatesModern and highly energy efficient plants: Given the current new stateof both Gboko (former BCC) and Obajana Plants, the plants have thepotential to achieve peak utilisation rate. Also, the plants are highly energyefficient unlike other cement plants in the country - most of which are quiteold and have not undergone any major revamping in recent times.Nigerian Cement Sector: Unbundling Potentials I January 2011 I 32
    • Nigeria I Building Materials I EquitiesGenerally in sub-Sahara Africa, most cement plants are quite obsolete andhave low capacity utilisation rates. According to World Bank/Carbon FinanceAssist research in April 2009, the capacity utilisation observed for most Dangote Cement currently has thecement plants in sub-Saharan Africa is quite low, standing at an average most modern and energy efficient plants in the industry(excluding South Africa) of 54%. Until 2006, average capacity utilisation inWest Africa and Nigeria were even lower at about 46% and 22% respectively.In a region where the cement industry is characterised by low capacityutilisation mainly as a result of the aged nature of most cement plants, theDangote Group is evidently well poised to dominate the market with itsrelatively younger and new cement plants. Obajana Cement Plant is about 3years old while BCC‟s cement lines (following the total overhaul andexpansion of its plants completed in 2008) are also about 2 - 3 years old.Figure 33: Energy consumption of Nigerian cement producers Average Gross Profit Company Plant Location Kiln Type Energy/tonne Margin 3 (%) Dry- Ewekoro Precalciner 4.03 Lafarge (WAPCO) Shagamu Wet 5.94 33.1 CCNN Sokoto Small dry kiln 5.13 43.5 Dry BCC Precalciner 4.03 55.4 Dangote Dry Cement Obajana4 Precalciner 4.03 72.4 Lafarge (Ashaka) Ashaka Dry 4.29 34.3 Sources: Vetiva Research, “Alternative fuels in Cement manufacture” by Energy & Resource Group, and UC Berkele Note: 3as at FY‟09, 4 Obajana‟s EBITDA Margin is based on 10 month management accountsProximity to key markets: One of the strongest competitive advantages of The nearness of rapidly growingDangote Cement Plc is the proximity of its business units and cement plants to cities to Dangote cement‟skey markets for construction and building – Lagos and Abuja. Lagos and Abuja factories also offers an advantage as regards growth and sales.account for the largest consumption of cement in Nigeria given the rapid growthin infrastructural development in these regions. By road travel, Obajana CementPlant located at Obajana Kogi state, is approximately 213 km and Benue CementCompany, at Gboko, Benue state is approximately 404km, to Abuja. Comparedto other players - Ashaka, CCNN, and Lafarge WAPCO, Obajana Cement Plant isthe closest to Abuja market, followed by BCC as shown in the chart below.Nigerian Cement Sector: Unbundling Potentials I January 2011 I 33
    • Nigeria I Building Materials I EquitiesApart from the Abuja market, Dangote Cement‟s Ibese plant, (constructioncurrently on-going), places the group at the unique advantage of tapping into Strategic positioning of outlets even asthe Lagos and the South West, market which hitherto has been dominated by far at the Niger Delta, gives DangoteLafarge WAPCO. The group, through the operation of its import terminals in the strongest potential for nationalPort-Harcourt - also has significant foot-prints in the oil rich Niger Delta coverage among peers.region. Dangote Cement Group therefore is the only player in the NigerianCement Industry, capable of extending its market beyond its immediatelocalised regions, given the strategic positioning of its cement plants. Aspreviously stated, the bulky nature of cement, further compounded by a non-functional railway system, makes the distribution of cement a difficult taskforproducers, thus resulting in regional monopolies. Figure 34: DCP‟s depot distributionAggressive distribution network: Another core competitive advantage of in NigeriaDangote Cement is its extensive distribution network. Dangote Cement Plcoperates 40 depots or warehouses in all the major cities of Nigeria (see sidechart), thus easing the burden of distributors in getting the product.Distributors get the product at the depot at the ex-factory price without 9additional premiums. Similar to the distribution network for Dangote food-based products, the cement division also has a country-wide distributorship, 16especially in view of the ready accessibility of the product at the depots.Despite the bulky nature of cement which typically limits the penetration ofcement distribution over very long distances, Dangote Cement‟s fleet of 11trucks as well as its leverage on DIL‟s haulage and transportation business 3helps Dangote Cement penetrate key isolated markets. This further impliesthat Dangote Cement is well positioned to capture additional market share invarious regional markets particularly the North-East and North-West where Lagos/S.West Abuja/N. CentralAshaka Cement and Sokoto Cement (CCNN‟s brand) are somewhat N.West /N. East S. East/S. Southpredominant brands.  Lagos /South West depot are served by the plants and Lagos terminals since LagosStrong support from the Parent - DIL: Dangote Cement, being a is the biggest cement market in Nigeriasubsidiary of the entire Dangote Industries Limited has the unique advantage  Abuja/North Central region is the second biggest market. However, there are fewerof benefiting from the haulage business of the group to enhance the depots given the closeness of the region todistribution of its products. In effect, distribution costs for Dangote Cement Obajana plant  The north east/ north west region has theGroup would likely be lower, (relative to other players), as it is expected to second highest number of depots in viewbenefit from cheaper and more convenient lease terms. Furthermore, being a of their far distance to Dangote Cementpart of the DIL, which has a specific haulage business, implies that Dangote plants  The south/south and south/east depotsCement can significantly increase its penetration since it can entirely contract are mainly served by the Portharcourt anddistribution of cement to the haulage division of DIL, thus enabling it Onne import terminals(Dangote Cement Group) to focus on its core business. Dangote Cement isalso well poised to benefit from DIL in terms of financial support – eitherdirectly as intercompany funding or guarantees to access cheaper debt The Company can also takefinancing given the robust balance sheet size of Dangote Industries Limited advantage of the haulage arm of(DIL). In pursuing its Pan-African expansion strategy, Dangote Cement is at a the DIL group as well as financialunique advantage given that the Pan-African expansion is largely mid-wife by support from the parentDIL. According to the company‟s management, the African assets would be company.transferred, at cost to Dangote Cement, which will then take the projects tocompletionExport Alternative – supporting local sales: Given the various expansionprojects current on-going in the sector, which would perhaps lead to surplussupply in the near term, Dangote Cement is well-positioned to reduce thelikely impact of surplus supply on its revenue through export.Nigerian Cement Sector: Unbundling Potentials I January 2011 I 34
    • Nigeria I Building Materials I EquitiesAccording to management, plans to build export terminals at its portconcessions in Lagos are on-going. With the expected completion of the Dangote Cement plans to offsetsecond line at Obajana Cement Plant and Ibese Cement Plant, total cement its short term supply surplus withoutput by the Dangote Cement Group (manufacturing) would be about 19 export as plans are underway formillion tonnes per annum at full capacity utilisation of the plants. As we have the construction of export terminalsnoted the expected additional capacity from Dangote Cement coupled withother expansion and kiln upgrading projects currently being carried in thesector by other players, suggests that players may as well be looking beyondlocal markets to sell their products.Pioneer tax status: Another key attraction to the combined DangoteCement Plc is the prolonged period for which the company would enjoy thetax exemption in view of the combined pioneer tax status of its cement As the cement plants of theplants. BCC and Obajana plants were given pioneer tax status for three years company enjoy pioneer taxand five years, respectively effective from 2009. This exempts both plants status, the company enjoys somefrom tax payment between till 2012 and 2014 respectively. We believe also tax exemptions under the combined structurethat a pioneer tax status would be granted to Ibese plant at completion (firstquarter 2011); implying therefore that the combined DCP would be furtherpoised to enjoy some tax exemption for a much longer period, till 2017perhaps. This further improves the return outlook for DCP especially in termsof the expected absolute dividend payout.Economies of Scale: There are significant cost reduction benefits for thebigger cement producers in the cement business. It is estimated, according Economies of scale is bound toto JPMorgan and Nov-08 edition of International Cement Review, that a 5 boost gains for the large cement producer as higher volumes helpmillion tonnes cement plant can produce cement at a much lower cost cut unit production cost(around $25 per tonne) than a smaller plant (estimated at $43 per tonne).Thus, we expect Dangote Cement to continue to enjoy immense gains in costreductions from its large scale of operation.Business OverviewDangote Cement Plc (DCP) was incorporated as Obajana Cement Plc on 04November 1992. DCP, prior to the planned special sale of shares, is 95.9%owned by DIL. Following plans by Dangote Industries Limited (“DIL”) toconsolidate all the cement entities within the Dangote Group into a singleentity, it initiated the transfer of all cement assets into Dangote Cement Plc.The current organisation structure of Dangote Cement Plc is show in Figure 2.Further to plans for an African expansion, Dangote Industries Limited iscurrently establishing cement plants and terminals across Africa. Some of thecountries include: Ghana, Sierra Leone, Liberia, Republic of Benin, Angola,DRC, Congo Brazaville, Senegal, Zambia and South Africa.Nigerian Cement Sector: Unbundling Potentials I January 2011 I 35
    • Nigeria I Building Materials I Equities Figure 35: Dangote Cement Plc - Plant /Terminal Structure Dangote Cement Plc Obajana Ibese Gboko Plant Cement Plant (DCW)* (former BCC) Cement Plant Lagos Dangote Bail Cement Cement (PH & Terminal Onne) Terminal * Dangote Cement Works Though, DCW and Benue Cement were previously individual companies prior to the Scheme of merger and consolidation with the other cement entities, they will all now operate as “plant/term inal entities with separate management structures including Production/Bagging, Finance, Logistics and Human Resources Source: Vetiva Research, Scheme of Merger Document, DCP Analyst PresentationObajana plantProduction DynamicsObajana Plant currently controls the largest market share in the Nigeriancement producers and also accounts for the larger chunk of Dangote Obajana Cement Plant currentlyCement‟s output in the cement industry. Since the plant began operation in produces 46% of the company‟s2007, production has rapidly risen to 3.3 million tonnes in 2009 from 1.62 cement at an average utilization rate of 86% which is expected tomillion tonnes in 2007 - an increase of 106% in just two years. As at 2009, drop as new lines ramp upOCP accounted for 46% of the total output of the Dangote Cement Group,rising from c.29% in 2007. Despite the 106% increase seen in productionoutput of OCP in two years, the plant, as at FY‟09, operated at an averagecapacity utilisation rate of 66%, based on our estimate. We expect anaverage utilisation rate of 86% for Obajana Plant by FY‟10. Following theaddition of another 5 million tonnes from the on-going expansion at theObajana Plant, we estimate an average utilisation rate of 65% for FY‟11. Thedrop in average utilisation rate is expected from the gradual ramping up ofthe new lines. Figure 35 below shows our forecasts of production output fromObajana plant and the expected contribution of the plant to DangoteCement‟s overall revenue.Nigerian Cement Sector: Unbundling Potentials I January 2011 I 36
    • Nigeria I Building Materials I Equities Figure 36: Obajana plant output (million tonnes) and %age contribution to Dangote Cement Plc total output (Actual and Forecast) 9000 60% 54% 7500 50% 46% 47% 6000 40% 34% 4500 30% 27% 3000 19% 20% 1500 10% 2007 2008 2009 2010E 2011E 2012E OCP Output (million tonnes)-LHS Contribution of OCP to Dangote Cement Total Output (%)-RHS Sources: Vetiva Research, Company ManagementProduction costsEnergy costs (kiln fuel and power) typically make up about 55% to 60% oftotal production costs of Nigerian cement producers. As we have earlier Obajana Plant uses the PreCalcinernoted, the technology used in the OCP kiln (Pre-Calciner dry) process is the rotary kiln, known to be the mostmost energy efficient method in cement production. Its energy consumption energy efficient kiln type in thelevel is significantly lower (c.700 kcal) in comparison to the common dry kiln cement industrymethods (750 to 950 kcal), and the most energy intensive traditional wet kilnmethods (1300 to 1600 kcal). As an evidence of this, OCP‟s energy cost issignificantly lower relative to the others in the sector Figure 37: Comparison of cost of sales as percentage of net sales (average FY‟10E to FY‟12E) 60% CCNN WAPCO 45% Ashaka 30% Gboko1 Obajana 15% 0% 0 1 2 3 4 5 6 Sources: Annual Accounts, Vetiva ResearchNigerian Cement Sector: Unbundling Potentials I January 2011 I 37
    • Nigeria I Building Materials I EquitiesAccording to management‟s guidance and our estimates, energy (fuel andpower) constituted about 20% of net sales revenue, which is far lower than Despite having the lowest cost-the conventional estimate of about 40% - 45% for a typical local cement revenue ratio in the Industry, weplant. Consequently, we estimate that Obajana plant‟s total input costs as expect Dangote Cement Plc topercentage of net sales revenue for 2009 is about 19.8% - the lowest in the improve more on its gasindustry. We expect Obajana‟s plant production cost to trend lower by FY‟10 substitution to further cut cost ofas the company has achieved a higher rate of gas substitution in its fuel mix production per net sales to 14.1%relative to 2009. Thus, we expect cost of sales (as % of net sales) to drop to14.1% by FY‟10. From 2011, production costs would trend higher in line withthe anticipated rise in cement output from the new lines. Furthermore weestimate an average of 14.8% for production costs as % of revenue over2010 to 2013. Given that the Obajana plant utilises gas which is the cheapestenergy source for cement producers in Nigeria, its contribution to DCP‟soverall cost of production is just about 25%, despite accounting for c.50% ofDangote Cement‟s total revenue. Figure 38: Comparison of percentage contribution of Obajana plant to Dangote Cement‟s revenue and production costs 40% 30% 20% 10% 0% 2009 2010E 2011E 2012E Contribution to production cost Contribution to revenue Sources: Annual Accounts, Vetiva Research EstimatesGboko Plant – (former Benue Cement Company)Production dynamicsGboko plant is currently the second largest cement plant in Nigeria but have thethird largest market share in terms of cement production and output. Due to thegradual ramping up of capacity of its new plant, BCC is overtaken by LafargeWAPCO, (in terms of market share) despite having a larger plant.Nigerian Cement Sector: Unbundling Potentials I January 2011 I 38
    • Nigeria I Building Materials I EquitiesSince Unicem only started operations two years, the gradual ramping up of itscapacity utilisation rate also makes it lag behind Lafarge WAPCO in terms ofmarket share despite having a higher plant size as the third largest cement plant(by installed capacity) in Nigeria.The Gboko plant has not been able to ramp up capacity utilisation as fast asObajana plant due to the fact that the plant can only use Low Pour Fuel Oil(LPFO), although DCP‟s management is in the process of converting the plant toa dual-firing kiln capable of using coal and LPFO. As at half year, the plant wasoperating at c.55% capacity utilisation up from an average of about 24% in 2008when the second cement 1.4 million tonnes line started operations. Based on2009 figures, Gboko plant accounts for about 18.9% of Dangote Cement totalcement output, being the third largest contributor to the group‟s earnings, (theimport terminal in Lagos was the second largest revenue earner for the DangoteCement Group after Obajana Cement).We expect revenue generated from this plant to rise to N60.8 billion by FY‟11from N35.0 billion as at FY‟09. However, we estimate that its contribution toDangote Cement‟s overall revenue would dip to c.16% by FY‟11 from 33% as atFY‟09 in view of additional lines to be added at the Obajana plant and the newplant at Ibese. Figure 39: Gboko plant output (million tonnes) and %age contribution to Dangote Cement Plc total output (Actual and Forecast) 4.0 35% 28% 3.0 22% 21% 20% 19% 2.0 16% 14% 10% 1.0 7% 5% 0.0 0% 2007 2008 2009 2010E 2011E 2012E Gboko Plants Output Contribution to DCP total Sources: Annual Accounts, Vetiva Research EstimatesProduction costsEnergy costs as a whole constitutes about 60% of Gboko plant‟s total productioncosts, which is quite higher in comparison to the Obajana Plant for which energycosts is about 46% of production costs.Nigerian Cement Sector: Unbundling Potentials I January 2011 I 39
    • Nigeria I Building Materials I EquitiesThe plant uses Low Pour Fuel Oil, which is more expensive than gas; hence the Despite falling behind thedisparity in its energy costs in comparison to Obajana. Notwithstanding, the Obajana plant in terms ofGboko plant is more efficient in comparison to other competitors – Ashaka efficiency and productionCement, Lafarge WAPCO and CCNN. As a standalone entity prior to its merger economics, the Gboko plantwith Dangote Cement, it had the highest gross profit margin relative to the still stands out againstabove-named competitors. By FY‟10, we estimate that the plant would account competitorsfor c.19% of Dangote Cement‟s overall production costs; this is expected todecline to c.16% by FY‟12. Figure 40: Comparison of percentage contribution of Gboko plant to Dangote Cement‟s revenue and production costs 40% 30% 20% 10% 0% 2009 2010E 2011E 2012E Contribution to production cost Contribution to revenue Sources: Annual Accounts, Vetiva Research EstimatesDCW Limited (Ibese Plant)The Ibese Plant is a green-field project of the Dangote Cement Group located atIbese, Agbara Ogun State South-West Nigeria. The project which is being Dangote Cement‟s 6 million tonnesexecuted under a fixed price contract by Sinoma Engineering Company (a Ibese plant is about 80% completeChinese Engineering Company) is about 80% complete and scheduled to and is expected to becomecommence operation in 2011 (line 1 in January and line 2 in February). The operational by Q1‟11project comprise of a two lines of 3 million metric tonnes / annum, implying anannual capacity of 6 million metric tonnes (7,200 tonnes per day) at fullcompletion of the plant. The project also includes the construction of a 25kilometre gas pipeline which would supply gas to the cement plant. The factoryoccupies 2000 hectares of land with an estimated limestone capacity of 240million tonnes and life-span of 90 years. The Ibese Cement Factory is expectedto generate 102MW electricity using three gas turbines. Other investmentprojects at the plant site includes a six cement silos, and roto-parkers that wouldbe capable of packing 2,400 (50kg) bags per hour and about 18 trucks at a time.Nigerian Cement Sector: Unbundling Potentials I January 2011 I 40
    • Nigeria I Building Materials I EquitiesProduction dynamicsThe six million tonnes Ibese plant is expected to come on stream by Q1‟11. We believe the Ibese plant willThough a green-field plant like the Obajana plant, we believe its production ramp up capacity faster than thedynamics would differ from Obajana‟s plant at its commissioning next year Obajana plant and hence estimate 50% capacity utilisationbecause of the structure of the contract for the plant. Unlike the Obajana plant, by FY‟11the Ibese plant is being built as a turnkey contract, which is perhaps the mostreliable and expensive among other methods for constructing a cement plant.Under a turnkey contract, the contractor committees to complete the executionof the contract and to meet performance guarantees. Therefore, we expect theIbese plant to ramp up capacity utilisation somewhat faster than Obajana Plant.Thus we forecast an average capacity utilisation rate of 50% for FY‟11, andestimate that revenue generated from the plant would gradually rise from N76billion in FY‟11 to N136.89 billion by FY‟13, thereby increasing the contributionfrom Ibese plant to 27.1% by FY‟13 (from 21.5% by FY‟11). Figure 41: Ibese plant‟s expected output (million tonnes) and %age contribution to Dangote Cement Plc total output (Actual and Forecast) 6 30% 27% 5 25% 23% 22% 4 20% 3 15% 2 10% 1 5% 0 0% 0% 2010E 2011E 2012E 2013E Ibeses expected output Contribution to DCP total production Sources: Annual Accounts, Vetiva Research EstimatesProduction costsIbese plant‟s production costs dynamics is quite similar to the Obajana Plant asboth plants are built to predominantly run on gas. Similar to Obajana, the Like the Obajana plant, the Ibese plant is built to run on gas withDangote Cement is also making plans to have a fixed Gas Purchase Agreement arrangements already beingto the plant from the Nigerian Gas Company (NGC); this would help achieve made for fixed gas purchase fromsome stability in gas supply to the plant. Whilst we do not have the specifics of the NGC.the gas pricing, we expect the agreement to operate more like the Obajana Plantwhich is based on a fixed priced scalable upwards by a fixed percentage year-on-year.Nigerian Cement Sector: Unbundling Potentials I January 2011 I 41
    • Nigeria I Building Materials I EquitiesThus, in our forecast, we expect Ibese to only account 12% of Dangote Cement‟stotal production cost for 2011, despite contributing c.22% to DCP‟s revenue. Ascapacity utilisation rate and production at the Ibese plant increases, it‟s impacton Dangote Cement‟s total production costs is expected to rise as well; however,its input to DCP‟s total revenue would still outpace the implied increase inproduction costs.Import TerminalsDangote Cement Group has the highest cement importation quota, which isshared between the Lagos and Port-Harcourt terminals. The Group operatesthree cement import terminals in Lagos, namely Apapa, Aliko and Tincan, all ofwhich have facilities to bag imported bulk cement. The Lagos terminals have anestimated capacity of 3 million tonnes. Dangote Cement Group, through itssubsidiary-Dangote Bail Limited- operates two bulk cement terminals at Port-Harcourt (South-South) and Onne (South East). Both cement terminals have acombined annual bagging capacity of 3 million tonnes. As at FY‟09, the Lagosterminals contribute the second largest revenue among other Dangote Cemententities. Despite this, the import terminals are the least efficient and profitableamong Dangote Cement entities, given the huge cost of importation.Combined production costs as a of sales for the import terminals is close to 85% Dangote Cement import terminalscompared to 26% for Obajana and 38% for BCC (estimates for FY‟09). According have a combined capacity of 6to management, the import terminals are gradually been wound up in million tonnes and have thepreparation for the huge output expected from local production next year. In line highest cost of sales in the groupwith this, the Port/Harcourt terminal is almost non-operational, and the capacityutilisation of the Lagos terminals has been significantly reduced. We expectcement output through the import terminals to wane significantly in the mediumterm, as the new plants to be added to industry next year would almost doublelocal manufacturing capacity to c.28million tonnes (from about 14million tonnes).Thus we expect the short-fall in supply which has hitherto allowed for cementimports, to drop significantly or perhaps completely eliminated. Thus, forDangote Cement, we project that cement imports would shrink to 8.5% ofrevenue by 2013, down from 35% at FY‟09. Despite the expected decline inimport revenue, imports may still account for c.30% of Dangote Cement‟s totalproduction costs, owing to the huge costs associated with cement imports.Other African EntitiesImport Terminal Ghana: Dangote Industries Limited operates import Dangote Industries operate theterminals in Ghana through its subsidiary - Green-view International Company largest cement import terminal inLimited. Dangote Cement initially had a 750,000 tonne annual capacity import Ghanaterminal in Tamale Ghana. This year, the group expanded its operations inGhana through a $28 million investment in Tema Cement Factory (also an importterminal) which has an annual capacity of 1.2 million tonnes per annum.Nigerian Cement Sector: Unbundling Potentials I January 2011 I 42
    • Nigeria I Building Materials I EquitiesOnigbolo Cement Benin: Dangote Industries Limited acquired federal Dangote Industries recentlygovernment‟s 43% stake in Onigbolo Cement Company, Benin Republic following acquired federal government‟sthe privatisation of the company by the Beninoise government. The plant has an 43% stake in the 0.6 millionannual capacity of 0.6 million tonnes and is currently under management tonnes Onigbolo Cement, Benincontract that will expire in 2011.Sephaku Cement South Africa: In 2008, Dangote Industries acquired19.8% stake in Sephaku Holdings in South Africa. This year however, the grouphas been making plans to increase its stake in the company to 65% in line withthe overall initiative of Dangote Cement Group to build capacity on the Africancontinent. In August 2010, Dangote Industries entered into an agreement withSephaku Cement, in which Dangote Industries will increase its stake to 64% Recently also, DIL acquired afrom 19.8% in exchange for R779 million in cash (translating to 217.59 million controlling stake (65% equity) inordinary shares in the company at R3.58 per share). The equity investment of Sephaku Cement South AfricaDangote Industries in Sephaku Cement fulfils the equity requirements for theprojects to be embarked upon by the company and would also make thecompany well positioned to finalise debt funding terms as the debt would beguaranteed by Dangote Industries Limited. The funds would be utilised bySephaku Holdings to complete its ongoing projects-Aganang and Delmasprojects. The Aganang project includes a limestone mine and a cementmanufacturing plant in North-West Province, which is scheduled to produce The acquisition involves an900,000 tonnes per year of cement by 2012. The second project - Delmas exchange of R779 million cash inproject includes a cement milling plant in Mpumalanga province which would also exchange for 217.59 millionproduce 1.25 million tonnes a year of cement by the end of 2012. ordinary sharesThe cement plants will be built by Sinoma International Engineering Co. Ltd on afixed price full turnkey basis. Dangote investment in Sephaku Cement wouldreposition the company to be third biggest cement plant in South Africa. At thecompletion of Sephaku‟s cement plants, expected in four years, the companywould likely emerge as the third biggest cement producer in South Africa.Pretoria Portland Cement (PPC) which has a combined capacity of about 7 million DIL‟s acquisition makes Sephakutonnes is the biggest cement producer in South Africa, with Afrisam (formerly well positioned to pursue itsHolcim), which has an annual capacity of about 4.6 million tonnes per annum expansion to add over 2 millionbeing the second biggest cement producer. Another key factor which would also tonnes cement plantenhance the revenue and profitability growth of Sephaku Cement would be thenew state of the plants given that the average age of existing cement plants inSouth African is about 33 years, even with the two recent brown-field expansionsin the industry.Dangote Cement Senegal, other African countries: In 2008, DangoteIndustries Limited signed a financing deal with China‟s Sinoma International toconstruct a 1.5 million tonnes/annum cement plant in Senegal. The Senegal Dangote Industries is also buildinginvestment was a part of the $1.85 billion deal signed with the Chinese a 1.5 million tonnes cement plant inconstruction company to install the 3rd and 4th lines at Obajana plant and to Senegal and plans to expand toconstruct the Ibese Plant. The deal was financed partly with equity and debt. other countries like Tanzania andDangote Group provided equity of about $600 million, while the balance of $1.25 DRCbillion dollars was sourced from a consortium of ten local banks, which includesGuaranty Trust Bank (lead arranger), First Bank, First City Monument Bank(FCMB), United Bank For Africa, Zenith Bank and Stanbic IBTC Bank.Nigerian Cement Sector: Unbundling Potentials I January 2011 I 43
    • Nigeria I Building Materials I EquitiesThe Dangote Group however has repaid the loan through a refinancingarrangement from Standard Chartered Bank. DIL‟s contract with SinomaInternational also includes the construction of cement plants in DemocraticRepublic of Congo, Equitorial Guinea, Ethiopia, Tanzania, Senegal and Zambia.Recently the group signed an Investment Promotion and Protection agreementwith the Zambia government to establish a 1.5 million (per annum) cementplant. The plant is estimated to cost $400 million dollars and it is expected tobecome operational 27 months from March 2011. The 1.5 million tonnes (perannum) cement plant in Senegal is scheduled to start operation by end of 2010. Figure 41: Expected structure of Dangote Cement Plc post-transfer of African assets* from Dangote Industries Limited Dangote Cement Plc African assets (ongoing & planned) Ibese Obajana Benue (DCW)* Senegal - 1.5mn Cement Cement Plant Cement Zambia - 1.5mn Plant- 5 mn - 3 mn Plant- 6 mn Tanzania - 1.5mn South Africa - 2.2mn Lagos Cement Congo Brazzaville - Dangote Bail Terminal- 1.5mn Cement (PH & 3 mn Ethiopia - 1.5mn Onne) Terminal - 3 mn Cameroun - 1.5mn * Dangote Cement Works Source: Vetiva Research, DCP Management* African Assets are cement plants and terminals currently under construction or plannedForecasts – financial performanceOn the basis of our industry outlook using federal government‟s medium term(2010 – 2013) projections on capital expenditure, cement consumption would Our estimates put 2013 localgrow at a 4-year CAGR of 16.7%, to 27.54 million tonnes by 2013, we expect demand at 27.54 MT, while localDangote Cement to account for 72.4% of total industry output. Based on our supply stands at 25.15 MT,estimates of capacity utilisation rates in the industry, total production is likely to portending an importbe 25.15 million tonnes by 2013, indicating that c.2 million tonnes imports may augmentation of about 2.29 MTbe needed to augment local production. Therefore, we project that DangoteCement‟s revenue would grow at a CAGR of 27.8% to N505 billion, which webelieve would stem from local production as well as imports. At this point, weanticipate an average capacity utilisation rate of 91% for the Dangote Cement‟splants and 28.1% utilisation for the 6 million tonnes import terminal.Nigerian Cement Sector: Unbundling Potentials I January 2011 I 44
    • Nigeria I Building Materials I Equities Figure 42: Dangote Cement Revenue (N‟Mn) and capacity utilisation rates (%) 500000 100% 91% 400000 79% 81% 80% 64% 300000 61% 60% 200000 40% 100000 20% 0 0% 2009 2010E 2011E 2012E 2013E Revenue Capacity Utilisation Sources: Annual Accounts, Vetiva Research EstimatesOn profitability, we project that EBITDA margins would steadily rise to 68.5% byFY‟13 from 41.1% at FY‟10. Also, we expect EBIT margins to increase to 64.3%by 2013 from 35.0% as at FY‟09. We believe Dangote Cement can achieve thesemargins given its plants are built primarily (with the exception of Gboko plant-former BCC) to operate on gas. Furthermore, the significant decline expected inimports would also help drive higher profitability margins given the huge costs ofcement imports. Figure 43: EBITDA per tonne (N), EBITDA margin and Figure 44: EBIT per tonne (N), EBIT margin and EBITDA growth EBITDA growth 20000 120% 18000 120% 103% 100% 15000 100% 15000 80% 12000 80% 71% 10000 60% 9000 60% 55% 44% 40% 6000 40% 5000 3000 20% 20% 16% 0 0% 0 0% 2009 2010E 2011E 2012E 2013E 2009 2010E 2011E 2012E 2013E EBIT per tonne EBIT margin EBIT growth EBITDA per tonne EBITDA margin EBITDA growth Sources: Annual Accounts, Vetiva Research EstimatesNigerian Cement Sector: Unbundling Potentials I January 2011 I 45
    • Nigeria I Building Materials I EquitiesHaving re-financed its high interest bearing loans obtained from local banks, wesuspect that DCP‟s average cost of fund is now in the mid-single digits region. We suspect that Dangote Cement‟sThus in the next two years during which the new loan (re-financing obtained average cost of debt is currently infrom Standard Chartered) is fully repayable, we do not expect pre-tax (PBT) the mid-single digit region havingprofit growth to largely align with the growth in operating profit (EBIT). Thus, we refinanced its local loansforecast that PBT margin would increase to 56.6% by FY‟11 and 64.6% by FY‟13.Given that Dangote Cement plants are largely exempt from taxation at least inthe next five years, we hope to see the run rate in pre-tax profit filtering to thebottom-line. Thus, we project a 4-year CAGR of 51% from 2009 to 2013, whichimplies that PAT margin, would rise to 63% from 32%. Figure 45: PBT per tonne (N), PBT margin (%) and Figure 46: PAT per tonne (N) and PAT margin (%) effective tax rate (%) 18000 75% 18000 65% 62% 60% 13500 60% 13500 58% 50% 40% 9000 45% 9000 34% 20% 4500 30% 4500 0 15% 0 0% 2009 2010E 2011E 2012E 2013E 2009 2010E 2011E 2012E 2013E PAT per tonne PAT margin PBT per tonne Effective tax rate PBT margin Sources: Annual Accounts, Vetiva Research Estimates Figure 47: Dividend Per Share and Earnings Per Share Figure 48: Average Return on Assets and Equity 100% 22.0 75% 16.5 50% 11.0 25% 5.5 0% 0.0 2008 2009 2010E 2011E 2012E 2009 2010E 2011E 2013E 2014E ROAE ROAA DPS EPS Sources: Annual Accounts, Vetiva Research EstimatesNigerian Cement Sector: Unbundling Potentials I January 2011 I 46
    • Nigeria I Building Materials I EquitiesIn view of DCP‟s proposed acquisition of other DIL‟s cement plant projects acrossAfrica, DCP is likely to take on additional leverage perhaps from 2012 to push In view of the plannedthe projects to completion, as we believe that its internally generated funds acquisition of African assetswould not be sufficient to complete the projects. As earlier stated, DIL would be from DIL, we expect anothertransferring its Pan-Africa cement plant projects to Dangote Cement at cost in surge in Dangote Cement‟s2011. We note however that (with the exception of Senegal and Ghana) that leverage within the next 3most of these projects are somewhat at inception stages and DCP would still yearsrequire considerable financing to complete the projects.Whilst we note that the company can access intercompany funding from DangoteIndustries Limited, the degree of financing that would be needed to complete theprojects in our view would require taking additional debt from external sources. To facilitate the acquisition of theSince we do not have sufficient clarity on the state of the projects, the amount African cement projects, wealready spent and the amount that would be needed to complete the projects, estimate that at least USD 2 billionwe have excluded the projects from our forecasts. However, we surmise that would be needed to complete theDangote Cement might need at least US$2 billion to complete the projects. projectsTherefore, we anticipate some significant rise in Dangote Cement‟s leverage from2012. Figure 48 below shows DCP actual and forecast debt ratios, withoutconsidering the possible rise in its leverage to support its acquisition of otherDIL‟s cement producing assets across the African continent. Figure 49: Debt, Debt to equity and CAPEX to total assets ratios 2.0 35% 29% 30% 1.5 25% 20% 18% 1.0 15% 9% 10% 0.5 6% 7% 6% 5% 0.0 0% 2007 2008 2009 2010E 2011E 2012E Debt Ratio Debt to Equity ratio CAPEX/Total Assets Sources: Annual Accounts, Vetiva Research EstimatesDangote Cement‟s debt ratio has decreased consistently over the last three years Historically DCP has a goodto 22.3% as at FY‟09 from 54.9% as at FY‟07. The trend indicates DCP‟s good standing in terms of solvency andstead in terms of solvency as the company has been able to reduce its debt leveragelevels (we recall that the Obajana Plant was 60% debt financed).Nigerian Cement Sector: Unbundling Potentials I January 2011 I 47
    • Nigeria I Building Materials I Equities In a similar vein, DCP‟s interest coverage ratio stood at an average of 571% over the last three years and we expect this to improve further given that interest payments would be decreasing as outstanding loan balance reduces while operating profit (EBIT) is expected to increase substantially on the back of rising utilisation rates and increasing revenue. As earlier stated, the company‟s recent (early this year) refinancing of its local loans by Standard Chartered Bank would reduce interest burden on its profitability. Valuation We use a blend of the Discounted Cash-flow and market capitalisation weighted EV/EBITDA relative valuation for our valuation. Our overall fair Our valuation is based on a value however is significantly weighted to the DCF valuation (80% vs 20%) combination of the DCF and given the relatively lower volatility of the method relative to market EV/EBITDA methodology; thus we multiples. Our overall fair value range for Dangote Cement is N131.50 – obtained a fair-value estimate of N142.50 implying a midpoint of N136.00. N136.00 for Dangote Cement DCF assumptions – Our Discounted Cash-Flow valuation for DCP is based on segmental forecasts of revenue and production costs for each of the entities in the company. Our DCF valuation spans through a period of 10 years, because in our view, a longer time frame is necessary to capture the value inherent in the company and in view of the ramping up phase before the plants reach peak capacity utilisation. DCP‟s valuation was carried under the base case assumptions. The assumptions guiding forecasts for revenue and production costs under this scenario are presented below:  An important revenue driver in our DCF forecasts is the assumptions for capacity utilisation rates in the forecast years. We believe capacity utilisation would be gradual, as it has been the norm in the industry. Our forecasts for capacity utilisation over the forecast period for each of the plants are presented in the table below; Figure 50: DCF revenue assumptions Revenue Capacity5 Drivers (Mn MT) 2010 2011 2012 2013 2014 2015 Capacity Utilisation Obajana (%) 10.0 90.0 60.0 85.0 92.5 95.0 95.0 BCC (%) 4.0 60.0 75.0 85.0 90.0 95.0 95.0 Ibese (%) 6.0 0.0 50.0 70.0 90.0 90.0 95.0 Import terminals (%) 6.0 36.0 34.7 31.2 28.1 28.1 15.7 6 Average utilisation 79.2% 61.0% 81.0% 91.0% 94.0% 95.0% Output (Mn MT) 5.9 10.3 15.4 18.3 17.9 19.1 Selling price (N„000/tonne) 25 25.4 25.4 25.4 25.2 25.2 Revenue (N‟ Bn) 208 346 455 505 509 502 Source: Vetiva Research5 6 Only expected capacities are stated Average utilisation excludes import terminals Nigerian Cement Sector: Unbundling Potentials I January 2011 I 48
    • Nigeria I Building Materials I Equities As seen in the table above, we expect average utilisation rate for the cement plants to move towards full utilisation from 2015, implying therefore that volume In our view, DCP plants would be from local production would be capped at this level. The only prospect for close to full capacity utilisation by revenue increase would therefore come from price increase; since we believe 2015 that cement prices are more inclined to fall in the longer term, revenue would at best be capped beyond 2015. At optimal levels, the Obajana Ibese plant can run almost entirely on gas, or at worst a substitution rate of 10% LPFO (that is 90% gas, 10% LPFO). The Obajana plant significantly In 2009, the company was only able to achieve about 60% gas to 40% minimizes DCP‟s production cost as LPFO in its fuel usage. Taking this into consideration in our forecasts for it can run entirely on gas production costs therefore, we assume a year average of 80% to 20% gas to LPFO usage in 2010 on the back of the general improvement in gas supply in the country since the beginning of 2010, and the fact that the plant has increased its gas collection points from the NGC pipeline, as revealed by management. In the medium term of our forecasts (2011 to 2013), we assume the ratio (gas to LPFO) usage would hover around the 80%/20% region and would subsequently improve further to 90%/10% in the later years – 2014 onwards. Gas pricing is based on the approximate cost per million standard cubic feet of gas (Mscf) for the company in 2009, scalable by 9% yearly. According to Our estimates for gas pricing in Dangote Cement‟s forecasts is management, this price would not change in our forecast years since based on 2009 price per Mscf Dangote Cement has a 20 year (from 2007) fixed Gas Purchase Agreement scalable by 9% annually (GPA) with the Nigerian Gas Company for its Obajana Plant and intends to do the same for the Ibese plant. Thus, we largely believe that gas pricing for the company would be relatively shielded from fluctuations in gas price over the period. Also in arriving at our energy consumption split (between LPFO and gas), we estimated the average energy required to produce the tonnes of clinker expected in the forecast years and carried out a split of the overall energy Our forecasts of energy costs also consumption, (based on our forecast ratio of gas to LPFO usage) and involve an estimation of the energy thereafter estimated the monetary value (in Naira) of the required energy consumption level per tonne of clinker and assumption on level from each fuel type. LPFO/Gas usage Our estimate for power consumption is based on a common size analysis (power costs as % of sales), adjusted for some increases over the forecast period. Other variable costs - gypsum, explosives, refractories, packaging materials etc - a minor part of production costs are also estimated using common- size analysis. We kept depreciation charges in line with management‟s forecast (as detailed in the Scheme of Merger) of a fixed depreciation rate of about 6.7%. The tax exempt nature of the cement plants given their pioneer tax status was also considered in our forecast of Net Operating Profit After Tax (NOPAT) in the forecast period. This further improves the outlook on the company‟s free cash flow at least in the first five years of our forecast. WACC assumptions are as detailed in the table below; Nigerian Cement Sector: Unbundling Potentials I January 2011 I 49
    • Nigeria I Building Materials I Equities Figure 51: WACC Assumptions After tax cost of debt 6.8% Tax rate 32.0% Risk free rate4 10.8% Beta 1.0 Equity risk premium 5.0% Target Debt/Total Capital 25.9% Shareholders Equity/Total Capital 74.1% WACC 13.5% DCF value N140.094 six month exponential weighted average of 20 year bond yields adjusted quarterlyRelative Valuation: EV/EBITDAThis valuation is based on emerging market (Middle East and Africa) averageforward EV/EBITDA estimate, and Dangote Cement‟s forward EBITDA assummarised in the table below; Figure 52: Valuation using 2011 market cap weighted EV/EBITDA estimates of EM peers Average EM peer average (x) 8.9 EBITDA (N‟m) 216,318 Enterprise Value (N‟m) 1,925,230 Market Capitalisation (N‟m) 1,879,167 Shares Outstanding (mn) 15,494 Per share value N121.28 Final fair value range: N131.50 -N142.50; implied mid-point: N136.33RatingWe upgrade our rating on Dangote Cement to an “Accumulate” given theupward revisions in our fair value and the fact the stock has declined by 11% We upgrade our rating on Dangotesince its listing on October 26th 2010. The stock now trades at an upside of Cement to an “Accumulate”14% to the mid-point of our new fair value range. The increase in ouroverall fair value estimate for the stock is due to a raise in our DCF-basedvaluation, as we adjusted the company‟s target debt ratio and WACC to reflectour expectation of a major increase in long term debt in view of the plannedacquisition of other African Assets from DIL and the expectation that DangoteCement would continue with the projects till completion.Nigerian Cement Sector: Unbundling Potentials I January 2011 I 50
    • Nigeria I Building Materials I EquitiesFigure 53: Financial Statements: Actual and Forecasts (N‟Mill) INCOME STATEMENT (NMill) 2007 2008 2009 2010 F 2011 F 2012 F Turnover 34,596 61,906 189,621 208,500 346,332 455,590 Cost of Sales (8,183) (14,054) (94,345) (82,463) (111,757) (116,792) Gross Profit 26,413 47,852 95,276 126,037 234,575 338,798 Operating Expenses (4,992) (9,470) (17,422) (5,421) (15,931) (37,814) Core Operating Profit 21,420 38,382 77,853 120,616 218,643 300,984 EBITDA 21,420 38,382 77,853 120,616 218,643 300,984 Depreciation & Amortization (5,462) (5,982) (11,527) (13,577) (15,308) (17,586) EBIT/Operating Profit 15,958 32,400 66,326 107,039 203,335 283,398 Interest Payable & Charges (6,137) (8,647) (6,043) (993) (456) (1,176) Profit Before Taxation 9,820 23,753 60,283 106,046 202,879 282,222 Taxation (630) (8,665) (2,384) (3,181) (4,058) (5,644) Profit After Taxation 11,623 17,960 61,392 102,864 198,821 276,577 BALANCE SHEET (NMill) 2007 2008 2009 2010 F 2011 F 2012 F Fixed Assets 130,519 135,622 186,393 215,788 277,546 289,659 Investments - - 99 99 99 99 Inventories 2,790 5,043 13,374 11,690 15,842 16,556 Debtors 876 2,924 6,826 7,505 12,467 16,400 Bank and cash balances 6,291 5,264 10,733 48,668 117,961 208,649 Other Receivables and Current Assets 28,005 87,867 98,913 108,761 180,660 237,653 TOTAL ASSETS 168,481 236,720 316,339 392,511 604,574 769,016 Creditors & Accruals 1,879 2,411 4,715 1,467 4,311 10,233 Other Creditors 9,833 17,205 65,349 71,855 119,356 157,009 Short Term Loan 20,823 78,339 18,061 10,644 7,724 79,886 Taxation 631 1,336 4,347 5,285 7,812 9,846 Long-Term Loans 77,211 56,890 49,620 102,120 70,745 38,735 Provision for Gratuity 34 67 981 2,169 3,602 4,738 Prior Year Dividend - - - - 137,745 139,742 Deferred Taxation - 7,959 9,475 9,475 9,475 9,475 TOTAL LIABILITIES 110,410 164,208 152,548 203,014 360,770 449,665 Share Capital 500 500 500 7,747 7,747 7,747 Share Premium 42,430 42,430 42,430 42,430 42,430 42,430 Revenue and Capital reserve 15,141 29,582 113,752 125,342 119,482 233,184 Shareholders Fund 58,071 72,512 157,668 175,519 169,659 283,361 Minority Interest - - 6,122 6,945 8,535 10,748 Total Equity 58,071 72,512 163,790 189,497 178,194 319,351Nigerian Cement Sector: Unbundling Potentials I January 2011 I 51
    • Nigeria I Building Materials I EquitiesFigure 54: Financial Statements: Actual and Forecasts (USD Mill) INCOME STATEMENT 2007 2008 2009 2010 F 2011 F 2012 F Turnover 294 497 1,287 1,345 2,234 2,939 Cost of Sales (70) (113) (641) (532) (721) (753) Gross Profit 225 384 647 813 1,513 2,186 Operating Expenses (42) (76) (118) (35) (103) (244) Core Operating Profit 182 308 529 778 1,411 1,942 EBITDA 182 308 529 778 1,411 1,942 Depreciation & Amortization (46) (48) (78) (88) (99) (113) EBIT/Operating Profit 136 260 450 691 1,312 1,828 Interest Payable & Charges (52) (69) (41) (6) (3) (8) Profit Before Taxation 84 191 409 684 1,309 1,821 Taxation (5) (70) (16) (21) (26) (36) Profit After Taxation 99 144 417 664 1,283 1,784 BALANCE SHEET 2007 2008 2009 2010 F 2011 F 2012 F Fixed Assets 1,110 1,089 1,265 1,392 1,791 1,869 Investments 0 0 1 1 1 1 Inventories 24 40 91 75 102 107 Debtors 7 23 46 48 80 106 Bank and cash balances 53 42 73 314 761 1,346 Other Receivables and Current Assets 238 706 672 702 1,166 1,533 TOTAL ASSETS 1,433 1,901 2,148 3,337 5,141 6,539 Creditors & Accruals 16 19 32 12 37 87 Other Creditors 84 138 444 611 1,015 1,335 Short Term Loan 177 629 123 91 66 679 Taxation 5 11 30 45 66 84 Long-Term Loans 657 457 337 868 602 329 Provision for Gratuity 0 1 7 18 31 40 Prior Year Dividend 0 0 0 0 1,171 1,188 Deferred Taxation 0 64 64 81 81 81 TOTAL LIABILITIES 939 1,319 1,036 1,726 3,068 3,823 Share Capital 4 4 3 66 66 66 Share Premium 361 341 288 361 361 361 Revenue and Capital reserve 129 238 772 1,066 1,016 1,983 Shareholders Fund 494 582 1,070 1,492 1,443 2,409 Minority Interest 0 0 42 59 73 91 Total Equity 494 582 1,112 1,611 1,515 2,715Nigerian Cement Sector: Unbundling Potentials I January 2011 I 52
    • Nigeria I Building Materials I EquitiesFigure 55: Financial Ratios – Actual and Forecasts 2008 2009 2010 E 2011 E 2012 E Growth (%) Turnover growth 78.9% 206.3% 10.0% 66.1% 31.5% Growth in EBITDA 79.2% 102.8% 54.9% 81.3% 37.7% Growth in PBT 117.3% 139.5% 66.3% 91.3% 39.1% Growth in PAT 54.5% 241.8% 67.6% 93.3% 39.1% Profitability (%) Return on Average Equity 27.5% 53.3% 60.5% 95.2% 101.7% Return on Average Assets 8.9% 22.2% 29.0% 39.9% 40.3% EBITDA Margin 62.0% 41.1% 57.8% 63.1% 66.1% EBIT Margin 52.3% 35.0% 51.3% 58.7% 62.2% Pretax Profit Margin 43.0% 33.6% 50.9% 58.6% 61.9% Net Profit Margin 29.0% 32.4% 49.3% 57.4% 60.7% Liquidity Ratios (x) Quick ratio 1.06 0.97 1.26 1.85 2.23 Cash ratio 0.19 0.05 0.12 0.55 0.85 Current ratio 1.14 1.02 1.40 1.98 2.35 Days in inventory 101.72 35.63 55.47 44.96 50.63 Days in accounts payable 1109.83 171.34 64.85 28.92 136.07 Days in receivables 11.20 9.38 12.54 10.52 11.56 Activity Ratios (x) Sales to cash 11.76 17.67 4.28 2.94 2.18 Sales to inventory 22.19 37.60 15.59 29.63 28.76 Sales to total assets 0.26 0.60 0.53 0.57 0.59 Sales to total fixed assets 0.46 1.02 0.97 1.25 1.57 Production Data Capacity(million tonnes) 8.00 8.00 8.00 19.00 20.00 Production (million tonnes) 3.19 5.00 6.18 11.58 16.10 Average Utilization 39.9% 62.5% 77.3% 60.9% 80.5% Import terminal capacity 6.00 6.00 6.00 6.00 6.00 Import terminal utilisation 53.0% 42.9% 36.0% 34.7% 31.2% Revenue/tonne (N000) 25.00 25.35 25.35 25.35 25.20 Per Share Data Earnings/share 35.92 122.78 6.64 12.83 17.85 Dividend/share1 0.00 2.00 4.98 9.32 12.96 Net Asset/share 116.14 145.02 12.23 15.74 20.61 Sales/Share 123.81 379.24 13.46 22.35 29.40 Valuation Multiples P/E (x) 3.35 0.98 18.11 9.37 6.74 P/B (x) 1.04 0.83 9.83 7.64 5.83 Dividend Yield (%) 0.0% 1.7% 4.1% 7.7% 10.8% EV/EBITDA (x) 48.54 23.93 15.45 8.52 6.19Nigerian Cement Sector: Unbundling Potentials I January 2011 I 53
    • Nigeria I Building Materials I EquitiesLafarge WAPCO Cement ACCUMULATESet to Defend Market Share More Efficiency Gains to Accrue: Despite the negative impact of Stock Data slowing sales on Lafarge WAPCO‟s top-line this year, the growth in Bloomberg Ticker WAPCO:NL bottom-line earnings have been impressive, owing to the improvement Market Price (N) 40.07 in gas supply and the resultant reduction in the importation of clinker Shares Outs (bn) 3.002 which historically has accounted for a massive portion of the company‟s Market cap (N‟bn) 117.08 cost of sales. Beyond our expectation of relatively stable gas supply, the Fair value range 47.71 – 51.68 recent conversion of the existing Sagamu and Ewekoro kilns to dual- Rating ACCUMULATE firing would help sustain the efficiency gains seen this year. Furthermore, the Lakatabu plant, which is expected to be more energy efficient relative to the older plants, would to a good extent, reduce Price Perf. Lafarge WAPCO NSE Lafarge WAPCO‟s overall energy costs. 12-month (%) 43.2 19.2 Getting Set for the „Volume‟ Play: With its Lakatabu plant almost set 6-month (%) -3.7 -5.0 (c.85% complete) for operation, Lafarge WAPCO cement is on course to 3-month (%) 7.7 -2.0 sustain its market share in the next phase of growth in the cement industry, which as we have always stated would be driven by volume. The new plant, planned to be commissioned next year, would more than Financials 2009A 2010F 2011F double Lafarge WAPCO‟s production capacity to 4.2 million tonnes (from Turnover (Nbn) 45.59 42.86 68.82 2 million tonnes), thus positioning the company to effectively compete EBITDA (Nbn) 9.85 15.52 27.71 and defend its market share, which otherwise would have been PAT (Nbn) 5.06 7.11 12.31 significantly reduced as a result of Dangote Cement‟s aggressive EBITDA Marg (%) 21.6 35.4 33.0 expansion. PBT Margin (%) 18.2 25.9 26.3 PAT Margin (%) 20.0 26.0 26.0 Likely to incur more on marketing and distribution: As we have always maintained, we reiterate that Lafarge WAPCO‟s spend on marketing and distribution is set to increase, as part of its efforts to match up with expected competition from Dangote Cement‟s Ibese Valuation 2009A 2010A 2011F plant. We believe the company‟s recent launch of a new cement brand - P/E (x) 22.56 9.27 7.53 „Elephant Supaset‟ is a step in this direction. PBV (x) 2.28 1.98 1.71 Valuation and Recommendation: At its current price of N40.70, EV/EBITDA (x) 13.72 8.92 5.95 which portends c.22% upside potential to our new fair value, N49.69, Div. Yield (%) 0.6 1.3 5.3 we believe the stock is trading at a significant discount and thus maintain our “Accumulate” rating on the stock. Figure 56: 52-week Share price performance and shareholding structure 1.6 Other 1.4 Nigerians: 29.99% 1.2 Odua Lafarge Group: S.A : 60% 1.0 10.01% 0.8 15-Dec 15-Feb 15-Apr 15-Jun 15-Aug 15-Oct 15-Dec ASI BMIndex WAPCO Sources: NSE, Vetiva ResearchNigerian Cement Sector: Unbundling Potentials I January 2011 I 54
    • Nigeria I Building Materials I EquitiesInvestment ThesisStrong Brand Name: Given its historical dominance of WAPCO‟s elephant Lafarge WAPCO‟s elephant cementcement in the South-West region of Nigeria, Lafarge WAPCO‟s elephant cement is a well respected brand in thehas a renowned brand name associated with strength and good quality in the industry as it‟s known for itsregion. As a flagship brand of the Nigerian Cement industry, Elephant Cement strength and good qualityhas won the NIS certificate of quality and recently the company won got theMANCAP Certificate for Portland Limestone Cement CEMII 32.5 BL, making it thefirst cement manufacturer to own the certificate in Nigeria.Good Track Record: Lafarge WAPCO has a good history of revenue andprofitability growth in the Nigerian Cement industry even during periods when Lafarge WAPCO had a good historymost cement plants (Nkalagu plant, Okpella, BCC) established about the same of plant operations and revenuetime were either non-functional or recording losses from huge operational growth even during periods ofchallenges. Whilst Lafarge WAPCO was not immune to these operational industry wide operationalbottlenecks especially fuel supply and power challenges, it has been able to challengessustain production by milling imported clinker into cement, whilst adjustingprices to according compensate for the huge production costs. We believeLafarge WAPCO‟s history of competitive survival and experience in the Nigeriancement sector is a pointer that the company can adequately measure up tocompetitive threats to defend its market share and remain profitable.Robust Revenue upside: Lafarge WAPCO‟s on-going expansion to 4.2 milliontonnes annual capacity implies a potential c.100% revenue upside from its At the completion of the “Lakatabu”current levels assuming that prices remain constant. Using a more realistic plant in Ewekoro, there‟s aassumption that price would perhaps moderate slightly downwards, to make its potential 100% revenue upside forcement competitive in comparison to Dangote Cement (as Lafarge WAPCO‟s per Lafarge WAPCOtonne cement price is currently higher than Dangote Cement‟s); we still foreseeat least 70% – 80% upside on its current revenue. Whilst noting that thetimeline for Lafarge WAPCO to achieve this revenue growth is based on thespeed of ramping up capacity utilisation at the new plant, we estimate that itsrevenue would more than double (110% growth relative to 2009 level) by 2014.Strong Parent Support: Also, being the biggest Nigerian subsidiary of theLafarge Group is an added advantage given the leadership position of the group As Lafarge‟s biggest subsidiary inin the global building materials industry and the resultant gains in terms of Nigeria, the company enjoys theproduct research, innovation and quality from which Lafarge WAPCO has been competitive advantage of Lafarge‟sbenefitting. We believe Lafarge‟s product innovation would particularly be a key leadership position in the globalarea in which Lafarge WAPCO can be competitively positioned against Dangote building materials industryCement in Lagos and south west market. Lafarge Group recently patented a newcement brand (Sensium® technological cements) which is 100% dust free andhas started testing the product in the South-East France market. We believeLafarge would soon introduce such product innovations to its other subsidiaries.Board diversification: With respect to corporate governance processes,Lafarge WAPCO‟s well-diversified board structure is quite an advantage, asthe diversification minimises „key-man‟ influence on management decisions.Nigerian Cement Sector: Unbundling Potentials I January 2011 I 55
    • Nigeria I Building Materials I EquitiesPioneer tax status for „Lakatabu‟ plant: In a similar fashion to its tax-exemptstatus at the completion of the Ewekoro plant in 2003, Lafarge WAPCO would We suspect that there will also be aagain qualify for another pioneer tax status on the new „Lakatabu‟ plant at tax exemption (pioneer tax status)completion, and we believe the company would duly apply for this tax incentive. for “Lakatabu” plant; this willWith the Lafarge WAPCO‟s current revenue expected to more than double at full further enhance profitability and investment returnoperation of the new plant, tax exemption (as a result of the pioneer tax status)would boost growth in profit after tax faster than turnover. We believe that thiswould translate to more returns for investors in terms of dividend pay-out.Business OverviewLafarge Cement WAPCO Nigeria Plc (WAPCO) was incorporated on 26 February,1959. It was listed on the floor of the Nigerian Stock Exchange on 16 February,1979. The Company‟s first plant was commissioned a year after, at Ewekoro, Lafarge WAPCO is owned byOgun State with a capacity to produce 200,000 tonnes of cement a year. The Lafarge S.A, through its controllingCompany later embarked on an expansion of its production capacity, increasing position in Blue Circle Industries Plcit by 1.49 million tonnes to 1.69 million tonnes, which partly led to thecommissioning of another plant in Sagamu, also situated in Ogun State (1.00million tonnes) in 1978. Until Lafarge‟s acquisition of Blue Circle Industries Plc in2001, Blue Circle Industries Plc was the majority owner of WAPCO. Following theacquisition, Lafarge S.A became the majority shareholder of WAPCO. The namewas eventually changed from West African Portland Cement Plc to LafargeCement WAPCO Plc in 2008.Ewekoro PlantThe Ewekoro plant was originally a wet-kiln plant commissioned with an annual Though originally commissioned ascapacity of 200,000 tonnes in 1969. The plant eventually expanded, using wet a 200,000 tonnes (per annum) wetand semi-wet manufacturing processes to 690,000 tonnes in the seventies. kiln plant, the Ewekoro Plant hasFollowing the acquisition of the company by Lafarge, the old Ewekoro plant was undergone various upgrading to itsreplaced with a modern dry kiln plant, having an annual capacity of 1.32 million current capacity of about 1 milliontonnes in 2003. The new Ewekoro plant is Lafarge WAPCO‟s production plant tonnesgiven its relatively new state, and its expansion by an additional 2.2 milliontonnes (Lakatabu project) currently on-going.Sagamu PlantThe plant, also built with the wet-kiln manufacturing process was commissionedin 1978, with an annual capacity of 600,000 tonnes. With the addition of a RawMill and Roller Crusher in 1980, the plant‟s capacity was upgraded to 850,000.Production Dynamics Lafarge WAPCO currently has a 2 million tonnes annual capacity,Lafarge WAPCO currently has a production capacity of 2 million tonnes, which which reached peak utilisation rateexpectedly would double by 2011. The company average capacity utilisation of 97% in 2006stood at 84%, though it reached its peak utilisation rate of 97% in 2006.Excluding the portion of cement obtained from milling imported clinker, actualcapacity utilisation rate for the company is actually lower. Thus, we note that thepeak utilisation rate of 97% reported for 2006 is actually lower.Nigerian Cement Sector: Unbundling Potentials I January 2011 I 56
    • Nigeria I Building Materials I EquitiesIn the same vein, we stripped out the cement volume obtained from millingimported clinker (as against cement obtained from actual clinker production) andextrapolate that actual capacity utilisation rate for 2009 was about 63% asagainst the widely reported figure (based in cement volume in tonnes) of 81%. Production has historically beenLafarge WAPCO‟s production and capacity utilisation has historically been disrupted by acute gas supplyadversely affected by disruption in gas supply as it plants were mono-firing. shortagesSince we hope to see stable gas supply (given the relative calmness of the Niger-Delta region), we expect significant improvements in capacity utilisation, and adrastic reduction in the importation of clinker. Furthermore the conversion of theexisting kilns to dual-firing would also improve production as the company nowhas more fuel options.Production costsAlthough Lafarge WAPCO‟s plants are primarily built to operate on gas,disruptions in gas supply have historically resulted in significantly highproduction costs, as result of importation of clinker. In view of the recentconversion of its plants to dual-firing kilns, the flexibility to use LPFO would Although Lafarge WAPCO‟s plants were built to run on gas, productionreduce the pressure on WAPCO‟s production costs. Based on our overall costs has been historically high dueexpectation of continuing stability in gas supply in the medium term, we believe to importation of clinkerLafarge WAPCO would be able to sustain the improvement seen in its operatingefficiency so far this year as a result of the reduction in its production costs.However, the company is more susceptible to fluctuations in gas pricing thanDangote Cement. Whilst Dangote Cement plants predominantly operate on gas,Dangote Cement is relatively immune to adverse volatility in gas prices in view ofthe fixed term Gas Purchase Agreement (GPA), which the company already hasin place for its Obajana Plant. Thus, hikes in gas price is only likely to affectLafarge WAPCO and possibly Unicem which source their gas supply from gasdistributors like Gaslink. Raw materials (limestone, gypsum, kaolin and otheradditives) account for a relatively small portion of production costs – we put thisat 15% - 20%. Ewekoro and Shagamu have about 50 -70 years of limestonereserve.Forecasts – financial performance We project that Lafarge WAPCOFollowing from our overall industry outlook on cement consumption, we project would account for c.15% ofthat Lafarge WAPCO would account for c.15% of total industry output. Nigeria‟s cement industry output atTherefore, we forecast that Lafarge WAPCO‟s revenue would grow at a CAGR of the full operation of its new plant25.3% to N89.70 billion by 2013; this would stem from ramping up of the new2.2 million tonnes plant. At this point, we anticipate an average capacityutilisation rate of 82%.Nigerian Cement Sector: Unbundling Potentials I January 2011 I 57
    • Nigeria I Building Materials I Equities Figure 57: Actual and forecast Revenue (N‟Mn) and capacity utilisation rates5 (%) 100000 100% 84% 82% 75000 81% 76% 75% 61% 64% 50000 50% 25000 0 25% 2008 2009 2010E 2011E 2012E 2013E Revenue Utilisation rate Sources: Annual Reports, Vetiva Research5 Historical capacity utilisation rates are based on cement volumes produced from locally produced and importedclinkerOn profitability, we project that EBITDA margins would rise to c.40% by FY‟13from 21% at FY‟09. Also, we expect EBIT margins to increase to 32% by 2013 We forecast EBITDA margin of 40% by FY‟13from 18% as at FY‟09. Consistent with our expectation of higher synergy inoperating efficiency at the operation of the new plant, we believe Lafarge WAPCOcan achieve these profitability margins. The Lakatabu plant would operate usinga more modern dry-kiln technology which would substantially compensate for thechallenges associated with old wet kiln technology being used at the WAPCOEwekoro plant. Also, the new plant would operate using a captive power plantwhich would be cheaper relative to sourcing power from Independent PowerProducers.Nigerian Cement Sector: Unbundling Potentials I January 2011 I 58
    • Nigeria I Building Materials I Equities Figure 58: EBITDA per tonne (N), EBITDA margin Figure 59: EBIT per tonne (N), EBIT margin and EBIT and EBITDA growth (%) growth (%) 10000 60% 8000 70% 7500 6000 30% 35% 5000 4000 0% 0% 2500 2000 0 -30% 0 -35% 2008 2009 2010E 2011E 2012E 2013E 2008 2009 2010E 2011E 2012E 2013E EBITDA per tonne EBITDA margin EBITDA growth EBIT per tonne EBIT Margin EBIT Growth Sources: Annual Reports, Vetiva ResearchAs Lafarge WAPCO‟s moratorium on its C225 million (secured for the constructionof the Lakatabu plant) expires by end of 2011, pre-tax profit margin wouldsomewhat decrease by 2012. Thus, we expect pre-tax profit margin to increaseto 28.4% by FY‟11, but expect a decline to 25.9% by FY‟12. In view of ourexpectation of partial tax exemption (based on pioneer tax status considerationfor Lakatabu plant), we anticipate stronger growth in profit after tax, relative to With the moratorium on its 225pre-tax profit and operating profit. Thus, we forecast that a CAGR of 42.8% in million loan expiring by end of 2011, interest payments wouldprofit after tax over the four year period to 2013 from 2009, clearly ahead of our start taking tow on profitability byCAGR forecast of 25.3% in revenue. In line with our expectation of faster growth 2012in after tax profit, we believe the Lafarge WAPCO would shore up its dividendpayout from 2011. By 2012 and 2013, a minimal reduction in dividends is likelysince we expect the company to make interest payments on its C225 millionloan. Notwithstanding, we believe the pay-off from tax exemption wouldoutweigh the impact of interest payments on after-tax earnings.Nigerian Cement Sector: Unbundling Potentials I January 2011 I 59
    • Nigeria I Building Materials I Equities Figure 60: PBT per tonne (N), PBT margin (%) and Figure 61: PAT per tonne (N) and PAT margin (%) effective tax rate (%) 7500 30% 8000 48% 25% 6000 5000 20% 36% 15% 4000 2500 10% 24% 2000 5% 0 0% 0 12% 2008 2009 2010E 2011E 2012E 2013E 2008 2009 2010E 2011E 2012E 2013E PAT per tonne PAT Margin PBT per tonne Effective tax rate PBT Margin Sources: Annual Reports, Vetiva Research Figure 62: Earnings Per Share (N) and Dividend Per Figure 63: Return on Average Equity and Assets (%) Share (N) 33% 6.00 25% 4.50 17% 3.00 1.50 8% 0.00 0% 2008 2009 2010E 2011E 2012E 2013E 2008 2009 2010E 2011E 2012E 2013E EPS DPS ROAA ROAE Sources: Annual Reports, Vetiva ResearchAt the completion of Lakatabu‟s expansion, we do not expect significant capitalexpenditure beyond 2012. Thus, we project that capital expenditure (aspercentage of sales) would slow down to 5%.Nigerian Cement Sector: Unbundling Potentials I January 2011 I 60
    • Nigeria I Building Materials I EquitiesAs the two year moratorium on Lafarge WAPCO‟s current C225 loan expires,interest expense would rise within the next two years. Thus, a significant portionof the company‟s cash-flow within the next three years would be gulped by debt We expect the loan to be fully liquidated by 2013 and projectrepayment. We believe the loan will be fully liquidated by 2013. Therefore, we minimal long term debt exposureproject that Lafarge WAPCO‟s debt ratio (long term debt divided by total assets) for the companywould gradually decline to 0% from 28.4% at FY‟09. Long term debt to equityratio is expected to follow the same trend, as declining from c.57% (at FY‟09) to0% by FY‟13. Figure 64: Lafarge WAPCO debt and debt to equity ratios 60% 57% 49% 43% 45% 30% 28% 23% 22% 14% 15% 8% 0% 0% 0% 2008 2009 2010E 2011E 2012E 2013E Long term debt to equity Long term debt to total assets CAPEX to total assets Sources: Annual Reports, Vetiva ResearchValuationWe used a blend of the Discounted Cash-flow and EV/EBITDA relative We use a blend of DCF andmethodologies for our valuation. Our overall fair value however is significantly EV/EBITDA valuation with a 80/20weighted to the DCF valuation (80% vs 20%) given the relatively lower volatility weighting criteriaof the DCF method relative to market multiples. Our overall fair value range forLafarge WAPCO is N47.71 – N51.68 implying a midpoint of N49.69.DCF assumptions - Based on industry trends, we assume gradual ramping-up of the new 2.2 million tonnes plant. Capacity utilisation rates are summarised below;Nigerian Cement Sector: Unbundling Potentials I January 2011 I 61
    • Nigeria I Building Materials I Equities Figure 65: DCF revenue assumptions Revenue Capacity Drivers (Mn MT) 2010 2011 2012 2013 2014 2015 Capacity Utilisation Existing plants (%) 2.0 76.0 70.3 85.0 85.0 90.0 95.0 Lakatabu (%) 2.2 - 25.0 50.0 80.0 90.0 95.0 Average utilisation 76.0% 60.0% 67.0% 83.0% 90.0% 95.0% Output (Mn MT) 1.52 2.50 2.80 3.48 3.80 4.00 Selling price (N„000/tonne) 28.2 27.45 26.5 26.0 25.7 25.7 Revenue (N‟ Bn) 42.86 68.12 74.20 89.96 97.05 105.44 Source: Vetiva Research As seen in the table above, we expect average utilisation rate for the cement plants to move towards full utilisation from 2015, implying therefore that volume from local production would be capped at this level. Beyond this point, the only prospect for revenue increase would therefore come from price increase; since we believe that cement prices are more inclined to fall in the longer term, revenue would likely decline in the longer term if the additional capacities are not added. Assuming that price would at best remain constant, revenue would at best be flat beyond 2015. Given expected higher efficiency of the new plant, we expect to see a In line with our overall expectations, we expect a downward trajectory in continuing downward trend in Lafarge WAPCO‟s production costs. Though we do not have specific details on Lafarge WAPCO production costs the actual of gas, its major energy input, we have assumed that WAPCO‟s cost of sales decline to c. 53% and 50% of sales by FY‟10 and FY‟11 (from c.67% at FY‟09) respectively. Our assumption is predicated on peer analysis using Dangote Cement, which also use gas as its major energy input (Obajana), whilst adjusting the estimate Our forecast for production costs is obtained for Lafarge WAPCO upwards to account for the relatively lower pricing premised on peer analysis using being enjoyed by Dangote Cement as a result of purchasing its gas directly from DCP plants which also uses gas as its major fuel the Nigerian Gas Company (NGC). Alongside the construction of the 2.2 million tonnes Lakatabu plant, Lafarge WAPCO is also constructing a 100MW multi-fuel power plant capable of operating using diesel, Low Pour Fuel Oil (LPFO) and gas. The captive power plant at completion, will supply electricity to Lafarge WAPCO‟s new and existing plants. Following from this, we expect some major reductions in the company‟s operating expenses as the captive power plant would supply cheaper electricity compared to Independent Power Producer, upon which the company historically relied. This also feeds into our forecasts of declining costs of sales. We assumed a long term CAPEX to sales ratio of 5% and kept average depreciation years at twenty-five. The expected tax exemption of the new Lakatabu plant is also considered in our forecast of Net Operating Profit After Tax (NOPAT) in the forecast period. This further improves the outlook on the company‟s free cash flow at least in the first five years of our forecast. Nigerian Cement Sector: Unbundling Potentials I January 2011 I 62
    • Nigeria I Building Materials I Equities WACC assumptions are detailed in the table below Figure 66: WACC Assumptions After tax cost of debt 6.6% Tax rate 32.0% 4 Risk free rate 10.8% Beta 0.85 Equity risk premium 5.0% Target Debt/Total Capital 17% Shareholders Equity/Total Capital 83% WACC 13.57% DCF value N47.89 Relative Valuation: EV/EBITDA This valuation is based on emerging market (Middle East and Africa) average forward EV/EBITDA estimate, and Dangote Cement‟s forward EBITDA as summarised in the table below; Figure 67: Valuation using 2011 market cap weighted EV/EBITDA estimates of EM peers Average EM peer average (x) 8.9 EBITDA (N‟m) 23,207 Enterprise Value (N‟m) 206,542 Market Capitalisation (N‟m) 185,376 Shares Outstanding (mn) 3,002 Per share value (N) 57.93 Final fair value range: N47.71 – N51.68; implied mid-point: N49.69 Rating We maintain an “Accumulate” Despite raising our fair value for Lafarge WAPCO slightly, we maintain an rating on Lafarge WAPCO “Accumulate” rating on stock as it‟s trading at an upside of 23% to our new fair value. Nigerian Cement Sector: Unbundling Potentials I January 2011 I 63
    • Nigeria I Building Materials I EquitiesFigure 68: Financial Statements: Actual and Forecasts (N‟Mill) INCOME STATEMENT (NMill) 2007 2008 2009 2010 F 2011 F 2012 F Turnover 38,665 43,274 45,590 42,864 68,817 74,200 Cost of Sales (21,945) (25,026) (30,513) (22,847) (35,785) (37,100) Gross Profit 16,720 18,247 15,077 20,017 33,032 37,100 Distr. & Admni Expenses (4,843) (4,542) (5,224) (4,865) (10,323) (11,130) Core Operating Profit 11,877 13,705 9,853 15,152 22,710 25,970 EBITDA 11,877 13,705 9,853 15,152 22,710 25,970 Depreciation & Amortization (1,378) (1,580) (1,576) (4,045) (4,618) (4,773) EBIT/Operating Profit 10,499 12,125 8,277 11,107 18,091 21,197 Interest Payable & Charges (831) (228) - - - (3,168) Profit Before Taxation 11,665 12,769 8,956 11,107 18,091 18,029 Taxation (1,358) (1,781) (4,182) (3,999) (5,789) (2,885) Profit After Taxation 11,179 11,252 5,056 7,109 12,302 15,144 BALANCE SHEET (NMill) 2007 2008 2009 2010 F 2011 F 2012 F Non-Current Assets Total fixed Assets 33,356 43,121 69,681 87,301 93,115 95,674 Long Term Investments 60 60 60 60 60 60 Current Assets Inventories 8,572 10,083 12,517 9,372 14,680 15,220 Debtors - 166 185 174 280 302 Bank and cash balances 4,220 5,974 3,628 2,871 7,006 5,414 Other Receivables and Current Assets 4,388 2,364 1,092 1,715 2,753 2,968 Total Current Assets 17,180 18,587 17,422 14,132 24,719 23,903 TOTAL ASSETS 50,596 61,769 87,163 101,494 117,894 119,638 Current Liabilities Creditors & Accruals 7,732 8,353 8,573 7,985 16,941 18,266 Other Creditors 1,461 1,422 1,056 1,341 2,152 2,321 Short Term Loan 4,713 7,113 - - 8,632 15,519 Taxation 1,842 1,212 1,044 - - - Total Current Liabilities 15,748 18,099 10,674 9,325 27,726 36,106 Non-current Liabilities Long-Term Loans - - 24,793 24,793 24,793 9,274 Provision for Gratuity 1,748 1,758 2,801 717 3,661 3,680 Deferred Taxation 294 1,455 5,183 2,072 4,225 4,001 Total Non-Current Liabilities 2,042 3,213 32,778 27,582 32,678 16,955 TOTAL LIABILITIES 17,790 21,312 43,452 36,907 60,404 53,062 Net Assets 32,806 40,456 43,711 64,586 57,490 66,576Nigerian Cement Sector: Unbundling Potentials I January 2011 I 64
    • Nigeria I Building Materials I EquitiesFigure 69: Financial Statements: Actual and Forecasts (USD‟Mill) INCOME STATEMENT (USDMill) 2007 2008 2009 2010 F 2011 F Turnover 329 347 310 286 444 Cost of Sales (187) (201) (207) (152) (231) Gross Profit 142 147 102 133 213 Distr. & Admni Expenses (41) (36) (35) (32) (67) Core Operating Profit 101 110 67 101 147 EBITDA 101 110 67 101 147 Depreciation & Amortization (12) (13) (11) (27) (30) EBIT/Operating Profit 89 97 56 74 117 Interest Payable & Charges (7) (2) - - - Profit Before Taxation 99 103 61 74 117 Taxation (12) (14) (28) (27) (37) Profit After Taxation 95 90 34 47 79 BALANCE SHEET (USDMill) 2007 2008 2009 2010 F 2011 F Non-Current Assets Total Fixed Assets 284 346 473 582 621 Long Term Investments 0.5 0.5 0.4 0.4 0.4 Current Assets - - - Inventories 73 81 85 64 100 Debtors - 1 1 1 2 Bank and cash balances 36 48 25 19 48 Other Receivables and Current Assets 37 19 7 12 19 Total Current Assets 146 149 118 96 168 TOTAL ASSETS 430 496 592 678 789 Current Liabilities Creditors & Accruals 66 67 58 53 109 Other Creditors 12 11 7 9 14 Short Term Loan 40 57 - - 56 Taxation 16 10 7 - - Total Current Liabilities 134 145 72 62 179 Non-current Liabilities Long-Term Loans - - 168 165 160 Provision for Gratuity 15 14 19 5 24 Deferred Taxation 2 12 35 14 27 Total Non-Current Liabilities 17 26 223 184 211 TOTAL LIABILITIES 151 171 295 246 390 Net Assets 279 325 297 431 371Nigerian Cement Sector: Unbundling Potentials I January 2011 I 65
    • Nigeria I Building Materials I Equities Figure 70: Financial ratios: Actual and Forecasts 2007 2008 2009 2010 E 2011 E 2012 E Growth (%) Turnover growth -2.5% 11.9% 5.4% -6.0% 60.5% 7.8% Growth in EBITDA -15.2% 15.4% -28.1% 53.8% 49.9% 14.4% Growth in PBT -1.6% 9.5% -29.9% 24.0% 62.9% -0.3% Growth in PAT 4.7% 0.7% -55.1% 40.6% 73.1% 23.1% Profitability (%) Return on Average Equity 38.7% 30.7% 12.0% 15.2% 22.9% 24.4% Return on Average Assets 22.6% 20.0% 6.8% 7.5% 11.2% 12.8% EBITDA Margin 30.7% 31.7% 21.6% 35.4% 33.0% 35.0% EBIT Margin 27.2% 28.0% 18.2% 25.9% 26.3% 28.6% Pretax Profit Margin 30.0% 30.0% 20.0% 26.0% 26.0% 24.0% Net Profit Margin 28.9% 26.0% 11.1% 16.6% 17.9% 20.4% Liquidity Ratios (x) Quick ratio 0.64 0.41 0.15 0.64 0.33 0.44 Cash ratio 0.27 0.33 0.34 0.12 0.25 0.15 Current ratio 1.09 1.03 1.63 0.59 0.89 0.66 Days in inventory 113.27 136.04 135.18 174.86 122.67 147.08 Days in accounts payable 110.25 110.62 93.76 153.38 110.70 170.71 Days in receivables 0.15 0.70 1.41 1.53 1.20 1.43 Activity Ratios (x) Sales to cash 9.16 7.24 12.57 14.93 9.82 13.71 Sales to inventory 4.63 3.83 3.46 4.86 2.92 4.52 Sales to total assets 0.76 0.70 0.52 0.42 0.58 0.62 Sales to total fixed assets 1.16 1.00 0.65 0.49 0.74 0.78 Production Data Capacity(million tonnes) 2.00 2.00 2.00 2.00 4.20 4.20 Production (million tonnes) 1.70 1.68 1.60 1.52 2.51 2.80 Average Utilization (%) 0.85 0.84 0.80 0.76 0.60 0.67 Revenue/tonne (N000) 22.74 25.80 28.49 28.20 27.45 26.50 Per Share Data (N) Earnings/share 3.72 3.75 1.68 2.37 4.10 5.05 Dividend/share 1.20 0.60 0.10 0.24 0.50 2.02 Net Asset/share 10.93 13.48 14.56 16.69 19.15 22.18 Sales/Share 12.88 14.42 15.19 14.28 22.93 24.72 Valuation Multiples P/E (x) 10.20 10.14 22.56 16.05 9.27 7.53 P/B (x) 3.48 2.82 2.61 2.28 1.98 1.71 Dividend Yield (%) 3.2% 1.6% 0.3% 0.6% 1.3% 5.3% EV/EBITDA (x) 9.66 11.39 9.87 13.72 8.92 5.95Nigerian Cement Sector: Unbundling Potentials I January 2011 I 66
    • Nigeria I Building Materials I EquitiesAshakaCem Plc REDUCERating Downgraded to „Reduce‟ Share Price Performance: With a YTD gain of 116% Ashaka has been Stock Data the best performing stock amongst the cement producers this year. We Bloomberg Ticker ASHAKACEM:NL attribute its impressive stock performance to rising investors‟ interest in Market Price (N) 26.50 the sector and the fact that it started the year on a low base which Shares Outs (bn) 2,240 made its price attractive to investors. Whilst maintaining that Ashaka Market cap (N‟bn) 61.60 fundamentals present a long term value play, we believe our Fair value range 22.40 – 26.26 expectations have been fully priced in by investors. Hence, we Rating REDUCE downgrade our rating on the stock to a „reduce‟. Ramping up coal utilisation: Following the completion of its coal plant in Q4‟09, Ashaka has begun substituting Low Pour Fuel Oil with coal, Price Perf. Ashaka NSE which is cheaper relative to the former. Whilst we are yet to see 12-month (%) 135.0 19.2 considerable improvement in margins in its quarterly earnings, we 6-month (%) 50.0 -5.0 strongly maintain that the company is poised to improve its margins in 3-month (%) 7.5 -2.0 the medium to longer term as it achieves higher coal substitution levels and fully integrate the coal plant into its cement operations. At about 90% of coal utilization, energy cost is expected to drop to 2.1-2.7 Financials 2009A 2010A 2011F Euro(can we convert to dollars or naira for consistency) per GigaJoule Turnover (Nbn) 17.19 18.19 21.02 (GJ) from about 7 Euro per Giga-Joule (representing a 60% to 70% EBITDA (Nbn) 4.48 7.53 9.83 decline). PAT (Nbn) 2.53 4.37 5.97 EBITDA Marg (%) 8.9 24.6 35.8 In tune with industry expansion drive: In addition to its coal plant PBT Margin (%) 7.7 19.3 31.0 investment, Ashaka is not lagging in positioning itself for the expected PAT Margin (%) 5.5 13.9 20.8 volume drive in the sector from next year. The company‟s is upgrading its existing kiln capacity of 0.85 million tonnes to 1.25 million tonnes and we expect this to be completed next year. Whilst Ashaka is a Valuation 2009A 2010A 2011F relatively small player in the Nigerian cement industry, the expansion P/E (x) 59.86 25.09 14.54 would somewhat help the company strengthen its position in its major PBV (x) 4.30 4.37 3.74 market – North-East Nigeria. EV/EBITDA (x) 41.42 14.17 8.43 Div. Yield (%) 0.0 1.8 3.1 Valuation and Recommendation: Despite our optimistic outlook on Ashaka, we downgrade the stock to a „reduce‟ as our valuation mid- point (relative to its current price of N27.50) implies a downside of 11%. Ashaka is trading at a 2011 P/E of 14.54x relative to peer of 12.70x. Fig 71: 52-week Share price performance and Shareholding structure Others: 2.5 49.84% 2.0 1.5 1.0 Lafarge S.A 0.5 : 50.16% 15-Dec 15-Feb 15-Apr 15-Jun 15-Aug 15-Oct 15-Dec ASI BMIndex Ashaka Sources: Annual Reports, Vetiva ResearchNigerian Cement Sector: Unbundling Potentials I January 2011 I 67
    • Nigeria I Building Materials I EquitiesInvestment ThesisRising costs savings: The most compelling attraction to Ashaka Cement, in ourview, is its potential to sustain long term efficiency and profitability despite itsrelatively low scale of production. According to management‟s insights, thecompany can achieve 60% -70% savings in energy costs, when full substitutionof LPFO with coal is achieved. Nonetheless, we have discounted management‟sexpectation and assumed only a 55% savings in energy costs. Whilst noting that Ashaka‟s most prominentAshaka has not met its projection on coal utilisation level so far this year, investment case is the expected(management achieved only coal utilisation rate as at half year relative to a 60% reduction in its productions and theprojection), we still maintain long term optimism on its operating efficiency, implied improvement in operatingthough we have adjusted our expectation to reflect a long time frame for the marginscompany to reach peak (c.100%) coal utilisation. Therefore, we project thatEBITDA margins would increase to 35% by FY‟12 and 42% by FY‟15 (from 9% atFY‟09). Similarly, we forecast an EBIT margin of 32% by FY‟12 and 40% byFY‟15, (from 5.9% at FY‟09).Non-debt status: According to insights from Ashaka‟s management, the coalmine project completed by the company last year was purely financed byinternally generated cash-flows from Ashaka and intercompany funding from theparent company. The debt free status of the company implies that the companycan make significant savings from zero interest expense and boost bottom-line Ashaka currently has no debt; thusearnings. This, coupled with the expected rise in profitability from achieving the savings from non-payment ofhigher operating efficiency, enhances the potential return, in form of dividend interest would boost bottom-linepayments, to its shareholders. earningsThe Lafarge advantage: We believe Lafarge‟s clout as the parent company ofAshaka Cement gives the company a competitive edge relative to its closest peer– Cement Company of Northern Nigeria. In this regard, we highlight Ashaka‟saccess to intercompany funding from Lafarge, as the company did not take onany long term debt in completing its coal plant, which is estimated to have costapproximately N5 billion (US$333 million). Ashaka also benefits from productresearch and innovation – another competitive edge.Potential for revenue diversification from coal mining: Ashaka is thepioneer user of coal energy in cement production in Nigeria. The companyactually completed its coal plant last year, with the aim of utilising mining coalfrom the mine to power the kilns. Apart from the anticipated reduction energycosts which the company would achieve from substituting Low Pour Fuel Oil to Though the company has notcoal, we believe coal mining may in the longer term be an additional source of indicated any intentions torevenue for company, given the huge reserve of its coal mine. Ashaka has an generate revenue directly from its coal mine, we believe it mayinstalled coal capacity utilization of 300,000 tonnes per annum and can expand eventually be an additional sourcethis further since the coal mine (in Maiganga, Gombe State) has an estimated of revenue in the longer termproven reserve of 4.5 million tons which can adequately serve the company‟srequirement of at least 25 years fuel. Given the increasing interest of other localproducers in using coal fuel (CCNN and Dangote Cement), we see a possibility ofAshaka eventually diversifying its revenue through coal sales, especially ifpurchasing coal locally is cheaper for other cement producers in comparison toimportation.Nigerian Cement Sector: Unbundling Potentials I January 2011 I 68
    • Nigeria I Building Materials I EquitiesConsistent Track Record: Ashaka has a good history of revenue andprofitability growth in the Nigerian Cement industry even during periods when Ashaka has a consistent history ofmost cement plants (Nkalagu plant, Okpella, BCC) established about the same cement production in Nigeriatime were either non-functional or recording losses from huge operationalchallenges. Though Ashaka‟s production capacity is somewhat small, thecompany with Lafarge WAPCO has historically dominated cement manufacturinguntil 2007. Ashaka‟s capacity utilisation rate averaged 81% between 2004 and2009. Based on production level between 2004 and 2006, Ashaka‟s accountedfor 27% of cement production in Nigeria.Business OverviewAshaka is the second subsidiary of Lafarge (biggest cement producer in theworld) in Nigeria. Following the acquisition of Blue Circles Plc by Lafarge in 2001,the company became integrated into Lafarge Group in 2002. The company was Ashaka became Lafarge subsidiaryincorporated in 1974, with core activities in manufacturing and marketing of in 2001 following the acquisition of Blue Circle Industries by Lafargecement. AshakaCem became a publicly quoted company in 1990. S.AProduction DynamicsAshakaCem currently has a production capacity of 0.85 million tonnes, which isexpected to increase to 1.25 million tonnes by 2012 through a kiln upgradeprocess. In the last five years, Ashaka has an average capacity utilisation rate of84%. It reached its peak utilisation rate of 101% in 2008, but reported the least Ashaka currently has a productioncapacity utilisation rate of 76% in 2009 due to operational challenges which capacity of 0.85 million tonnes,adversely impacted on production. Ashaka Cement‟s market share has shrunk expected to be increased to 1.25significantly since Dangote‟s Obajana Cement plant started production in 2007. million tonnes, through a kilnBased on FY‟09 data, Ashaka cement only accounted for 4% of total cement upgrade by 2011consumed, and 7% of total local production, in Nigeria, down from 7.5% and27% as at 2005, respectively. Despite the 0.25 million tonnes additionalproduction capacity expected from Ashaka, we estimate that the company‟smarket share would likely remain at 4% by 2013, as the expected capacity is notsignificant enough to increase its market share, in view of the encroachment ofDangote Cement into its historical region of domination – North East Nigeria.Production costs Historically, Ashaka had one of the highest energy costs in the industry as it uses Low Pour Fuel Oil (LPFO) in cement production. The non-functional state of local refineries also made the situation worse as producers made use of imported LPFO. Therefore, Ashaka‟s production costs constitute c.70% (average of 2007 – 2009) of its sales revenue. The dynamics of Ashaka currently has a production capacity of 0.85 million tonnes, Ashaka‟s energy costs has however begun to take a different turn since the expected to be increased to 1.25 company started adapting coal energy. Whilst coal is the most popular million tonnes, through a kiln energy for cement producers globally, its use in the Nigerian cement upgrade process by 2011 industry is significantly minimal, although Nigeria has c.billion tonnes of coal deposits. In recent times, more producers like CCNN and Dangote Cement have indicated interest to adapt coal energy. Ashaka operates a coal mine located in Maiganga, about 10 km to its cement plant which house a coal grinding workshop.Nigerian Cement Sector: Unbundling Potentials I January 2011 I 69
    • Nigeria I Building Materials I Equities Apart from gypsum which is largely imported by producers, raw materials are largely sourced locally, and account for only 20%-25% of overall production costs whilst energy (kiln fuel and power) account for 50% – 60%. From historical patterns, production costs typically account for c.70% of Ashaka‟s revenue. With the anticipated savings in kiln fuel costs, we expect production costs to gradually decline to 39% of revenue by 2015. Consistent with this expectation, fuel costs would increasingly shrink, accounting for only 13.8% of production costs by 2015. Figure 72: Ashaka Cement Cost of Sales (N‟Mn) 16000 80% 68% 66% 65% 12000 60% 48% 42% 39% 8000 40% 4000 20% 0 0% 2008 2009 2010E 2011E 2012E 2012E Cost of sales Cost of sales as % of sales Source: Vetiva ResearchForecasts – financial performanceFollowing from our overall industry outlook on cement consumption, we projectthat Ashaka would account for only 4% of total industry output by 2013. Ashaka would only account for 4% of total production output by 2013Therefore, we forecast that Ashaka‟s revenue would grow at a CAGR of 11.3% toN26.34 billion by 2013; this takes into cognisance the additional 0.4 milliontonnes from kiln expansion. At this point, we anticipate an average capacityutilisation rate of 83%.Nigerian Cement Sector: Unbundling Potentials I January 2011 I 70
    • Nigeria I Building Materials I Equities Figure 73: AshakaCem Revenue (N‟Mn) and Capacity utilisation rates (%) 30000 101% 97% 81% 83% 90% 24000 73% 76.0% 63% 18000 35% 12000 30% 16% 13% 6000 11% 8% 6% -20% 0 -20% 2008 2009 2010E 2011E 2012E 2013E Revenue Capacity Utilisation Rate Revenue Growth Source: Annual Reports, Vetiva ResearchConsistent with our expectations on Ashaka‟s operating efficiency; we projectthat EBITDA margins would rise to 36% by FY‟13 from 8.9% at FY‟09. Also, weexpect EBIT margins to increase to 33% by 2013 from 5.9% as at FY‟09. Figure 74: EBITDA per tonne, EBITDA margin and EBIT Figure 75: EBIT per tonne, EBIT margin and EBIT growth margin 12000 12000 200% 180% 150% 9000 9000 130% 100% 6000 80% 6000 50% 30% 3000 3000 0% -20% 0 -50% 0 -70% 2008 2009 2010E 2011E 2012E 2013E 2008 2009 2010E 2011E 2012E 2013E EBITDA per tonne EBITDA Margin EBITDA growth EBIT per tonne EBIT Margin EBIT growth Source: Annual Reports, Vetiva ResearchNigerian Cement Sector: Unbundling Potentials I January 2011 I 71
    • Nigeria I Building Materials I EquitiesWe expect pre-tax profit margins to be the same as operating profit (EBIT)margin, since we believe Ashaka would maintain its debt-free status. Thus, weanticipate a pre-tax profit margin of We anticipate a CAGR of 33% in profit aftertax to N5.90 billion from 2010 estimate of N2.53 billion. Thus, we expect aftertax profit margin to rise to 23% by FY‟13, from 5.5% (as at FY‟09) and our FY‟10estimate of 14%.Figure 76: PBT per tonne(N), PBT margin and PBT growth Figure 77: PAT per tonne(N), PAT margin and PAT(%) growth (%) 12000 8000 300% 170% 220% 6000 9000 120% 140% 4000 70% 6000 60% 20% 2000 -20% 3000 -30% 0 -100% 2008 2009 2010E 2011E 2012E 2013E 0 -80% 2008 2009 2010E 2011E 2012E 2013E PAT per tonne PAT Margin PAT growth PBT per tonne PBT margin PBT growth Source: Annual Reports, Vetiva ResearchGiven the completion of Ashaka‟s coal project and the expected completion of itskiln-expansion next year, we do not foresee any major capital expenditure in themedium term, thus we expect Ashaka increase dividend payments. Based on theaverage of the Ashaka‟s dividend payment ratio over its three most recent years After the completion of the on-of dividend history, we forecast a payout ratio of about 45% from 2011 and thus going Kiln-expansion project, we doexpect a dividend per share of N0.66 by 2011 and N1.18 by 2013. not foresee any capital expenditure and expect Ashaka‟s dividendWe project that average return on equity (ROAE) and average return on assets payout to rise steadily(ROAA) would rise to 15% and 9% from 3.6% and 1.9% as at FY‟09respectively.Nigerian Cement Sector: Unbundling Potentials I January 2011 I 72
    • Nigeria I Building Materials I Equities Figure 78: Earnings Per Share (N) and Dividend Figure 79: Return on average equity and assets Per Share (N) (%) 35% 3.5 28% 3.0 2.5 21% 2.0 14% 1.5 7% 1.0 0% 0.5 2008 2009 2010E 2011E 2012E 2013E 2008 2009 2010E 2011E 2012E 2013E ROAA ROAE EPS DPS Source: Annual Reports, Vetiva ResearchWe do not expect any rise in Ashaka‟s leverage, especially since capitalinvestments are very unlikely in the medium term after the completion of kilnexpansion. Thus, we forecast that long term debt ratio would remain at itscurrent zero level.Valuation We use a blend of the Discounted Cash-flow and EV/EBITDA relativemethodologies for our valuation. Our overall fair value however is Our valuation is based on the DCFsignificantly weighted to the DCF valuation (80% vs 20%) given the relatively and EV/EBITDA multiplelower volatility of the DCF method relative to market multiples. Our overallfair value range for AshakaCem is N22.40 – N26.20 implying a midpoint ofN24.30.DCF assumptions -  In line with industry norm, we assume gradual capacity ramp-up additional We assume gradual ramp-up of the capacity from kiln upgrade. As seen in the table below, capacity utilisation additional 0.4 million tonnes would decline slightly in 2012 as a result of slow ramp up of the additional kiln capacity. However, utilisation would pick up from this point and we expect that the company would almost reach full capacity utilisation rate (c.100%) by 2015.Nigerian Cement Sector: Unbundling Potentials I January 2011 I 73
    • Nigeria I Building Materials I Equities Figure 80: DCF revenue assumptions Revenue Capacity Drivers (Mn MT) 2010 2011 2012 2013 2014 2015 Capacity Utilisation Existing line (%) 0.85 81.0 97.0 96.0 98.0 98.0 98.0 Kiln expansion (%) 0.40 - - 25.0 50.0 75.0 98.0 Average utilisation (%) 81.0 97.0 74.0 83.0 91.0 98 Output (Mn MT) 0.71 0.83 0.92 1.03 1.13 1.23 Selling price (N„000/tonne) 26.5 25.5 25.5 25.5 25.5 25.5 Revenue (N‟ Bn) 18.2 21.0 23.4 26.3 30.0 32.5 Source: Vetiva Research As we have earlier highlighted, we expect a downward trajectory in Ashaka‟s production costs. In line with management‟s guidance, coal fuel would only As Ashaka achieves higher coal be used for kiln firing. Thus, we expect that the power plants would still run utilisation relative to LPFO, we on diesel or LPFO. On the back of this, we estimate that energy cost (kiln expect a continuing reduction in fuel only) account for c.50% of total production cost and assume gradual energy costs in our forecasts ramp up of the additional 400,000 tonnes. Other assumptions regarding coal utilisation rate and expected energy savings over our forecast period are detailed in figure 79 below. Figure 81: Assumptions on coal subsitution and cost savings 2010 2011 2012 2013 2014 2015 Cement Production(Mn tonnes) 0.686 0.824 0.916 1.033 1.133 1.225 Total Energy consumption (Bn cal) 583.4 659.6 732.8 826.4 906.4 980.0 Coal Utilisation (%) 30.0 60.0 80.0 90.0 90.0 90.0 Coal Consumption („000 tonnes) 32.91 74.42 110.25 139.87 153.41 165.87 LPFO Utilisation (%) 70.0 40.0 20.0 10.0 10.0 10.0 LPFO consumption (MnL) 41.14 26.58 14.77 8.33 9.13 9.87 Fuel Costs (Bn N) 3.63 2.44 1.77 1.46 1.61 1.74 Savings in Fuel costs (Mn N) 779 2,544 3,768 4,781 5,244 5,669 %age savings in production costs 9.70 28.1 37.4 42.1 42.1 42.1 We assumed a long-term CAPEX to sales ratio of 5% and average depreciation period of 25 years. WACC assumptions are detailed in the table below Nigerian Cement Sector: Unbundling Potentials I January 2011 I 74
    • Nigeria I Building Materials I Equities Figure 82: WACC Assumptions After tax cost of debt 0.0% Tax rate 32.0% 4 Risk free rate 10.8% Beta 1.19 Equity risk premium 5.0% Target Debt/Total Capital 0.0% Shareholders Equity/Total Capital 100% WACC 16.74% DCF value N23.89Relative Valuation: EV/EBITDA Figure 83: Valuation using 2011 market cap weighted EV/EBITDA estimates of EM peers Average EM peer average (x) 8.9 EBITDA (N‟m) 7,528 Enterprise Value (N‟m) 66,999 Market Capitalisation (N‟m) 68,635 Shares Outstanding (mn) 2,240 Per share value (N) 30.64 Final fair value range: N22.40 - N26.20; implied mid-point: N24.20RatingWe downgrade our rating on Ashaka to a “reduce”, and believe the stock is fully Notwithstanding the positivevalued, despite raising our fair value mid-point to N24.20 (previous: N23.61). outlook on Ashaka, we downgradeGiven the recent rallies in Ashaka‟s share price the stock is now trading at a the stock to a “Reduce” because ofdownside potential of 11%, relative to the mid-point of our new fair value range. its rich valuationNigerian Cement Sector: Unbundling Potentials I January 2011 I 75
    • Nigeria I Building Materials I EquitiesFigure 84: Financial Statements: Actual and Forecasts (N‟Mill) INCOME STATEMENT (NMill) 2006 2007 2008 2009 F 2010 F 2011 F 2012 F Turnover 16,772 16,473 21,378 17,194 18,189 21,025 23,358 Cost of Sales (8,794) (10,868) (14,039) (11,771) (11,846) (10,132) (9,792) Gross Profit 7,978 5,605 7,339 5,423 6,343 10,893 13,566 Selling and distri. Expenses (2,408) (1,486) (1,437) (432) (771) (1,472) (1,635) Core Operating Profit 5,570 4,120 5,902 4,991 5,572 9,421 11,931 EBITDA 5,948 4,452 2,697 3,785 1,533 4,481 7,529 Depreciation & Amortization (436) (514) (519) (526) (966) (1,008) (1,054) EBIT/Operating Profit 4,016 2,183 3,265 1,007 3,515 6,521 8,774 Interest Payable & Charges - - - - - - - Profit Before Taxation 4,952 2,513 3,430 1,324 3,515 6,521 8,774 Taxation (1,574) (1,361) (911) (1,422) (984) (2,152) (2,808) Profit After Taxation 3,378 1,153 2,519 943 2,531 4,369 5,966 Dividends 1,087 1,106 597 - 1,126 1,944 2,655 Retained Earnings 2,291 47 1,922 943 1,405 2,425 3,311 BALANCE SHEET (NMill) 2006 2007 2008 2009 2010 F 2011 F 2012 F Non-Current Assets Fixed Assets 2,685 3,811 5,686 5,218 19,478 19,522 19,635 Work in Progress 5,333 8,891 10,901 13,849 2,981 3,030 3,031 Current Assets Inventories 4,931 4,220 4,706 4,707 5,017 4,292 4,148 Debtors 1,674 386 139 88 100 115 128 Bank and cash balances 3,798 2,137 1,636 850 508 5,062 9,085 Other Receivables and Current Assets - 2,785 1,958 908 1,200 1,388 1,542 Total Current Assets 10,403 9,528 8,440 6,552 6,826 10,856 14,902 TOTAL ASSETS 18,421 22,230 25,027 25,618 29,285 33,408 37,568 Current Liabilities Creditors & Accruals 887 1,151 1,921 2,296 1,099 1,986 2,206 Other Creditors 3,341 6,164 7,269 5,967 4,892 5,655 6,283 Short Term Loan - 968 - - - - - Taxation 1,661 1,687 928 1,385 984 2,152 2,808 Total Current Liabilities 5,890 9,971 10,117 9,648 6,976 9,792 11,296 Non-current Liabilities Long-Term Loans - - - - - - - Provision for Gratuity 408 836 982 1,648 2,862 1,994 1,610 Deferred Taxation 526 710 1,144 1,181 1,920 1,621 1,349 Total Non-Current Liabilities 934 1,546 2,125 2,829 4,783 3,615 2,959 TOTAL LIABILITIES 6,824 11,518 12,242 12,477 11,758 13,407 14,255 Net Assets 11,598 10,713 12,785 13,142 14,085 15,489 17,914 Shareholders fund 11,598 10,713 12,785 13,142 14,085 15,489 17,914Nigerian Cement Sector: Unbundling Potentials I January 2011 I 76
    • Nigeria I Building Materials I EquitiesFigure 85: Financial Statements: Actual and Forecasts (USD‟Mill) INCOME STATEMENT (USDMill) 2006 2007 2008 2009 F 2010 F 2011 F 2012 F Turnover 143 140 172 117 121 136 151 Cost of Sales (75) (92) (113) (80) (79) (65) (63) Gross Profit 68 48 59 37 42 70 88 Selling and distri. Expenses (20) (13) (12) (3) (5) (9) (11) Core Operating Profit 47 35 47 34 37 61 77 EBITDA 51 38 22 26 10 29 49 Depreciation & Amortization (4) (4) (4) (4) (6) (7) (7) EBIT/Operating Profit 34 19 26 7 23 42 57 Interest Payable & Charges - - - - - - - Profit Before Taxation 42 21 28 9 23 42 57 Taxation (13) (12) (7) (10) (7) (14) (18) Profit After Taxation 29 10 20 6 17 28 38 Dividends 9 9 5 - 8 13 17 Retained Earnings 19 0 15 6 9 16 21 BALANCE SHEET (USDMill) 2006 2007 2008 2009 F 2010 F 2011 F 2012 F Non-Current Assets Fixed Assets 23 32 46 35 130 126 127 Work in Progress 45 76 88 94 20 20 20 Current Assets Inventories 42 36 38 32 33 28 27 Debtors 14 3 1 1 1 1 1 Bank and cash balances 32 18 13 6 3 33 59 Other Receivables and Current Assets - 24 16 6 8 9 10 Total Current Assets 88 81 68 44 46 70 96 TOTAL ASSETS 157 189 201 174 195 216 242 Current Liabilities - - Creditors & Accruals 8 10 15 16 7 13 14 Other Creditors 28 52 58 41 33 36 41 Short Term Loan - 8 - - - - - Taxation 14 14 7 9 7 14 18 Total Current Liabilities 50 85 81 66 47 63 73 Non-current Liabilities - - - - - - Long-Term Loans - - - - - - - Provision for Gratuity 3 7 8 11 19 13 10 Deferred Taxation 4 6 9 8 13 10 9 Total Non-Current Liabilities 8 13 17 19 32 23 19 TOTAL LIABILITIES 58 - - - - - - Net Assets 99 98 98 85 78 86 92Nigerian Cement Sector: Unbundling Potentials I January 2011 I 77
    • Nigeria I Building Materials I EquitiesFigure 86: Financial ratios: Actual and Forecasts 2007 2008 2009 2010F 2011F 2012F Growth Turnover growth 29.8% -19.6% 5.8% 15.6% 11.1% 12.8% Growth in EBITDA -39.4% 40.3% -59.5% 192.3% 68.0% 30.5% Growth in PBT -49.2% 36.5% -61.4% 165.4% 85.5% 34.6% Growth in PAT -65.9% 118.6% -62.6% 168.4% 72.6% 36.6% Profitability Return on Average Equity 10.3% 21.4% 7.3% 18.3% 27.7% 32.0% Return on Average Assets 5.7% 10.7% 3.7% 9.7% 15.4% 18.4% EBITDA Margin 16.4% 17.7% 8.9% 24.6% 35.8% 42.1% EBIT Margin 13.3% 15.3% 5.9% 19.3% 31.0% 37.6% Pretax Profit Margin 15.3% 16.0% 7.7% 19.3% 31.0% 37.6% Net Profit Margin 7.0% 11.8% 5.5% 13.9% 20.8% 25.5% Liquidity Ratios (x) Quick ratio 0.53 0.37 0.19 0.26 0.67 0.95 Cash ratio 0.21 0.16 0.09 0.07 0.52 0.80 Current ratio 0.96 0.83 0.68 0.98 1.11 1.32 Days in inventory 153.67 116.04 145.95 149.83 167.67 157.28 Days in accounts payable 36.80 55.20 52.99 52.64 46.32 81.32 Days in receivables 22.83 4.48 2.41 1.88 1.87 1.90 Activity Ratios (x) Sales to cash 7.71 13.06 20.24 35.78 4.15 2.57 Sales to inventory 3.90 4.54 3.65 3.63 4.90 5.63 Sales to total assets 0.74 0.85 0.67 0.69 0.69 0.68 Sales to total fixed assets 1.29 1.29 0.90 0.93 1.08 1.19 Production data Capacity(million tonnes) 0.85 0.85 0.85 0.85 0.85 1.25 Production (million tonnes) 0.68 0.86 0.65 0.71 0.82 0.92 Utilization (%) 79.65 101.06 76.47 83.92 97.00 73.28 Revenue/tonne (000) 24.33 24.89 26.45 25.50 25.50 25.50 Per Share Data Earnings/share 0.58 1.27 0.47 1.13 1.95 2.66 Dividend/share 0.10 0.30 0.00 0.50 0.87 1.19 Net Asset/share 5.39 6.43 6.60 6.49 7.58 9.05 Sales/Share 8.27 10.74 8.64 8.12 9.39 10.43 Valuation Multiples P/E (x) 48.97 22.40 59.86 25.09 14.54 10.64 P/B (x) 5.26 4.41 4.30 4.37 3.74 3.13 Dividend Yield (%) 0.4% 1.1% 0.0% 1.8% 3.1% 4.2% EV/EBITDA (x) 23.54 16.78 41.42 14.17 8.43 6.46Nigerian Cement Sector: Unbundling Potentials I January 2011 I 78
    • Nigeria I Building Materials I EquitiesCCNN PlcDual uncertainties dampen future outlook UNDERWEIGHT Blur expansion, weak revenue outlook...Given its uncertain Stock Data expansion and cost reduction plans, we are currently pessimistic about Market Price (N) 15.49 CCNN‟s earnings outlook. Whilst noting that the company‟s management Shares Outs (bn) 1.256 has indicated at different times the likelihood of expanding its capacity Market cap (N‟bn) 18.84 to 1.4 million tonnes, the sustained lack of clarity about the plans have Fair value range 7.90 – 9.60 informed our negative outlook on the company, as potential for revenue Rating UNDERWEIGHT growth is significantly minimised with its current 500,000 tonnes cement plant. ...Further worsened by rising cost profile: The second worrisome Price Perf. CCNN NSE concern on CCNN‟s outlook is its growing energy costs as the company 12-month (%) 15.7 19.2 remains the only cement producer in Nigeria without definite steps 6-month (%) -19.7 -5.0 substituting Low Pour Fuel Oil with a cheaper fuel. Similar to Ashaka, we 3-month (%) 10.0 -2.0 believe the company should place emphasize on efficiency, as it seems the best way it can remain competitive, since it would be difficult to compete with Dangote Cement (perhaps the only substitute brand in the Financials 2009A 2010A 2011F region) on volume. Turnover (Nbn) 11.19 11.93 12.51 Location offers good prospects notwithstanding: Despite our EBITDA (Nbn) 1.64 1.73 1.84 cautious stance on CCNN, we maintain that the company perhaps has PAT (Nbn) 1.81 0.79 0.83 one of the best opportunities for growth in the Nigeria cement industry EBITDA Marg (%) 16.5 14.6 14.5 for two key reasons; the region has the least cement consumption in PBT Margin (%) 19.5 10.2 10.2 Nigeria and enormous potentials for growth. We highlight Australia PAT Margin (%) 15.3 7.0 6.9 Mines (Nigeria Gold Pty) Limited proposed investment in gold mining in the region as a major catalyst for infrastructural development in the North-West region in the longer term. Valuation 2009A 2010A 2011F P/E (x) 10.40 24.17 22.79 Valuation and Recommendation: In view of the fore-going, our PBV (x) 4.47 4.01 3.61 valuation indicates that CCNN is overpriced as it trades at a potential EV/EBITDA (x) 9.59 11.52 10.89 downside to c.42% to the mid-point of fair value range. Hence, we maintain an „underweight‟ rating on the stock, noting however, that Div. Yield (%) 6.0 1.6 1.7 clarity from the company‟s management on its investment plans could raise our valuation on the company. At its current price, CCNN is trading at a forward (2011) P/E of 23x relative to average sector P/E of 12.7x. Fig 87: 52-week Share price performance and Shareholding Structure 2.0 Ferrostal Dantata: A.G:0.10% Other 7.08% 1.8 Nigerians: 15.00% BUA group Kebbi, 51.00% 1.5 Sokoto &Kaduna 1.3 states: 15.01% Nasdal 1.0 Bap:11.63% 0.8 15-Dec 15-Feb 15-Apr 15-Jun 15-Aug 15-Oct 15-Dec ASI BMIndex CCNN Source: Annual Reports, Vetiva ResearchNigerian Cement Sector: Unbundling Potentials I January 2011 I 79
    • Nigeria I Building Materials I EquitiesInvestment ThesisPresent capacity inadequate to sustain market share: CCNN is the last ofthe cement producers to announce definitive plans around its expansion. Whilethere have been indications from management that the company may expandcapacity to 1.4 million tonnes, timelines and funding for the expansion are stillunclear. Compounded by its obsolete state, CCNN‟s 500,000 tonnes plant is Without major expansion, CCNNgrossly inadequate to position the company competitively in the industry. We current production capacity ishighlight that CCNN has one of the highest cement prices in the industry, grossly inadequate to position theevidently as a result of its higher energy costs, relatively obsolete technology company competitively goingand small production capacity. Due to supply deficit which has historically forwardplagued the Nigerian cement industry and CCNN‟s relative isolation in North-West Nigeria, revenue growth has been somewhat sustained through priceincreases. We recall in 2009 that the company increased its cement price (pertonne) by c.12% and has consistently hiked prices YoY since 2006. Infact inFY‟09 earnings, c.60% of revenue growth came from the 12% increase in price.However, in our view, CCNN is unlikely to continue to enjoy such revenue growthfrom price increases as it has historically done, in view of the surplus expected inthe industry and increasing competition from Dangote Cement, which has thehighest number of depots concentrated in the North.Increasing cost exert additional pressure on top-line: CCNN is still havingchallenges getting around its increasing energy costs to remain efficient andadequately profitable. In its FY‟09 accounts, management had stated the hugeincrease in energy costs (c.40%) arising from transportation expenses incurred Until CCNN adopts a cheaper fuel,in moving imported LPFO from the south to its plant (located in Sokoto, North- its energy costs would alsoWest Nigeria). Despite this reality in 2009, the company still operated more continue to exert pressure onefficiently, reporting a PBT margin of 21.1% as at Q3‟09, and 19.5% by FY‟09, earnings growthsignificantly higher than 11.1% achieved as at Q3‟10. Apart from energy costs,we believe fixed costs also took toll on CCNN‟s profitability, since the impact ofsuch fixed costs would have been felt more as a result of lower sales. As impliedby the fall seen in CCNN‟s pre-tax margin, the plunge in efficiency as at Q3‟10broadly negates our expectation of slight reductions in fuel costs. As it standstherefore, CCNN is the least efficient amongst the cement producers. Moreworrisome is the fact that CCNN‟s plans to curtail the rising costs trend are stilluncertain, though management had vaguely stated intentions to convert to coalfuel, which is cheaper relative to LPFO.Accessibility to financing: We believe CCNN‟s delay in pursuing its proposedexpansion relates to funding considerations, given the huge investment required In our view, funding considerationsfor such brown-field expansion. We extrapolate using the cost of Benue Cement is most likely the key factorCompany‟s (now Dangote Cement) Gboko Plant brown-field expansion in 2008, delaying definite actions on CCNN‟sthat the cost of CCNN‟s proposed 0.9 million tonnes capacity would cost around expansion$190 per tonne. This per tonne cost, which excludes the coal plant investment,translates into approximately $171 million dollars (N25.65 billion), indicating thehuge funding needed. Despite possible access to debt financing through theenlarged balance sheet of the parent company- BUA group, a substantial equityinvestment would still be required. In our view also, another limiting factor toaccessing financing might be the absence of a core international investor in thecompany after Heidelberg pulled out.Nigerian Cement Sector: Unbundling Potentials I January 2011 I 80
    • Nigeria I Building Materials I EquitiesLafarge WAPCO was favoured in this regard as the loan obtained from StandardBank to fund the “Lakatabu” expansion was partly based on the credit worthinessof the parent – Lafarge. Ashaka enjoys similar leverage – but in the form ofintercompany funding.Business OverviewCement Company of Northern Nigeria (CCNN) is a 51% owned subsidiary of theBUA group, a growing indigenous conglomerate with interests in sugar and flour- The BUA bought majority stakes inmilling industry. The company owns a 500,000 tonnes production plant in Sokoto CCNN from Damnaz- aNorth – West Nigeria. BUA group bought majority stakes CCNN via a management investment vehiclemanagement investment vehicle - Damnaz, created by the management buy-out created by the management buy-of Heiderlberg majority stake in 2008. CCNN was originally established as a out of Heidelberg in 2008government-owned entity before the company was privatised. Production DynamicsCCNN cement plant is one of the oldest in Nigeria, being about 25 years. Hence,it‟s quite prone to operational challenges. Recently, the company spent close toN436 million to replace its burnt electro-static filter for the control of dustemission this year. The plant has a production capacity of 500,000 tonnes and CCNN is the smallest cementhas operated at an average utilisation rate of 72% over the last four years. The producer (by capacity size) andcompany reached its highest capacity utilisation rate in 2009. Similar to other operates one of the oldest cement plantexisting producers, CCNN‟s market share has shrunk since the entry of DangoteCement into local production. Based on FY‟09 data, CCNN only accounted for 3%of total cement consumed, down from 11% as at 2005 respectively. Withoutcapacity expansion, our estimate indicates that CCNN‟s market share woulddecline further to 1.7% by 2013.Production costs Historically, CCNN had the highest energy costs in the industry as it mainly used heavy oil and LPFO in cement production until 2008. Following its right issue in 2007, the company invested in a biomass plant and substituted 30% of its heavy oil consumption with biomass. This brought its energy Though CCNN‟s energy cost has costs down to an average of 57% in 2008 and 2009 from 72% of sales in somewhat reduced following its 2007. Without additional investment in cost-saving projects, the reduction investment in LPFO and diesel would not be significant enough to competitively position the company for plants in 2007, its energy costs is still high relative to other cement profitability going forward. The non-functional state of local refineries also producers made the situation worse as producers made use of imported LPFO. CCNN‟s production costs constitute c.65% (average of 2006 – 2009) of its sales revenue. According to management, the company incurred additional 40% in costs on the transportation of imported LPFO. With the deregulation of the LPFO market in 2009, the price of the product reached record highs. With CCNN small production scale, its comparatively huge energy costs would be a major albatross to profitability growth. Since there are no definite plans on costs reductions, we project production costs would continue to rise.Nigerian Cement Sector: Unbundling Potentials I January 2011 I 81
    • Nigeria I Building Materials I EquitiesForecasts – financial performanceWithout considering expansion plans, we project that CCNN would account foronly 2% of total industry output by 2013, implying has the least potential forrevenue growth in the industry. Our forecasts imply a 4-year (2009 – 2013E) With no expansion, CCNN would only account for 2% of industryCAGR of 4.8%, as we project that revenue would grow to N14.29 billion by 2013 output by 2013from N11.87 billion as at FY‟09. This revenue growth is even predicated on arather bullish assumption that the existing plant would operate at a peakcapacity utilisation rate of 96%, despite the fact that the company‟s highestcapacity utilisation in the last five years is 82%. (See figure 86 below) Figure 88: CCNN Revenue (N‟Mn) and Capacity utilisation rates (%) 16000 100% 94% 12000 86% 82% 82% 76% 77% 8000 75% 4000 0 50% 2008 2009 2010E 2011E 2012E 2013E Revenue Capacity utilisation rates Source: Annual Reports, Vetiva ResearchWe project that EBITDA margins would close to 18% by FY‟13 from 14% atFY‟09. Also, we expect EBIT margins move towards 14% by 2013 from 11% asat FY‟09.Figure 89: EBITDA per tonne (N), EBITDA margin and Figure 90: EBIT per tonne (N), EBIT margin and EBITEBITDA growth (%) growth (%) 4500 5000 30% 26% 30% 22% 17% 20% 3000 19% 4600 15% 10% 24% 9% 8% 29% 0% 0% 4200 1500 -10% -15% -17% -20% 3800 -20% 0 -30% 2009 2010E 2011E 2012E 2013E 2009 2010E 2011E 2012E 2013E EBITDA per tonne EBITDA margin EBITDA growth EBIT per tonne EBIT margin EBIT growth Source: Annual Reports, Vetiva ResearchNigerian Cement Sector: Unbundling Potentials I January 2011 I 82
    • Nigeria I Building Materials I EquitiesBased on the company‟s current long term debt, we expect minimal interestpayments, barring any increase in leverage, which we believe is quite inevitablefor the company to invest in capacity expansion. Thus, we anticipate that pre-tax profit margin will decline towards 13% by 2013, from 19% as at FY‟09. In asimilar manner, we expect after tax profit margin to dip to c.9% by FY‟13, from15.3% (as at FY‟09); our FY‟10 estimate stands at 14%. Figure 91: PBT per tonne (N), PBT margin and PBT growth Figure 92: PAT per tonne (N), PAT margin and PAT (%) growth (%) 6400 5000 40% 38% 40% 18% 21% 4000 20% 4800 21% 10% 15% 6% 10% 3000 0% 3200 32% -10% 2000 -20% 1600 -35% -51% 1000 -40% 0 -60% -57% 0 -60% 2009 2010E 2011E 2012E 2013E 2009 2010E 2011E 2012E 2013E PBT per tonne PBT margin PBT growth PAT per tonne PAT margin PAT growth Source: Annual Reports, Vetiva ResearchAlso, we expect ROAE and RoAA to follow the expected declining trend inprofitability. Figure 93: PBT per tonne (N), PBT margin and PBT Figure 94: PBT per tonne (N), PBT margin and PBT growth (%) growth (%) 1.60 20% 1.20 15% 0.80 10% 0.40 5% 0.00 0% 2009 2010E 2011E 2012E 2013E 2009 2010E 2011E 2012E 2013E EPS DPS ROAA ROAE Source: Annual Reports, Vetiva ResearchNigerian Cement Sector: Unbundling Potentials I January 2011 I 83
    • Nigeria I Building Materials I Equities In our view, CCNN is highly likely to take up additional debt in the 2 – 3 years to pursue its expansion plans. Whilst we do not have clarity on the funding For the CCNN to fully pursue its considerations for the projects, it‟s possible, based on CCNN‟s history, the expansion plan, we expect some company embark on equity issue. In view of the huge financing required for substantial increase in CCNN‟s cement plants however, a substantial amount of leverage would still be needed leverage in the next 2 to 3 years to augment the equity issue. As we earlier highlighted, close to N26 billion ($171 million) would be need for the cement plant expansion. This project sum would even be higher if we factor in the cost of the coal plant, implying therefore the enormous financing required by CCNN for its proposed capital project. Valuation We use a blend of the Discounted Cash-flow and EV/EBITDA relative Our fair value mid-point for CCNN is methodologies for our valuation. Our overall fair value however is N8.70 significantly weighted to the DCF valuation (80% vs 20%) given the relatively lower volatility of the DCF method relative to market multiples. Our overall fair value range for CCNN is N7.90 – N9.60 implying a midpoint of N8.70. DCF assumptions - Our valuation is based on the Discounted Cash-Flow with forecasts spanning through a 6 year period.  We have excluded additional capacity from our revenue forecast for CCNN. All assumptions made on revenue growth are based on its current 500,000 tonne and are summarised in figure 93 below; Figure 95: DCF revenue assumptions 2010E 2011E 2012E 2013E 2014E 2015E Utilisation (%) 77.0 82.0 86.0 94.0 98.0 98.0 Output (%) 0.385 0.410 0.430 0.470 0.490 0.490 Selling Price (N „000) 29.09 29.09 29.09 29.09 29.09 29.09 Revenue (N‟Bn) 11.19 11.93 12.51 13.67 14.25 14.25 Source: Vetiva Research Also in deriving our forecasts for production costs, we excluded the use of coal, and project that energy costs would be on the uprise from the increasing use of heavy oil and LPFO. Using the average of the last two years, we project that would be 57% of sales in our forecasts. We assumed a long-term CAPEX to sales ratio of 5% and average depreciation period of 25 years. WACC assumptions are detailed in the table below Nigerian Cement Sector: Unbundling Potentials I January 2011 I 84
    • Nigeria I Building Materials I Equities Figure 96: WACC Assumptions After tax cost of debt 6.80% Tax rate 32.0% Risk free rate4 10.8% Beta 0.80 Equity risk premium 5.0% Target Debt/Total Capital 13.0% Shareholders Equity/Total Capital 87.0% WACC 13.76% DCF value N7.34Relative Valuation: EV/EBITDA Figure 97: Valuation using 2011 market cap weighted EV/EBITDA estimates of EM peers Average EM peer average (x) 8.9 EBITDA (N‟m) 2,027 Enterprise Value (N‟m) 18,040 Market Capitalisation (N‟m) 17,995 Shares Outstanding (mn) 1,256 Per share value (N) 14.33 Final fair value range: N7.90 – N9.60; implied mid-point: N8.70Rating We maintain an “underweight”We maintain an “Underweight” rating on CCNN, despite raising our fair value toN8.70. The stock is trading at a downside potential of 42% relative to the mid- rating on CCNNpoint of our new fair value range.Nigerian Cement Sector: Unbundling Potentials I January 2011 I 85
    • Nigeria I Building Materials I EquitiesFigure 98: Financial Statements: Actual and Forecasts (N‟Mill) INCOME STATEMENT (NMill) 2007 2008 2009 2010 F 2011 F 2012 F Turnover 8,042 9,878 11,868 11,200 11,927 12,509 Cost of Sales (5,759) (5,709) (6,704) (6,664) (7,097) (7,380) Gross Profit 2,283 4,169 5,164 4,536 4,830 5,129 Operating Expense (591) (640) (762) (661) (716) (751) Core Operating Profit 1,692 3,530 4,402 3,875 4,115 4,378 EBITDA 138 1,611 1,964 1,635 1,729 1,876 Depreciation & Amortization (321) (343) (369) (362) (387) (413) EBIT/Operating Profit (183) 1,268 1,595 1,273 1,342 1,463 Interest Payable & Charges (387) (537) (346) (127) (127) (127) Interest received - - - - - - Profit Before Taxation 172 1,681 2,317 1,146 1,216 1,337 Taxation (34) (150) (505) (367) (389) (428) Profit After Taxation 138 1,531 1,812 779 827 909 BALANCE SHEET (NMill) 2007 2008 2009 2010 F 2011 F 2012 F Non-Current Assets Fixed Assets 4,017 4,655 4,950 5,452 5,795 6,605 Capital work in progress 439 4 66 - - - Current Assets Inventories 3,016 2,424 2,510 2,823 3,006 3,126 Debtors 775 717 1,002 1,066 1,135 1,191 Bank and cash balances 284 400 626 447 667 968 Other Receivables and Current Assets 588 597 649 739 787 826 Total Current Assets 4,663 4,137 4,787 5,075 5,595 6,110 TOTAL ASSETS 9,118 8,795 9,803 10,526 11,390 12,715 Current Liabilities Creditors & Accruals 4,982 2,500 3,447 3,124 3,340 3,503 Other Creditors - - - - - - Short Term Loan 553 1,092 671 1,218 1,218 1,218 Taxation 40 39 210 367 389 428 Total Current Liabilities 5,575 3,631 4,327 4,709 4,947 5,148 Non-current Liabilities Long-Term Loans - 633 507 380 253 126 Provision for Gratuity 320 360 490 802 1,041 1,727 Deferred Taxation 76 195 262 - - - Total Non-Current Liabilities 396 1,188 1,259 1,182 1,294 1,853 TOTAL LIABILITIES 5,970 4,819 5,586 5,891 6,241 7,001 Net Assets 3,148 3,976 4,217 4,635 5,149 5,714Nigerian Cement Sector: Unbundling Potentials I January 2011 I 86
    • Nigeria I Building Materials I EquitiesFigure 99: Financial Statements: Actual and Forecasts (USD‟Mill) INCOME STATEMENT (USD‟Mill) 2007 2008 2009 2010 F 2011 F 2012 F Turnover 68 79 81 75 77 81 Cost of Sales (49) (46) (46) (44) (46) (48) Gross Profit 19 33 35 30 31 33 Operating Expense (5) (5) (5) (4) (5) (5) Core Operating Profit 14 28 30 26 27 28 EBITDA 1 13 13 11 11 12 Depreciation & Amortization (3) (3) (3) (2) (2) (3) EBIT/Operating Profit (2) 10 11 8 9 9 Interest Payable & Charges (3) (4) (2) (1) (1) (1) Interest received - - - - - - Profit Before Taxation 1 13 16 8 8 9 Taxation (0) (1) (3) (2) (3) (3) Profit After Taxation 1 12 12 5 5 6 BALANCE SHEET (USDMill) 2007 2008 2009 2010 F 2011 F 2012 F Non-Current Assets Fixed Assets 34 37 34 36 37 43 Capital work in progress 4 0 0 - - - Current Assets Inventories 26 19 17 19 19 20 Debtors 7 6 7 7 7 8 Bank and cash balances 2 3 4 3 4 6 Other Receivables and Current Assets 5 5 4 5 5 5 Total Current Assets 40 33 32 34 36 39 TOTAL ASSETS 78 71 67 70 73 82 Current Liabilities Creditors & Accruals 42 20 23 21 22 23 Other Creditors - - Short Term Loan 5 9 5 8 8 8 Taxation 0 0 1 2 3 3 Total Current Liabilities 47 29 29 31 32 33 Non-current Liabilities Long-Term Loans - 5 3 3 2 1 Provision for Gratuity 3 3 3 5 7 11 Deferred Taxation 1 2 2 - - - Total Non-Current Liabilities 3 10 9 8 8 12 TOTAL LIABILITIES 51 39 38 39 40 45 Net Assets 27 32 29 31 33 37Nigerian Cement Sector: Unbundling Potentials I January 2011 I 87
    • Nigeria I Building Materials I EquitiesFigure 100: Financial ratios: Actual and Forecasts 2007 2008 2009 2010F 2011F 2012F Growth (%) Turnover growth 26.2% 22.8% 20.1% -5.6% 6.5% 4.9% Growth in EBITDA 1066.6% 21.9% -16.7% 5.8% 8.5% 16.6% Growth in PBT 878.3% 37.8% -50.5% 6.1% 9.9% 21.2% Growth in PAT 1012.4% 18.3% -57.0% 6.1% 9.9% 21.2% Profitability (%) Return on Average Equity 5.9% 43.0% 44.2% 17.5% 16.7% 16.5% Return on Average Assets 1.6% 17.1% 19.5% 7.6% 7.5% 7.5% EBITDA Margin 1.7% 16.3% 16.5% 14.6% 14.5% 15.0% EBIT Margin -2.3% 12.8% 13.4% 11.4% 11.3% 11.7% Pretax Profit Margin 2.1% 17.0% 19.5% 10.2% 10.2% 10.7% Net Profit Margin 1.7% 15.5% 15.3% 7.0% 6.9% 7.3% Liquidity Ratios (x) Quick ratio 0.30 0.47 0.53 0.48 0.52 0.58 Cash ratio 0.05 0.11 0.14 0.09 0.13 0.19 Current ratio 0.84 1.14 1.11 1.08 1.13 1.19 Days in inventory 173.62 173.90 134.29 146.03 149.89 151.63 Days in accounts payable 321.15 241.67 155.26 178.24 164.63 167.95 Days in receivables 34.46 27.57 26.43 33.70 33.68 33.93 Activity Ratios (x) Sales to cash 28.29 24.71 18.95 25.05 17.89 12.92 Sales to inventory 2.67 4.08 4.73 3.97 3.97 4.00 Sales to total assets 0.88 1.12 1.21 1.06 1.04 0.98 Sales to total fixed assets 1.80 2.12 2.37 2.03 2.03 1.87 Production Data Capacity(million tonnes) 0.50 0.50 0.50 0.50 0.50 0.50 Production (million tonnes) 0.34 0.38 0.41 0.39 0.41 0.43 Average Utilization 68.5% 76.0% 81.6% 77.0% 82.0% 86.0% Revenue/tonne (N000) 23.48 25.99 29.09 29.09 29.09 29.09 Per Share Data Earnings/share 0.12 1.22 1.44 0.62 0.66 0.72 Dividend/share 0.10 0.90 0.90 0.23 0.25 0.27 Net Asset/share 2.51 3.17 3.36 3.74 4.15 4.60 Sales/Share 6.40 7.86 9.45 8.92 9.50 9.96 Valuation Multiples P/E (x) 118.90 11.48 9.70 22.56 21.27 19.35 P/B (x) 5.59 4.42 4.17 3.74 3.37 3.04 Dividend Yield (%) 0.7% 6.4% 6.4% 1.7% 1.8% 2.0% EV/EBITDA (x) 127.38 10.92 8.96 10.75 10.17 9.37Nigerian Cement Sector: Unbundling Potentials I January 2011 I 88
    • Nigeria I Building Materials I EquitiesNon-listed CompaniesUnited Cement Company of Nigeria Limited (UniCem)UniCem was formed in 2002 by Holcim Trading S.A and Flour Mills of Nigeria Plc.The company acquired the assets Calcemco, a state owned cement company sold UniCem is owned by Nigerianby the Nigerian government after liquidation. On acquisition, UniCem embarked Cement Holding B.V (NCH) andon a two phase project; the rehabilitation of Calabar Grinding Station and the Flour Mills of Nigeria Plcproduction of cement. In 2004, the company initiated the construction of a 2.5million tonnes green-field plant in Calabar, with the construction of the plantcontracted to Orascom industries (Egypt) and FLSmidth (Denmark). The DangoteGroup also became a shareholder in UniCem in 2005.Lafarge acquired Orascom Cement in 2007. Thus, Orascom operations, whichincluded the UniCem plant (then under construction) in Nigeria, became a part ofthe Lafarge group. Subsequently, Lafarge became a shareholder in UniCem. Thecement plant was commissioned in 2009.With the departure of the Dangote Group, the current shareholders of UniCemare Nigerian Cement Holding B.V (NCH) and Flour Mills of Nigeria Plc. NCH is themajority shareholder and is controlled by Holcim Limited Switzerland and LafargeS.A France.ProductionThe company‟s plant, located at Mfamosing Calabar, Cross-River State (South-South Nigeria), started production in 2009 and reached a capacity utilisation rate Unicem‟s 2.5 million tonnes (annualof about 25%. According to insights from management, the company intends to capacity) plant in Mfamosingachieve a utilisation rate of 48% by 2010 and 72% by 2011. Due to UniCem‟s Calabar -South South Nigerialocation, the South-East and South-South Regions are its major market. Its commenced operation in 2009 andmajor competitor is Dangote Cement which has 9 depots in the South East/South only reached a 25% capacitySouth region. Apart from Dangote Cement, Eastern Bulk Cement (imports) is utilisation in the same yearalso a major brand in the region. UniCem‟s plant was primarily built to operateon gas, although the kiln can also be fired with LPFO (dual-firing). The companygets its gas supply from East Horizon Gas Company (EHGC), a special purposevehicle set up by Oando Plc, to develop, finance, construct and operate gastransmission pipeline linking the Calabar cluster of industries to the Nigerian GasCompany (NGC) grid in Akwa-Ibom State. UniCem is the primary customer, asEHGC was set up to supply c.20% of its daily capacity gas to the company.Nigerian Cement Sector: Unbundling Potentials I January 2011 I 89
    • Nigeria I Building Materials I EquitiesInvestment Recommendations Vetiva uses a 5-tier recommendation system for stocks under coverage: Buy, Accumulate, Neutral, Reduce and Sell.  Buy/Overweight ≥ +25% expected absolute price performance  Accumulate +10% to +25% expected absolute price performance  Neutral/Hold +/-10% range expected absolute price performance  Reduce -10% to -20% expected absolute price performance  Sell/Underweight ≤ -20% expected absolute price performance Definition of Ratings Buy/Overweight recommendation refers to stocks that are highly undervalued but with strong fundamentals and where potential return in excess of or equal to 25% is expected to be realized between the current price and analysts‟ target price. Accumulate recommendation refers to stocks that are undervalued but with good fundamentals and where potential return of between 10% and 25% is expected to be realized between the current price and analysts‟ target price. Neutral/Hold recommendation refers to stocks that are correctly valued with little upside or downside where potential return of between +/- 10% is expected to be realized between current price and analysts‟ target price. Reduce recommendation refers to stocks that are overvalued but with good or weakening fundamentals and where potential return of between -10% and -20% is expected to be realized between current price and analysts‟ target price. Sell/Underweight recommendation refers to stocks that are highly overvalued but with weak fundamentals and where potential return in excess of or equal to -20% is expected to be realized between current price and analysts‟ target price. Disclosures: Analyst Certification The research analysts who prepared this report certify as follows:  That all of the views expressed in this report articulate the research analyst(s) independent views/opinions regarding the companies, securities, industries or markets discussed in this report.  That the research analyst(s) compensation or remuneration is in no way connected (either directly or indirectly) to the specific recommendations, estimates or opinions expressed in this report. Other Disclosures Vetiva Capital Management Limited or any of its affiliates (collectively “Vetiva”) may have financial or beneficial interest in securities or related investments discussed in this report, potentially giving rise to a conflict of interest which could affect the objectivity of this report. Material interests which Vetiva may have in companies or securities discussed in this report are herein disclosed:  Vetiva may own shares of the company/subject covered in this research report.  Vetiva does or may seek to do business with the company/subject of this research report  Vetiva may be or may seek to be a market maker for the company which is the subject of this research report  Vetiva or any of its officers may be or may seek to be a director in the company which is the subject of this research report  Vetiva may be likely recipient of financial or other material benefits from the company/subject of this research report.Nigerian Cement Sector: Unbundling Potentials I January 2011 I 90
    • Nigeria I Building Materials I Equities Disclaimer This research report is based on public information which the research analyst(s) consider credible and reliable. Facts and views presented in this material have not been reviewed by, and may not reflect information known to, professionals in other business areas of Vetiva, including the investment banking team, as Vetiva has established information barriers between its Research team and certain business groups. Whilst reasonable care has been taken in preparing this document, no responsibility or liability is accepted either by Vetiva, its officers or any of its employees for any error of fact or opinion expressed herein. No reliance should be placed on the accuracy, fairness or completeness of the information contained in this report as it has not been verified by the research analyst(s) involved or the companies whose securities have been referred to except as otherwise disclosed. Neither Vetiva nor any of its officers or employees including the research analyst (s) warrant or represent the accuracy or completeness of information set out in this report. Any ratings, forecasts, estimates and opinions set forth in this report constitute the analyst(s) position as at the date of this report and may not necessarily be so after the report date as they are subject to change without notice. It is also instructive to note that a company‟s past performance is not necessarily indicative of its future performance as estimates are based on assumptions that may or may not be realized. The value, price or income from investments mentioned in this report may fall as well as rise due to economic conditions, industry cycles, market indices, operational or financial conditions of companies or other factors. Thus, Vetiva and its officers and employees shall not accept liability for any loss arising from the use of this report or its contents in making investment decisions or recommendations. This report provides general information only. It is not intended to provide personal investment advice and does not take into account the specific investment objectives, financial situation and the particular needs of any specific person. Investments discussed in this report may not be suitable for all investors and the reader(s) should independently determine their suitability and evaluate the investment risks associated with such investments. All investors are solely responsible for their investment decisions. Any decision to purchase or subscribe for securities in any offering must be based solely on existing public information on such security or the information in the prospectus or other offering document issued in connection with such offering, and not on this report. Vetiva, through business units other than Vetiva Research, may have issued and may in the future issue trading ideas or recommendations that are inconsistent with, and reach different conclusions from, the information presented in this report. Such ideas or recommendations reflect the different time frames, assumptions, views and analytical methods of the persons who prepared them, and Vetiva is under no obligation to ensure that such other trading ideas or recommendations are brought to the attention of any recipient of this report. To the extent this report discusses any legal proceeding or issue, it has not been prepared as nor is it intended to express any legal conclusion, opinion or advice. Information relating to the tax status of companies whose securities are discussed in this report is not intended to provide tax advice or to be used by anyone to provide tax advice. By accepting this research report, you agree to be bound by the foregoing limitations. Vetiva Capital Management Limited is registered with the Securities & Exchange Commission to conduct Financial Advisory, Fund/Portfolio Management, and Trusteeship business in Nigeria. This document is for information purposes only and for private circulation. No portion of this document may be reprinted, sold or redistributed without the written consent of Vetiva Capital Management Limited. Vetiva research report is disseminated and available primarily electronically, and, in some cases, in printed form. Additional information on recommended securities/instruments is available on request. © 2010 Vetiva Capital Management Limited. All rights reservedNigerian Cement Sector: Unbundling Potentials I January 2011 I 91