Dangote Cement: Bigger, Stronger, Riskier

BMI View: We are expecting the rise of Dangote Cement to be one outstanding feature of a strong performing Nigerian construction sector over 2013. An announcement that the firm is looking to diversify beyond the Sub-Saharan African market into Iraq and Myanmar (amongst other emerging markets, suggests that the firm is looking to enhance its global reputation before its proposed London IPO, which we currently expect to occur in mid-2013. We have previously identified the countries targeted as potential outperformers in the cement sector over the coming years, yet also note that investments will only serve to increase the risks inherent in Dangote's stock. Indeed, although Dangote Cement's Q312 performance suggests an ongoing profitability in the company's core operations, we continue to outline a number of risks which weigh to the downside to our generally optimistic outlook.

Long-Term Potential
Dangote's Planned Expansion - BMI's Cement Forecast - Consumption Growth (%, y-o-y)

Following a process of expansion which has seen Dangote's total output capacity rise to 20 million tonnes per anum (mpta) over the course of the year, CEO Aliko Dangote told the Financial Times that the firm were hoping to begin production in Iraq and Myanmar by as early as 2013, with plants also being considered in Indonesia, Brazil and Chile. On top of this, by 2015, the company plans to raise output to 46.3mtpa across Sub-Sahara Africa, with 32 mtpa coming from Nigeria alone. In other remarks, Dangote has suggested that the intended figure stands at up to 60mtpa. This intensification of Dangote ' s aggressive expansion campaign will, if coming to fruition, launch the firm as a truly global player.

The ambitious remarks come at a time where the firm is gearing up for a float on the London Stock Exchange. According to the latest sentiment, we believe that the deal will go ahead and an IPO should be offered over the course of 2013 with the firm looking to offload a 20% stake. As the current market cap stands at over US$13bn, the sale could rise in the region of US $ 2.6bn - Aliko Dangote has stated that the majority of the funds will be used to pay off investors, making it appear ever more likely that an extra-African expansion will be financed without recourse to private equity.

Today: Cameroon, Tomorrow: The World
Dangote Cement - Cement Plants

A Global, Nigerian Player?

Although Dangote ' s growth is firmly rooted in a surge in demand for cement in Nigeria, we believe that the firm will be well placed to capitalise on a boom in Myanmar if it can gain first mover advantage in the hastily liberalising state. As we wrote in October, Myanmar's reliance on imported cement and the potential for growth driven by demand for mining-related infrastructure projects could generate significant rewards for foreign players prepared to brave the political and industry-specific risks (see our online service, October 5, 'Building Materials - Robust Asian Demand, Despite China Slowdown').

Indonesian manufacturer Semen Gresik's announcement in March 2012 that it is in talks with Myanmar's foreign investment body over plans to build a 1.5mn to 2.5mn tonnes/year cement plant in the country is a significant outlier in an industry in which many still fear the repercussions of investing whilst uncertainty and risk remains high in the nascent construction industry ( see our online service, March 20, 'Semen Gresik's Seeks Frontier Foothold'). The company recently announced that it has allocated US$200mn for the project, slated to begin in 2014. Dangote's other competitors will likely hail from East Asia and India - with Thailand's LVT currently mulling a move, and established players such as Chinese major Anhui Conch likely to provide strong competition - especially after 2013 when we expect the Chinese cement industry to lapse.

We expect cement consumption in Indonesia to grow by an average of 6.2% y-o-y between 2012 and 2016, but note that the robust outlook for infrastructure investment over the coming years, combined with ongoing improvements in the business environment creates upside risks. Through passing a much-delayed land bill at the end of 2011 ( see our online service, December 16 2011, 'Land Acquisition Bill A Big First Step') Indonesia took a major step towards removing a long-term obstacle to investment in the sector.

Because of this potential, Dangote is not the only firm with its eye on the Indonesian market. In July 2011, Siam Cement announced plans to spend US$219mn on developing its ceramic and construction material businesses in Indonesia, whilst Anhui is reportedly planning to build plants in South Kalimantan, East Kalimantan and Papua - investing in a new capacity of 10mtpa. In August 2012, Mexico's Cemex announced that it was raising the cement production capacity of its APO plant in the Philippines by 1.5mtpa.

We have long been bullish on Iraq's cement market, yet once again note that Dangote will face significant risks - especially in light of a recent downturn in the country's security situation. Iraqi demand for building materials will be premised in extensive reconstruction efforts teemed with many planned large-scale infrastructure builds. However, the risks presented by increasing sectarianism continue to weigh on our forecast ( see our online service, August 30, 'Reconstruction Underway In Worsening Conditions'). Competition will come from UCC & BCC (Lafarge Cement Iraq), who operate a 2.5 mtpa cement plant in Bazian and a 2.3 mtpa cement plant in Tasluja.

Steady Performance Highlights Mixed Picture
Share Price Performance (% Appreciation) - Dangote Cement vs Nigerian Stock Exchange (Rebased November 2011) (LHS) / Dangote Cement vs Lafarge WAPCO & Julius Berger Cement (Rebased November 2010)

Strong Foundations

2012's expansion strategy has seen Dangote take more than a 70% share of the total Nigerian cement market. This dominance is evidenced by the firm's spending power - Dangote fund a huge percentage of the infrastructure it needs to get its output to markets. A lack of regional competition due to the protection afforded by financial and regulatory barriers to entry within Nigeria and problems of scale afforded to potential competitors (compounded by the relative stagnation of South African firms), should see Dangote consolidate this position in the medium term.

Indeed, showing the firm's position of strength within Nigeria, Q312 results revealed a nine-month increase in revenues of 19.8%, with profit after tax rising 15%. The firm also showed that it has stopped the import of cement, being entirely self-sufficient in domestic sales - further showing the success of output expansion.

However, we have often highlighted the domestic risks threatening the firm. Due to the consistently high price of cement inputs afforded to Nigerian producers, Goodluck Jonathan's government have occasionally intervened to enforce lower prices by fiat. Dangote's position of strength in a relatively uncompetitive market mean that loses flowing from these policies have been easily absorbed. However, if prices continue to stick regardless of increasing cement production, long-term political risks would be a change in government policy from protectionism to greater market liberalisation or, conversely, greater and more intrusive schemes to set the price of cement.

As well as the plants mentioned above, the firm has contracted to build in eight further Sub-Saharan African countries. However, we believe expansion will not prove as lucrative or as straightforward to Dangote has predicted. Indeed, the continued high price of cement despite the huge increase in output within the Nigerian market posits a major question mark over the firm's competitive strength and raises questions over the viability of expansion in an environment in which infrastructural issues abound.

The high costs of transacting in Africa caused by a dearth of infrastructure and relatively pricey mineral and labour inputs are a constant squeeze on profit margins: the radius within which a standard cement plant is competitive is 300km and this problem is particularly compounded by SSA's underdeveloped road and energy infrastructure. Dangote's ventures may also be threatened by political risk. The company's plan to construct a US$109m plant in Cameroon was put on hold due to arguments over government land regulations, yet has since been restarted.

Another risk - albeit less direct - is that a Chinese slowdown may impact upon resource-dependent African economies that are exposed to external demand fluctuations for raw materials. This, in turn, may impact upon investment in infrastructure and demand for cement. This is especially true of Zambia - a country heavily reliant upon Chinese demand for copper and the recipient of a new US$400m Dangote plant. It is our view that the unpredictable business environment of SSA will continue to afford such downside risks for the foreseeable future, providing a potential curb on Dangote's ambitions to regional dominance.

Credibility Key Before IPO

In the Lagos exchange, a high market cap (almost US$13bn) yet consistently low 12-month revenues debate the valuation of the firm. For the same market cap, one could buy an established global cement firm with multiple times Dangote's sales, far higher output capacity and greater infrastructural linkages. In terms of the simple price/earnings ratio, Dangote does not perform.

However, as suggested, this valuation is contingent upon Dangote's indisputable position as leader in a market with huge potential for growth. Adding to this is the attraction of the firm's margins. Dangote have consistently posted hefty quarterly operating margins of around 50% net profit - more than twice that of the second most profitable cement firm in SSA in 2011 ( Lafarge Zambia.) As the table below shows, the firm are increasing profit margins year-on-year, in a market which offers producers relatively low returns on costs. Indeed, last year Dangote proved that they could increase revenues in line with 2011's rising cost of sales that were caused by the spike in energy prices, passing on the marginal profit to investors.

With scale advantages over competitors boosting profitability and the absence of regulation that will diminish profits, there is no reason to believe that this trend will be significantly bucked. Furthermore, company data would appear to show a very respectable debt-to-equity ratio. We do note that borrowing has increased dramatically over the past year to enable the company to finance its strategy, yet we feel that this is a promising sign and proves that Dangote is has credit market sentiment on its side. The next yardstick will be 2013's proposed London IPO.

Leading Nigerian Building Materials Firms By Market Capitalisation
Company Market Cap (US$) P/E Ratio Revenue T12M
Source: Bloomberg, BMI
DANGOTE CEMENT 13.1bn 16.26 1.5bn
LAFARGE CEMENT W 1.1bn 19.81 4bn
ASHAKA CEMENT 260mn 11.37 133.4mn
JULIUS BERGER 226mn 7.24 1.9bn
This article is tagged to:
Sector: Infrastructure
Geography: Nigeria

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