When Africa’s richest man, Aliko Dangote, announced a 40% price cut on bags of Dangote Cement last week, Nigerian consumers rejoiced.
The stock market’s reaction, on the other hand, was decidedly less enthusiastic. Shares of the company have plunged nearly 19% since the news broke.
So, will the stock weigh down a portfolio’s performance going forward or does it have a solid foundation for market-beating gains? Let’s take a closer look.
Digging into Dangote Cement
There’s no disputing it. A 40% price cut will take a big toll on profitability.
But it’s important to keep in mind that Dangote Cement (DANGCEM) boasts a 63% share of Nigeria’s cement market. Thus, because cement is essentially a commodity, Dangote’s competitors have little choice but to cut their prices, too. In fact, one has already announced that it will do so.
The competition, however, is ill-prepared for a price war.
Over the past few years, Dangote has invested heavily in efficiency improvements that allow it to produce and distribute cement cheaply. The kilns at its two largest plants are now fueled primarily by natural gas, which is five to seven times cheaper than the more commonly used fuel oil. And an extensive network of cement depots and a huge fleet of trucks allow for deliveries direct to the customer, cutting out the middle man.
The table below shows the net profit margin of Dangote and its listed competitors over the first three quarters of 2014.
[table id=203 /]
So, with an average net margin of 19.7%, Dangote’s largest competitors can’t cut prices by 40% and remain profitable. They will be compelled to find ways to lower their cost of production or else cede their share of the market, giving a virtual monopoly to Dangote.
Meanwhile, Dangote is rapidly widening its geographic reach. By the end of the year it will complete construction on new cement plants in Nigeria, Senegal, Sierra Leone, Cameroon, Zambia, South Africa, and Ethiopia. The new facilities will double its production capacity to 40 million tons. And CEO Devakumar Edwin says additional expansion will increase this figure to 60 million tons by mid-2016.
Moreover, in spite of its huge capital investments, the company still generates gobs of free cash flow, helping to keep finance costs low.
But What’s It Worth?
Dangote shares currently trade at a price/book ratio of 5.1. That’s nearly the lowest level its ever traded at in its history as a public company. Meanwhile, one of its largest pan-African rivals, PPC Limited (PPC), enjoys a price/book multiple of 9.7 in spite of being far less profitable.
Over the past four years, Dangote has grown its book value at an average rate of 20.9% without any injections of additional capital. If the company manages to bring the additional production capacity on line as it plans, then I am reasonably confident that it will maintain this pace over the next five years.
If we assume that
- net asset value grows at a rate of 20.9% over five years,
- the shares continue to trade at a price/book ratio of 5.1 five years from now,
- and that management freezes its dividend at 7.00 naira per share,
then investors at today’s price of N169.74 would realize a an annualized return of 22.8% between now and late 2019. Of course, if the multiple expands and the dividend rises, a much juicier return is possible.
So, at today’s price, I believe the stock makes for a rock solid addition to Africa investors’ portfolios.
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What Do You Think?
Will Dangote’s price cut ultimately lead to higher profits? Do you think the shares are attractively priced? Let’s hear your thoughts in the comments!