Kestrel Capital (East Africa) Ltd Member of the Nairobi Stock Exchange
Cement Sector Initiation of Coverage
Digging for Profits! 16 January 2009 EQUITY RESEARCH Industry Recommendation: HOLD Cement Sector Investment Summary
We recommend a SHORT TERM HOLD and a LONG TERM LIGHTEN
on the Kenya Cement Industry. This view is backed by relatively strong
demand over the medium term followed by excess capacity in 2011 with
the emergence of new players and expansion by existing players. The
sector is trading at an FY08E PER of 15.0% and dividend yield of 1.5%.
We forecast a 3 year CAGR in EPS for the sector of 14.9%.
In Kenya, demand, currently at 3.2m tonnes, has grown at a CAGR of 12.9% over a five year period to 2008. We expect regional demand
(Eastern Africa) to grow at 18.3% if infrastructure investments are sustained and economic momentum quickly returns to pre 2008 growth trend. Since Kenya is a key exporter of cement in the Eastern Africa region, this is a fair indicator of future uptake for cement in the medium term. We note that Kenya exported 0.5m tonnes of cement in 2007. We estimate that current sector utilization of capacity stands at 90.5%, offering minimal room for upside unless new capacity is added. Key sector concerns include the escalating cost of energy. Energy is
estimated to constitute approximately 40% of all production costs and has risen significantly over the last few years. Since the electricity tariffs were hiked up by 20% on average in June 2008, the situation has further been exacerbated. Companies are partially mitigating against this by using alternative sources of fuel (bio fuel and coal). We expect operating margins to be constrained in FY2008E as a result of high energy costs. While cement consumption per capita in Kenya (at 52 kg) is relatively low, we do not foresee substantial upside in the near term. This can be
attributed to cement being classified as a consumer product, sold mainly by the bag in Kenya, rather than in bulk to large users. An economic slowdown in Kenya and reduced disposable income will most likely have a negative impact on short term cement consumption and the industry. With high operating leverage, profitability growth is likely to come under pressure in an adverse trading environment. Analyst In particular, we are concerned about the risk of imported cement, especially if the ongoing global slow down persists. The further lowering Eric Kimanthi of import duty for cement into the East African region is also expected to [email protected] exacerbate the situation. The decrease of import duty on cement in the
2008/9 budget from 40% to 25% is likely to make imported cement more affordable, although still relatively more expensive when compared to locally produced cement. Website: Within the sector, we recommend a LIGHTEN on East Africa Portland www.kestrelcapital.com Cement, an ACCUMULATE on Athi River Mining and a HOLD on Bamburi Cement.
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Kestrel Capital (East Africa) Ltd Member of the Nairobi Stock Exchange
Cement Sector Initiation of Coverage
Sector Key Statistics Key Statistics Bamburi EAPC ARM* Sector (Simple. Sector (mkt cap Average) wtd avg) Price (Kshs) 160 85 91 - - No of shares (m) 363 90 99 - - Market Cap (Kshs m) 58,080 7,650 9,014 - - Market Cap (USD m) 745 98 116 - - Free Float % 41.4 6.0 40.4 - -
EPS (Kshs) 2007 9.91 5.96 4.26 - - 2008E 10.93 -1.40 5.20 - - 2009F 11.36 14.74 6.06 - - 2010F 13.14 18.00 7.83 - - 1 yr EPS Growth % 10.3 - 22.0 - - 3 yr EPS CAGR % 9.9 44.5 22.4 - -
DPS (Kshs) 2007 6.00 - 1.25 - - 2008E 6.62 - 1.52 - - 2009F 6.88 6.00 1.78 - - 2010F 7.96 7.28 2.29 - - 1 yr DPS Growth % 10.3 - 22.0 - - 3 yr DPS CAGR % 9.9 - 22.4 - -
Relative PERx 2007 20.2 22.0 25.8 22.7 21.0 2008E 14.6 - 17.5 - - 2009F 14.1 8.9 15.0 12.7 13.7 2010F 12.2 7.3 11.6 10.4 11.6
P/NAVx 2007 5.1 2.9 6.3 4.8 5.0 2008E 3.4 3.0 4.0 3.5 3.4 2009F 3.1 2.3 3.3 2.9 3.0 2010F 2.8 1.9 2.7 2.5 2.7
Div. Yield % 2007 1.1 - 1.1 0.8 1.0 2008E 1.7 - 1.7 1.1 1.5 2009F 2.0 7.1 2.0 3.7 2.5 2010F 2.5 8.6 2.5 4.5 3.1 *ARM ratios include cement and non-cement divisions
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Kestrel Capital (East Africa) Ltd Member of the Nairobi Stock Exchange
Cement Sector Initiation of Coverage
Relative Valuations Key Statistics Bamburi EAPC ARM* Sector (Simple. Sector (mkt cap Average) wtd avg) EV/EBIT (x) 13.4 7.7 16.3 12.5 13.1 2007 9.2 4.5 14.5 9.4 9.3 2008E 9.0 3.4 17.8 10.0 9.4 2009F 7.9 2.9 20.0 10.2 8.8 2010F
EV/EBITDA (x) 11.9 5.4 13.1 10.1 11.4 2007 8.1 3.7 11.4 7.7 8.0 2008E 7.9 2.8 12.5 7.8 7.9 2009F 7.1 2.4 12.7 7.4 7.3 2010F
EV/Sales (x) 3.3 1.1 6.0 3.4 3.4 2007 2.3 0.9 5.2 2.8 2.5 2008E 2.3 0.7 5.9 2.9 2.6 2009F 2.1 0.5 5.4 2.7 2.3 2010F
Market Cap/Sales (x) 3.3 1.1 36.3 13.6 7.0 2007 2.4 0.8 30.0 11.1 5.6 2008E 2.4 0.7 24.0 9.0 4.8 2009F 2.1 0.7 15.0 5.9 3.5 2010F
Market Cap/Tonne (Kshs/Tonne) 2007 3,272 10,625 36,320 16,739 8,010 2008E 2,298 5,885 30,047 12,743 6,012 2009F 2,300 5,885 24,037 10,741 5,289 2010F 2,088 5,885 15,023 7,665 4,037 *ARM ratios include cement and non-cement divisions
3
Kestrel Capital (East Africa) Ltd Member of the Nairobi Stock Exchange
Cement Sector Initiation of Coverage
Selected Key Ratios Key Statistics Bamburi EAPC ARM* Sector (Simple. Sector (mkt cap Average) wtd avg) Gross Margin 2007 46.8 32.9 36.0 38.6 44.1 2008E 46.9 36.0 34.5 39.1 44.3 2009F 47.5 36.0 35.5 39.7 44.9 2010F 47.5 36.0 35.5 39.7 44.9
Operating Margin 2007 24.5 13.7 19.7 19.3 22.8 2008E 25.0 19.2 18.9 21.0 23.7 2009F 25.7 19.3 18.2 21.1 24.1 2010F 26.6 18.5 17.6 20.9 24.7
Net Margin 2007 16.3 7.4 10.9 11.5 14.7 2008E 16.3 -1.3 11.0 8.7 13.9 2009F 16.7 12.1 11.4 13.4 15.6 2010F 17.0 13.8 11.2 14.0 15.9
Net Debt to Equity 2007 -1.8 -1.6 0.9 -0.8 -1.5 2008E -13.3 17.0 1.7 1.8 -8.4 2009F -6.5 -9.5 3.0 -4.3 -5.7 2010F 3.1 -23.2 4.7 -5.2 0.6
Debt to Total Capital 2007 -1.5 -0.8 45.9 14.6 4.3 2008E -10.8 8.5 31.5 9.7 -3.7 2009F -5.3 -5.5 75.4 21.6 4.4 2010F 2.4 -14.4 166.2 51.4 20.4
EV/Tonne 2007 3,457 10,538 41,586 18,527 8,780 2008E 2,766 6,394 42,467 17,209 7,925 2009F 2,766 5,502 45,571 17,946 8,208 2010F 2,251 4,759 40,588 15,866 7,131
ROE Margin 2007 26.4 14.1 27.6 22.7 25.3 2008E 25.2 -3.2 25.9 16.0 22.4 2009F 22.8 29.1 24.3 25.4 23.6 2010F 23.9 27.9 25.9 25.9 24.5
ROCE Margin 2007 19.4 6.5 12.4 12.8 17.3 2008E 17.9 -0.9 6.9 8.0 14.6 2009F 16.1 14.4 5.1 11.8 14.6 2010F 16.8 15.3 5.2 12.4 15.2 *ARM ratios include cement and non-cement divisions
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Kestrel Capital (East Africa) Ltd Member of the Nairobi Stock Exchange
Cement Sector Initiation of Coverage
Comparative Ratios for Regional Cement Players Capacity Market Market (tonnes Cap Per Cap Historic Debt/ KENYA m) Ton USD m P/E Div Yield Equity Athi River 220 116 20.6 1.3% 65.3 Bamburi Cement 2,300 365 839 16.7 2.0% 0.0 E A Portland Cement 550 184 101 10.6 2.9% 64.9
TANZANIA Tanga Cement 750 119 89 4.9 10.3% 0.0 Tanzania Portland Cement 670 330 221 9.4 10.3% 0.7
ZIMBABWE Lafarge Zimbabwe 400 431 172 n.m. n.m. 0.0
ZAMBIA Lafarge Zambia 550 513 282 19.9 1.0% 57.7
NIGERIA Ashaka Cement 900 559 499 36.6 3.7% 0.2 Benue Cement 3,000 1,322 1,096 103.0 0.0% 2.4 Lafarge WAPCO 2,170 361 782 9.6 3.9% 32.6
SOUTH AFRICA PPC Cement 6,000 273 1,637 10.6 7.3% 2.9 Source: Exotix
Capacity by Cement and Clinker in Kenya Company Clinker Cement Bamburi Cement 1.0 1.8 EA Portland Cement 0.45 0.65 Athi River Mining 0.25 0.3 Total Industry 1.70 2.75
Source: Kestrel Capital, Various
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Kestrel Capital (East Africa) Ltd Member of the Nairobi Stock Exchange
Cement Sector Initiation of Coverage
Industry Overview
2008
While the Kenyan economy has posted sustained growth over the last
five years, this momentum was threatened by the events of January 2008
following the controversial elections which triggered violent protests. This was followed by sustained cost-push inflation fueled further by the During the post election crisis construction then rising international commodity prices. During the post election projects in Kenya were halted as a result of chaos, products destined for Western Kenya and Uganda had to be the security concerns at the time coupled with moved by armed escort. This extra cost was partially borne by labor scarcity. manufacturers. It resulted in numerous delays of consignments of up to
five days, stifling supply and causing stock-outs in key markets. Despite
these conditions, the resilience of the Kenya market was demonstrated by
Kenya Annual Demand Trend a 29.1% rise in cement consumption for 1H08 to 1.2 million metric tonnes Consumption Capacity compared to the previous period. Production rose 7.6% to 1.3 million 7 metric tonnes over the same period. 6 5 Construction projects in Kenya were halted as a result of the security 4 concerns at the time coupled with labour scarcity. Some companies such 3 as Athi River Mining started exporting cement to neighboring Tanzania 2 from their Mombasa factory; which is just 100 kilometers from the 1 boarder. While transport bottlenecks have improved, challenges still 0 1994 1996 1998 2000 2002 2004 2006 2008E 2010F 2012F remain with the pending entry of more cement players in the Kenyan
Source: East Africa Cement Producers Association market in addition to a lowering of import tariffs on the product.
Demand and Supply Play
While there have been considerable efforts to increase cement capacity,
the East African region still remains in deficit with most countries (except
Kenya) relying on imports to fulfill demand. We however expect this Kenya Monthly Demand and Supply Trend Consumption Production situation to reverse with additional capacity being introduced by various 300,000 players in the region.
250,000 Cement forms concrete which is used for various constructions and is a 200,000 key component of any road or infrastructure development. Clinker is a 150,000 primary product and the most important raw material in the manufacture
100,000 of cement. While considering the entire cement capacity in the region,
new capacity being brought on stream is expected to reduce under- 50,000 capacity in the region.
0 Jan-05 Jul-05 Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 While cement consumption per capita in Kenya is at 52 Kg, we expect
Source: Kenya National Bureau of Statistics only moderate consumption growth potential through various
construction activities in consumer, industrial and public infrastructure.
6
Kestrel Capital (East Africa) Ltd Member of the Nairobi Stock Exchange
Cement Sector Initiation of Coverage
Concrete Plans or Pipe Dreams? In the past, the demand for cement has outstripped supply, a move that has resulted in a deficit in the East African region. Cement demand
historically has been seen to grow at approximately two times of Gross
Domestic Product growth. This demand has however been constrained
by factors such as contractor capacity for large infrastructural projects. This has had the effect of delaying large projects which are key drivers of cement demand. In Uganda for example, the construction of the USD 800m Bujagali dam has been delayed by over 5 years since the contract was first awarded. As a result, we see demand growth slowing across parts of the construction sector.
Currently, all the three main cement producers are currently operating at almost 90% capacity utilization rates ahead of capacity expansions
planned over the next few years. ARM plans to double capacity from Capacity expansions by various firms are 300,000 tonnes to 600,000 tonnes by September 2009, Bamburi is stepping likely to cause an overcapacity in cement up capacity at its subsidiary, Hima Cement by 470,000 tonnes which production in coming years means that 27% of Kenya volume exported to Uganda will be ploughed back as capacity in Kenya from 2010. EA Portland Cement is also increasing its capacity from 720,000 tonnes to 1.3m tonnes due from
January 2009. National Cement, a new cement factory in Kenya, has also
invested to have 700,000 tonnes of cement and clinker capacity to come
on stream before the end of the year.
In Tanzania, Tanga Cement plans to increase capacity by 500,000 to 1.25m
tonnes due in the 3Q09. Dangote Cement, Nigeria industrial conglomerate and a new entrant into the East African cement market, is
also planning for a 2.0m gas fired cement plant in Tanzania as part of it’s
pan-African strategy to expand across the continent. Below is a table of
existing and planned capacity in East Africa over the next few years:
Existing Planned Total Completion Company Country capacity Capacity Capacity Date Bamburi Cement Kenya 2,200 - 2,200 2010 EAPCC Kenya 720 680 1,400 2009
Athi River Mining Kenya 300 1,800 2,100 2011**
Hima Cement Uganda 480 480 960 2010 Tororo Cement Uganda 700 300 1,000 2010* Existing capacity is expected to more than Mbeya Cement Tanzania 250 - 250 2010* double in five years within East Africa Twiga Cement Tanzania 700 700 1,400 2011* Tanga Cement Tanzania 750 500 1,250 2012* National Cement Kenya - 700 700 2009* Dangote Tanzania - 2,000 2,000 2015* 1,000 1,000 2010* Cemtech Kenya 6,100 8,840 15,740 Source: Various, Kestrel Capital Estimates,*approximate**300,000 tonnes in 2009
7
Kestrel Capital (East Africa) Ltd Member of the Nairobi Stock Exchange
Cement Sector Initiation of Coverage
Looming Overcapacity or Pent-up demand? Whereas we expect overcapacity within four years, we highlight the
reasons below for a different scenario:
The lead time for getting new plants on stream is about 3 years, and
some of the planned capacity expansions may be shelved due to lack of funding or contractor capacity. The underdeveloped mortgage market indicates that demand for new housing construction, although relatively high, is likely to accelerate
in coming years as a result of rising disposable incomes and
improved access to credit which would have more people moving to
better and larger housing. Dilapidated infrastructure across the East African region coupled with strained facilities such as roads is expected to be a basis for expansions in years to come. Improved governance is also
encouraging greater participation of international organizations to
fund new projects as well as reconstructions in war torn regions such
as Southern Sudan.
Most of the new entrants are setting up grinding capacity rather than clinker capacity. While imported clinker is more expensive than
locally produced clinker, we expect grinding plants to be less
profitable compared to fully integrated plants with their own clinker
capacity. EA Portland and Bamburi still rely wholly or partially on
imported clinker to supplement their local production. Most of the
other new plants being constructed most likely rely on imported clinker.
Capacity expansions are brought on stream in a phased manner
meaning that initially, the capacity utilization rates may be low when Indicative Retail Prices per 50Kg Bag in Select demand is low; with utilization rates rising as demand increases until Countries additional capacity has been fully utilized. Country Price (USD) Kenya 9.30 Demand for cement is strong in the region with little supply expected
Sudan 16.00 from low cost producers in the region such as Egypt. Regional Uganda 14.80 South Africa 6.20 demand from neighboring countries such as Uganda and Sudan is Nigeria 15.30 expected to continue. Demand side drivers are in favor, with large Tanzania 12.00 infrastructure projects on facilities such as airports, roads and India 5.50 buildings expected to keep on growing in the medium term. Source: Various, Kestrel Capital Estimates Retail prices in Kenya compare favorably with other countries. The
side bar shows a table with indicative prices across the continent and
Kenya has one of the lowest prices per 50 Kg the neighboring countries. As a result, downward pricing pressure in bag of cement in the region Kenya from new capacity could result in higher exports to other
regional markets with higher margins.
8
Kestrel Capital (East Africa) Ltd Member of the Nairobi Stock Exchange
Cement Sector Initiation of Coverage
Factors hindering use of cement Cement has many uses which have contributed to increased cement
consumption per capita especially in other parts of the world. Kenya and Over the last five years, CAGR per capita consumption grew 7.7% while CAGR of the the East African region in general are burdened by the following concerns total demand grew at a pace of 10.2%. which have persistently caused these levels to remain low:
Concrete roads are 40-50% more expensive, although they last up to
50 years with minimal maintenance. Bituminous roads last 10-12
years with an initial cost of about 9% of the cost set aside for maintenance. The high initial cost is usually a deterrent for the Kenya cement consumption per capita trend adoption of concrete roads for developing countries with limited
Kenya Cem ent consum ption per capita (Kg) resources. In addition, contractor capacity is inadequate as concrete 57.00 roads require specialized equipment which is not easily available in 53.00 Kenya and East Africa. Also, concrete roads are considered noisy to 49.00 drive on and the wear and tear on tires is high compared to typical 45.00 bitumen roads. 41.00 Research on new applications of cement is limited. We however note
37.00 that Bamburi Cement is pioneering the development of value added 2002 2003 2004 2005 2006 2007 products which we expect will result in higher margins in the long Source: Kenya National Bureau of Statistics term. Uptake of such products remains low currently but the future remains promising for such initiatives.
As a result of these factors, the cement consumption per capita in East
Africa remains low compared to other countries in the region/world. Below is an indicative table of the trend in per capita consumption of cement for some selected countries:
Country Per Capita GDP Growth 2007 GDP Per Capita Consumption (Kg) (est) (USD) Kenya 52 7.0 845 Uganda 33 8.9 363 Tanzania 39 7.1 415 South Africa 250 5.1 5.906
Mauritius 80 5.6 11,900 Egypt 380 7.2 1,739
Nigeria 75 6.3 1,159 Ghana 91 6.3 676 Source: Industry data 2006, International Monetary Fund, Kestrel Capital Estimates
9
Kestrel Capital (East Africa) Ltd Member of the Nairobi Stock Exchange
Cement Sector Initiation of Coverage
Energy and Cement Production Energy costs in cement production on average constitute 38.5% of total
costs. This makes this cost element a key focus for most of the producers.
The reliability upon electricity power in most East African countries is
generally not guaranteed and cement producers are forced in some circumstances to use expensive thermal power. In addition, electricity cost tariffs have been increasing, resulting in an increase of between 15- 20% on the electricity bill. The pass through cost in energy bills of fuel is Indicative Efficiency Table a factor of crude oil prices. Generally, the extra costs were passed to Net Margin % Gross margin % 50% consumers through higher retail prices which are estimated to have risen
45% about 12%. This situation is expected to reverse in the coming months 40% 35% with lower crude oil prices. 30%
25% Energy as a percentage of production cost 20% 15% Year Bamburi EAPCC* ARM Average Weighted 10% Average 5% 2006 47.9% - - 0% 2007 33.9% 44.6% 37.0% 38.5% 35.4% Bamburi ARM EAPCC Source: Company Reports, Kestrel Capital estimates, 2008E 37.80% 42.30% 39.00% 39.7% 38.4% ARM includes non cement products Source: Various, Kestrel Capital estimates Notes on above Estimates: • Bamburi is increasingly using bio-fuels as energy sources • EAPCC is switching to coal use from electricity • ARM produces high value products such as Lime and sodium Silicate
Some producers such as Bamburi are switching partially to bio-fuels for secondary processes. Bio-fuels are playing an important part, with these being cheaper by a factor of 1:8 compared to electricity whose rates
peaked over the last few months, as per management guidance. Bio fuels
are however not widely available and Bamburi is developing its own
sources through growing of tree plantations. As per management, Bamburi has managed to use 28% of its secondary energy requirements from bio-fuels in 2007 with a further increase expected in coming years.
ARM and EAPCC are stepping up the use of coal as an alternative source of power. Despite coal being relatively cheaper than electricity, it is environmentally detrimental and a key source of carbon emissions. Nevertheless, coal remains an attractive source of power as its prices has not risen as much as crude oil. In addition, ARM strategy to have a coal
powered energy plant near its clinker plant is expected to result in
improved efficiency through cheap raw material, coal ash, used in the
cement binding process.
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Kestrel Capital (East Africa) Ltd Member of the Nairobi Stock Exchange
Cement Sector Initiation of Coverage
Installation of fuel efficient machinery e.g. in cooling is expected to result in energy cost savings. These gains are particularly expected to be most noticeable in EAPCC earnings from 2009. Low energy costs are a key
driver for the low production costs in cement exporting countries. We
note however that natural barriers to entry of imported cement include long distances, mountainous terrain coupled with poor transport infrastructure in the region. High electricity tariffs as well as increased use of imported clinker (which is more expensive) make locally produced
cement generally more expensive compared to imports.
Strategic position of Lafarge in Kenya’s cement market
Lafarge holds stakes in the three main cement industry players in Kenya
directly and indirectly as follows:
Company % Holding (2008) . Bamburi Cement 58.6 East African Portland Cement 41.7 Athi River Mining 14.1 Source: Company Reports
Lafarge acquired a 41.7% stake in East Africa Portland cement after it
acquired UK cement firm, Blue Circle Industries, in 2001 which had a
stake in the company. Part of the stake, 12.5%, is held indirectly by
Bamburi which is a Lafarge subsidiary. The ARM stake was acquired
when ARM issued a 5% unsecured convertible bond to Bamburi in the
year 2000, whose proceeds were used to reduce interest on existing
borrowings at the time.
It should however be noted that the government remains with an
unprecedented say in the running of East African Portland Cement
Company; being government controlled. In Athi River Mining, Bamburi
only holds a minority stake.
11
Kestrel Capital (East Africa) Ltd Member of the Nairobi Stock Exchange
Cement Sector Initiation of Coverage
Company Comparison Summary Bamburi EAPCC ARM* Lowest cost producer in Least efficient but Second most efficient Kenya which means better improving with installation producer with efficiencies Cost Control margins and a strong of new equipment. expected to improve further competitive position with new plants and capacity Has not employed leverage Current additional capacity Is not shy of employing high in the recent past. The does not require additional leverage to opportunities capacity expansion Hima debt as EAPCC had funds presented. Most leveraged Leverage Cement subsidiary will on deposit. Long term Yen with more debt added for the result in some additional denominated loan still construction of planned debt. carried in the books. Tanzania plant. Most respected cement Well respected brand. Is Increasing popularity of its brand in the market recently upping it’s spend cement brand in Kenya. Brand strength in marketing ahead of new Strong brand equity in its capacity coming on-stream. other niche products. Gross margin- 46.9%, Net Gross margin- 36.0%, Net Gross margin- 34.5%, Net Margins margin 16.3% margin -1.3% margin 11.0% Price leader. Lack of pricing power but Lacks significant pricing better placed than ARM. power for cement products Price but likely to improve with planned additional capacity. Corporate Social Exceptional corporate social Adequate corporate social Adequate corporate social Responsibility responsibility responsibility responsibility Multinational structure may Follows government Small and nimble; quick Decision make it less responsive to procurement procedures decision making. making market conditions than which are generally slow smaller competitors and cumbersome. Anchor Lafarge Government Paunrana family Shareholder Diversified within cement Least diversified Diversified into industrial in Kenya and Uganda minerals and other countries Diversification such as Tanzania, South Africa and Zambia Comparatively low FX High FX risk due to Yen Natural hedge for FX exposure in Uganda denominated loan. Yen has exposures although USD Currency Risk appreciated 40% YTD denominated loans could expose the company to exchange risk Source: Kestrel Capital, *ARM includes cement and non-cement divisions 12
Kestrel Capital (East Africa) Ltd Member of the Nairobi Stock Exchange
Cement Sector Initiation of Coverage
Sector SWOT Analysis
Stren gths Weaknesses
• Financial capacity to take advantage of • High cost of power in Kenya makes the country opportunities an expensive production zone compared to other large regional players such as Egypt • Skilled human resources and management capability • A dilapidated infrastructure connecting to key • Abundant source of high quality limestone in Kenya markets in the region increase the cost of moving compared to regional countries makes the country cement to various regional export markets a suitable location for regional cement production
• Robust and growing construction industry provides remarkable credence to the ongoing capacity expansions
Opp ortunities Threats
• Reconstruction activities in war torn countries such • Leverage (for some players) as Sudan, Uganda and the Democratic Republic of • Loss of key personnel
Congo • Growth/expansion strategy may not work as • Ongoing infrastructure projects and those on plan anticipated • Improving economic growth in the region • A global recession which could lead to demand • Economies of scale from the ongoing expansion slow down and subsequently overcapacities in
• Cement deficit region, especially the non cement low cost cement producing countries which could producing regional markets is expected to provide be exported into Kenya thereby eroding market share from expensive local producers upside and justify new capacities being added • Infrastructure projects, ongoing and planned, are • Lowering of cement import duty in the region
expected to sustain the demand for cement can be expected to result in higher competition
• Substantial leverage by some of the cement companies might Source: Kestrel Capital
• Delays or cancellation of certain projects may occur if such projects do not find suitable funding; a situation that may be exacerbated by the ongoing credit crunch.
Source: Kestrel Capital
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Kestrel Capital (East Africa) Ltd Member of the Nairobi Stock Exchange
Bamburi Cement Initiation of Coverage
EQUITY RESEARCH Bamburi Cement Cement Sector Recommendation: HOLD Bamburi Cement 16 January 2009 Investment Summary
The investment case for Bamburi stems from a strong dividend Share Statistics Price (Kshs) 160 payout which stands at 60.6% as well as efficiency improvements, Price Range (12 Months) which have resulted in one of the highest cement sector ROE High (Kshs) 198 Low (Kshs) 160 (currently stands at 26.4%). We however estimate that current Issued shares (m) 363.0 expansion plan capital requirements would result in additional debt Market cap (Kshs b) 58.1 Market cap (USD m) 738.0 for the current dividend payout to be sustained. Year end 31 Dec With a market share of over 60% in Kenya, Bamburi needs to increase Free Float % 41.4 Av daily trdg vol (USD) 19,071 capacity and improve efficiency to sustain its market leadership position. As part of this, Bamburi initiated a USD 100m plant expansion in November 2007 in order to double capacity in its Price Performance Uganda subsidiary by 2010. This investment is likely to result in Absolute % Relative % capacity plough back in Kenya and enhance margins for the group 3 m -14.9 191.9 with better optimization of cost centres such as transport and 6 m -17.9 56.5 12 m -17.1 52.2 logistics. We however hold the view that this alone will be insufficient to maintain market share in view of new entrants. Price Trend Whereas exploratory drilling of quality limestone reserves in Mutomo District, Eastern province of Kenya, has commenced, the NSE 20 Index Bamburi Cement 200 contention over ownership and exploration of the find could drag in 5,400 courts for over two years before any concrete plans are set out for x5,000 190 e capacity expansion in the area. d n4,600 e I c Productivity improvements aimed at increasing margins include the 0 180 ri 24,200 P E cooler installed in 2007 at the Mombasa plant to boost productivity S N3,800 efficiency. We expect a stable CAGR in earnings of about 9.9% over 170 3,400 the next three years from Bamburi and hence recommend a HOLD 3,000 160 for the stock. Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Key Statistics (Year ending 31 Dec) Kshs FY2007 FY2008E FY2009F FY2010F EPS 9.91 10.93 11.36 13.14 ch % Bloomberg| Reuters Code 37.6 10.3 3.9 15.7 DPS 6.00 6.62 6.88 7.96 BMBC KN|BAMB.NR Growth % 9.1 10.3 3.9 15.7 Relative Ratios Analyst PER x 20.2 14.6 14.1 12.2 Div Yield % 3.0 4.1 4.3 5.0 Eric Kimanthi Price to Book x 5.1 3.4 3.1 2.8 [email protected] Return on equity % 26.4 25.2 22.8 23.9 EV/EBIT 13.4 9.2 9.0 7.9 Website: EV/EBITDA 11.9 8.1 7.9 7.1 www.kestrelcapital.com
14
Kestrel Capital (East Africa) Ltd Member of the Nairobi Stock Exchange
Bamburi Cement Initiation of Coverage
Company Overview
Bamburi views East Africa as part of a consolidated market by the parent Other company Lafarge. As a result, expansions and placement of the various Inland 13% plants are located such that they do not cannibalize on the sales of other Offshore 1% Lafarge subsidiaries.
Hima Cement, one of Bamburi’s active subsidiaries (70% stake) based in Uganda, accounts for 31.0% of volume sold and 21.6% of Bamburi’s net
earnings while accounting for 23.8% of assets. With capacity expansions
in Uganda, clinker transfers to Hima from Kenya are expected to end, thereby result to a capacity plough back into Kenya. We expect Mbeya Kenya Uganda 59% Cement, a Lafarge subsidiary based in Tanzania, to be eventually 27% consolidated under the listed Bamburi Cement in the future as part of Source: Company Reports having a cost effective, region wide cement unit by the parent company.
This opinion is partly based on Bamburi extending its marketing region to the south of Tanzania near the Zambian border.
We remain doubtful about Bamburi’s immediate plans to immediately
expand capacity in Kenya. Whereas the Commissioner of Mines and
Geology issued Bamburi with an Exclusive Prospecting License (EPL) for
limestone in Kanziku in March 2007, the 33 year lease which gives land
Uganda subsidiary accounts for 31% of rights over the same area signed by the smaller rival, ARM, makes further volumes sold progress in the area difficult. As the matter is still under litigation, we
have not forecast any increased capacity in Kenya from the venture.
With these delays in mind, it is possible that the market share of Bamburi
will decline Kenya over the next two years to about 51% and thereafter increase with capacity plough back from Uganda.
Alternative Fuels and Carbon Credits
Bamburi remains at the forefront in adoption of alternative fuels and such
efficiency gains can be expected to maintain its market leadership in Carbon emissions by the cement sector energy efficiency, at least, in the coming few years. As per management remain a key concern worldwide for guidance, coffee and rice husks in Uganda constitute 40% of total energy
environmentalists use while renewable energy contributed to a 28% fuel substitution for the
entire group in 2007. This is expected to average between 30-40% in 2008. As concrete is the most consumed substance on earth after water, according to Lafarge, the environmental challenges of its production remain a key concern especially with efforts to reduce carbon emissions being underway.
15
Kestrel Capital (East Africa) Ltd Member of the Nairobi Stock Exchange
Bamburi Cement Initiation of Coverage
Earnings Drivers
We expect capacity enhancement and equipment optimization to be
key drivers of earnings growth for Bamburi over the next three years. We expect new initiatives, in particular capacity plough back to reduce transports costs to Uganda and improve overall group margins.
A higher clinker to cement (CK) ratio through the manufacture of
high value products would enhance overall margins. Using less clinker implies a lower energy charge which lowers the overall cost of production (because the largest cost component is energy in the Location near markets is a key driver for clinker formation process). earnings Reduced costs as well as possible pricing upside are expected to
moderately increase margins and overall profits in the next two
years.
With a net debt to equity ratio of -1.8%, Bamburi has ample potential upside from additional gearing on planned capacity increase and a likely increase in shareholder value especially if interest rates remain
constrained within current ranges.
The key Bamburi plants are located near large markets thus lowering
the transport costs which can account for up to 70% of the landed cost
of cement for imported cement.
We are impressed by the sustainable business model put in place by
Bamburi, especially with regards to protecting the environment and
integrating with the community. Whereas we expect Bamburi Cement to eventually benefit from carbon credits from its use of alternative, less polluting energy
sources, we have not factored this in our projections for earnings
growth.
Whereas the stakes of Bamburi in EAPCC and ARM are held as
strategic investments, a substantial sale or industry wide restructuring could materially impact earnings positively as the investments are currently held at cost in Bamburi’s balance sheet.
Risks
Limestone is a critical component in the manufacture of cement, accounting for about 90 percent of the final product. Transport costs Limestone accounts for about 90% of cement of the raw material therefore influence the location and profitability of a cement factory. Bamburi is currently looking to explore the deposits in Eastern province of Kenya which in the medium term
appear to be in contention. 16
Kestrel Capital (East Africa) Ltd Member of the Nairobi Stock Exchange
Bamburi Cement Initiation of Coverage
High cost of imported clinker could pose a risk to Bamburi’s earnings. In 2006, Bamburi spent Kshs 776m on clinker while in 2007 it spent Kshs 2,516m (although this was largely as a result of a fire Imported clinker is more expensive than which disrupted operations in the Mombasa plant during 2H07). locally produced clinker This risk is partly mitigated by the fact that Lafarge is a major distributor of clinker in the world market. It is noteworthy that Bamburi received compensation for both equipment damaged and
business disruption.
Bamburi lacks significant diversification from the key cement product especially when compared to its smaller mining rival, Athi River Mining. Bamburi is focused in cement where it retains an industry wide competitive advantage.
Large scale operators are traditionally known for buying off smaller
operators rather than developing from scratch. Being a multinational, long lead times in decision making would tend to occur, compared to smaller local competitors.
Strategy
Bamburi plans to increase capacity in Kenya through additional
capacity and capacity plough back through an eventual reduction in
exports to Uganda.
Bio-fuels constituted 20% of total energy consumption in Kenya and
40-50% at the Hima plant in Uganda during 2007. Continued energy
substitution is expected to provide a key platform for minimizing the
energy costs in future as well as reducing the carbon footprint normally associated with the cement industry. Coal fuels 40% of world’s electricity and cement companies are major users of this form
of power which is a key carbon emitter.
Lafarge continues in its strategy to build capacity in fast growing markets such as Africa. This can be evidenced by the recent acquisition of Orascom Cement of Egypt by Lafarge. We expect this focus to trickle in additional capacity across the region in Lafarge
controlled entities such as Bamburi.
As ROE and EPS growth are key factors considered in investment decisions by Bamburi, additional debt taken at current interest rates is likely to improve overall profits, (the ROE is currently at 26.4%).
17
Kestrel Capital (East Africa) Ltd Member of the Nairobi Stock Exchange
Bamburi Cement Initiation of Coverage
Financial Summary (Kshs m) Year ending 31 Dec
Income Statement FY2007 FY2008E % ch FY2009F FY2010F Sales 22,111 24,271 9.8 24,713 28,125 Gross profit 10,343 11,383 10.1 11,739 13,359 Operating profit 5,411 6,067 12.1 6,351 7,474 Finance cost/income 32 (62) -293.2 (111) (256) Profit before tax 5,443 6,005 10.3 6,240 7,219 Taxation (1,633) (1,802) 10.3 (1,872) (2,166) Profit after tax 3,810 4,204 10.3 4,368 5,053 Minority interest (214) (236) 10.3 (245) (284) Attributable income 3,596 3,968 10.3 4,123 4,769 Dividends 2,178 2,403 10.3 2,497 2,888 Retained earnings 1,418 1,565 10.3 1,626 1,881
Balance Sheet FY2007 FY2008E % ch FY2009E FY2010E Fixed assets 9,030 12,030 33.2 15,030 19,030 Other non-current assets 4,601 4,601 - 4,601 4,601 Current assets 7,089 10,779 52.1 9,332 10,446 Total Assets 20,720 27,410 32.3 28,963 34,077
Shareholders equity 15,075 18,317 21.5 20,245 22,644 Non current liabilities 2,422 2,922 20.6 2,922 4,922 Current liabilities 3,223 6,171 91.5 5,796 6,511 Total equity and liabilities 20,720 27,410 32.3 28,963 34,077
Cash flow Statement FY2007 FY2008E % ch FY2009E FY2010E Cash generated by operations 6,123 6,915 12.9 7,199 8,322 Working capital (4,149) 1,793 (143.2) 7 (280) Operating Cash Flow 1,974 8,708 341.1 7,206 8,041 Net interest received/(paid) 52 (62) (218.9) (111) (256) Cash taxes (1,680) (1,802) 7.2 (1,872) (2,166) Net cashflow before investing 346 6,844 1,878.1 5,222 5,620 Net cash invested (1,237) (3,847) 211.0 (3,847) (4,847) Free cash flow (891) 2,997 (436.4) 1,375 772 Net financing cash flow (2,577) (643) (75.0) (2,441) (654) Net cash flow for the year (1,798) 2,354 (230.9) (1,066) 119 Opening cash balance 2,057 441 (78.6) 2,795 1,729
Closing cash balance 441 2,795 533.7 1,729 1,848
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Kestrel Capital (East Africa) Ltd Member of the Nairobi Stock Exchange
East African Portland Cement Initiation of Coverage
EQUITY RESEARCH East Africa Portland Cement Company Cement Sector Recommendation: LIGHTEN East Africa Portland Cement Company 16 January 2009 Investment Summary
EAPCC has had a very turbulent five years and has been generally Share Statistics Price (Kshs) 85 playing catch up with competitors. Initiatives it is carrying out now Price Range (12 Months) have been executed by competitors three to five years earlier. In High (Kshs) 140 Low (Kshs) 68 particular, a Yen denominated loan has made its earnings over the Issued shares (m) 90.0 years very volatile. The Yen has appreciated 51.8% against the KES Market cap (Kshs b) 7.7 Market cap (USD m) 99.0 this year, which does not bode well for FY09E profits. Year end 30 Jun With a planned capacity increase in milling capacity from 720,000 to Free Float % 6.0 Av daily trdg vol (USD) 357 1.3m tonnes by December 2008 at a cost of Kshs 1.8 billion and the adoption of a coal mill at the plant to reduce energy costs, we expect EAPCC to enjoy solid growth from 2008/09 financial year. These Price Performance earnings will however be tempered by a strengthening Yen which is Absolute % Relative % expected to result in a substantial forex loss, eroding operating 3 m -16.7 214.7 6 m -26.1 82.0 profitability. 12 m -38.4 117.2 Funding for the expansion project is expected to come from internally generated funds and we therefore expect leverage ratios to be little Price Trend changed. The switch to cheaper coal, as a source of fuel compared to thermal is NSE 20 Index EA Portland expected to drive margins up to levels more comparable to industry 5,400 145 peers. In addition, this switch is expected to save the company 30% x5,000 e 125 of its energy cost. d e n4,600 c I ri We advocate for further privatization in the government controlled 0 P 24,200 105 cement miller to make the counter more liquid and subsequently E S N3,800 more investable by investors. The free float in the counter is 85 3,400 currently at 6.0%.
3,000 65 Key Statistics (Year ending 30 June) Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Kshs FY2007 FY2008E FY2009F FY2010F EPS 5.96 (1.40) 14.74 17.89 ch % -29.0 -123.4 -1155.0 21.4 DPS - - 6.00 7.28 Bloomberg| Reuters Code Growth % - -! - 21.4 EAPC KN|EAPC.NR Relative Ratios PER x 22.0 - 8.9 7.3 Analyst Div Yield % - - 7.1 8.6 Price to Book x 2.9 3.0 2.3 1.9 Eric Kimanthi Return on equity % 14.1 -3.2 29.1 27.9 [email protected] EV/EBIT 7.7 4.5 3.4 2.9 EV/EBITDA 5.4 3.7 2.8 2.4 Website: www.kestrelcapital.com
19
Kestrel Capital (East Africa) Ltd Member of the Nairobi Stock Exchange
East African Portland Cement Initiation of Coverage
Company Overview
EAPCC is effectively government controlled through a direct government
stake and indirectly through the National Social Security Fund. The plant
has a capacity of 1.3m tonnes located in Athi River, near Nairobi. It
depends largely on purchased clinker as it does not have adequate capacity of its own. Below is a chart indicating the list of key shareholders:
EAPCC has a free float of 6.0%
Source: Company Reports
The shareholding structure above appears to have made EAPCC
relatively closed. The management has remained relatively unstable with
the company having changed the managing director five times in the last
six years.
Earnings drivers
EAPCC has a Yen denominated loan for Kshs 2.6 billion repayable in
yearly installments to March 2020. Whereas this loan continues to induce
volatility in earnings, future pay down of the loan is projected to reduce
the overall risk exposure as the loan becomes smaller and smaller in
proportion to the profits. We expect that the recent depreciation of the
Kenya shilling will impact the profits negatively in the near term with the
company being required to write down exchange losses on the value of
the loan from the income statement (but with an eventual deferred tax EAPCC is raising capacity from 720,000 to benefit). 1.3m tonnes by January 2009
20
Kestrel Capital (East Africa) Ltd Member of the Nairobi Stock Exchange
East African Portland Cement Initiation of Coverage
In addition, recent capacity expansions from 720,000 to 1.3m tonnes by January 2009 are expected to result in higher revenues and profitability. This capacity will come on stream much earlier than the other players
and thus we see EAPCC receiving a significant boost in sales for the 2009
year, with full benefits being expected in the 2009/10 financial year.
Risks and Strategies
EAPCC has lacked stable management over the past six years with EAPCC has changed the managing director the managing director being changed five times thus impacting the five times in the past six years strategic direction and policy consistency. This has largely been spurred by government control which now appears to be subsiding.
EAPCC announced long-term plans to shift its energy source from electricity to coal in order to cut down power bills and operation costs. Whereas electricity consumed between 45 and 50 per cent of the company’s total input costs, using coal to drive the equipment
would reduce the energy cost by at least 30% in coming years. Having a Yen denominated loan has led to volatility in earnings as a result of foreign exchange risk. The last few years have seen a strengthening of the Kenya Shilling against most currencies (which
has resulted to exchange gains for EAPCC). This scenario however
reversed for the FY2007 earnings announcements which resulted to an exchange loss of Kshs 414m. Whereas the company has an inefficient production process, steps are
being made to improve it with the installation of more modern and
efficient equipment and machinery. This is expected to bring its manufacturing technology in line with its peers. Reducing costs of production is expected to improve operating efficiencies and result to
more robust earnings growth.
A new mill being installed will come on stream almost a year ahead of ARM new capacity and two years ahead of Bamburi’s capacity plough back project. This mill will increase the company’s annual cement milling capacity from the current 720,000 metric tonnes to
about 1.4 million metric tonnes is expected to provide good return before any substantial slowdown in cement sales growth that could result from additional capacity being brought on stream by competitors.
21
Kestrel Capital (East Africa) Ltd Member of the Nairobi Stock Exchange
East African Portland Cement Initiation of Coverage
The Yen has appreciated 51.8% against the KES this year, which does not bode well for FY09E profits for EAPCC. The strengthening of the Forex gain/ (Loss) Yen has been as a result of unwinding of carry trade transactions by Exchange Gain/(Loss) traders which involved borrowing from Japan and lending out to 500 more expensive destinations across the world. Below is a table which ‐ FY05 FY06 FY07 FY08 FY09E FY10E FY11E indicates historical and estimated exchange gains/losses by the (500) n io company from the Yen denominated loans held in its books. il m(1,000) s sh K (1,500) FY2006 FY2007 FY2008 Now Exchange Rate (KES/YEN) 64.46 53.92 61.08 84.90 (2,000) KES % loss/(Gain) -6.7% -16.3% 13.3% 39.0% Source: Company Reports, Kestrel Capital estimates (2,500) Source: Company Reports, Kestrel Capital estimates
22
Kestrel Capital (East Africa) Ltd Member of the Nairobi Stock Exchange
East African Portland Cement Initiation of Coverage
Financial Summary (Kshs m) Year ending 30 Jun Income Statement FY2007 FY2008E % ch FY2009F FY2010F Sales 6,403 7,204 12.5 9,684 10,927 Gross profit 1,735 2,371 36.7 3,486 3,934 Operating profit 750 988 31.9 1,862 2,114 Finance cost/income 355 (404) -213.8 (2,044) (200) Profit before tax 1,105 716 -35.2 (181) 1,914 Taxation (348) (179) -48.6 56 (587) Profit after tax 756 537 -29.0 (126) 1,326 Minority interest - - - - - Attributable income 756 537 -29.0 (126) 1,326 Dividends 234 - - - 540 Retained earnings 522 537 2.7 (126) 786
Balance Sheet FY2007 FY2008E % ch FY2009E FY2010E Fixed assets 5,678 6,305 11.0 6,305 6,305 Other non-current assets 90 107 18.3 107 107 Current assets 3,170 2,662 -16.0 2,414 3,837 Total Assets 8,939 9,073 1.5 8,826 10,248
Shareholders equity 3,607 4,027 11.6 3,901 5,227 Non current liabilities 3,896 3,870 -0.7 3,870 3,870 Current liabilities 1,435 1,176 -18.0 1,054 1,151 Total equity and liabilities 8,939 9,073 1.5 8,826 10,248
Cash flow Statement FY2007 FY2008E % ch FY2009E FY2010E Cash generated by operations 962 1,404 45.9 247 2,331 Working capital (71) (657) 828.0 (599) (167) Operating Cash Flow 891 871 -2.2 (352) 2,164 Net interest received/(paid) 48 (55) -214.9 (30) (18) Cash taxes (311) (601) 93.4 56 (587) Net cashflow before investing 629 216 -65.7 (326) 1,558 Net cash invested (506) (1,041) 105.7 (399) (399) Free cash flow 123 (826) -772.9 (725) 1,160 Net financing cash flow (456) (365) -19.8 - - Net cash flow for the year (333) (1,191) 257.8 (725) 1,160 Opening cash balance 2,509 2,180 -13.1 989 264
Closing cash balance 2,176 989 -54.6 264 1,424
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Kestrel Capital (East Africa) Ltd Member of the Nairobi Stock Exchange
Athi River Mining Company Update
EQUITY RESEARCH Athi River Mining Cement Sector Athi River Mining Recommendation: ACCUMULATE
16 January 2009 Investment Summary Share Statistics The investment case for ARM presents several catalysts. Aside from Price (Kshs) 93 a healthy demand outlook, the other reasons we view this stock Price Range (12 Months) High (Kshs) 115 positively include a diversified portfolio of products especially with Low (Kshs) 84 regards to Lime and Sodium Silicate, products in which the company Issued shares (m) 99.1 Market cap (Kshs b) 9.2 holds market leadership positions across the region. ARM is also Market cap (USD m) 116.0 increasingly exposed to export markets with such contributions Year end 31 Dec Free Float % 40.4 accounting for 33-35% of the total turnover, and growing. Av daily trdg vol (USD) 30,650 ARM is separated into two distinct divisions; ARM Cement Ltd which concentrates on cement, lime and related products and ARM
Minerals and Chemicals for the manufacture and sale of minerals and Price Performance specialty building and related products. Absolute % Relative % The minerals and chemicals division is a market leader in Kenya and 3 m -2.1 27.1 6 m -17.7 55.7 the regional market, making ARM better placed from pricing 12 m -6.1 18.5 pressure on the cement division.
While fertilizer prices have increased in tandem with international
Price Trend crude oil prices, ARM uses 30% local content to produce it; thereby making better margins than comparable importers. Fertilizer NSE 20 Index Athi River Mining business has the potential to grow into an even larger profit centre 5,400 110 with current government initiatives to reduce the cost of fertilizer 5,000 x e through local production. d4,600 e n 100 ic I r 0 4,200 P Separate additional funding lines are likely to be established to fund 2 E S3,800 90 anticipated capacity expansions. As long as demand keeps going up, N 3,400 we expect ARM to increase the total return to shareholders through 3,000 80 an improved ROE from the current 27.6%. Jan-08 Apr-08 Jul-08 Oct-08 Jan-09
Key Statistics (Year Ending 31 Dec)
Kshs FY2007 FY2008E FY2009F FY2010F Bloomberg| Reuters Code EPS 4.26 5.20 6.06 7.83 ARML KN|ATHI.NR ch % 48.5 22.0 16.5 29.2 DPS 1.25 1.52 1.78 2.29 Growth % 25.0 22.0 16.5 29.2 Analyst Relative Ratios Eric Kimanthi PER x 25.8 17.5 15.0 11.6 Div Yield % 1.1 1.7 2.0 2.5 [email protected] Price to Book x 6.3 4.0 3.3 2.7 Return on equity % 27.6 25.9 24.3 25.9 Website: EV/EBIT 16.3 14.5 17.8 20.0 www.kestrelcapital.com EV/EBITDA 13.1 11.4 12.5 12.7
24
Kestrel Capital (East Africa) Ltd Member of the Nairobi Stock Exchange
Athi River Mining Company Update
Company Overview
Athi River Mining(ARM) Ltd (Holding Company)
ARM Cement Mavuno Wholly owned Subsidiaries (100%) ARM Minerals & Fertilizers ‐Maweni Limestone Company Chemicals(100%) (100%) ‐ARM Tanzania ‐ARM South Africa ‐ARM Zambia
Source: ARM, Kestrel Capital
Segmental Revenue distribution A special resolution during this year’s annual general meeting proposed to change the structure of the company. Initially, the cement division and Fertilizer 10% Cement the minerals and chemicals division were all under one holding Minerals 53% 9% company. The separation of the two entities was aimed at:
Lime 8% Creating strong and focused companies as well as have a clearer understanding of the company’s business Sodium Silicate Enhancing the possibilities of attracting new investment from 20% strategic investors who have industry specific interests
Source: Company Reports, Kestrel Capital Estimates Protect each subsidiary from any volatility in business of others
Assets were separated such that the Kaloleni plant in Mombasa Kenya which manufactures lime and cement would be owned by ARM Cement subsidiary while the plant in Athi River, near Nairobi, which
manufactures industrial minerals, sodium silicate, special cements, and
fertilizers, was allocated to ARM minerals and chemicals subsidiary.
Subsidiaries
In Tanzania, ARM Tanzania has a lime plant at Tanga which serves gold mines, roads, and the sugar sectors. After the close of year in 2007, ARM
Ltd purchased the entire 28% equity held by Cement Distributors Ltd in
the subsidiary thereby making the Tanzania subsidiary entirely owned by
the group.
25
Kestrel Capital (East Africa) Ltd Member of the Nairobi Stock Exchange
Athi River Mining Company Update
ARM formed the Zambian subsidiary with a view to gaining entry into the lucrative copper mining sector. ARM expects to possibly acquire a lime plant in Zambia which would open up further growth into the
market. Lime increases the yield in metals by lowering the acidity
environment which ‘eats up’ the metals being extracted.
The South African subsidiary is involved in Sodium Silicate production with raw materials sourced from Kenya. ARM is also looking to source
raw materials from much nearer locations to the market; with Botswana being a potential source of Soda Ash for use in the South Africa’s Sodium Silicate plant.
Cement
Cement is now the flagship product for ARM, contributing 54% of total revenues for 2007. This increased from the previous 37% in 2006 due to increased capacity utilization of the Kaloleni cement plant which was
commission in September 2006. In 2008, we forecast cement sales at Kshs
2,451 billion, a 16.9% y-o-y
ARM is constructing a USD 120m cement manufacturing plant in Tanga,
Tanzania through its wholly owned subsidiary, Maweni Limestone Ltd.
The new plant is expected to deliver a daily capacity of 4,000 tonnes and
an annual capacity of 1.5 m tons making it the largest plant in East Africa.
Whereas the current installed capacity in Tanzania is 1.5 m tones, the total
demand is at 1.7m tons. With the shortfall of cement supply, ARM
intends to raise the capacity to 3m tones against a backdrop of a growing economy and demand. Any excess capacity is expected to be sold into
Kenya due to the proximity of the market. ARM will be increasing its
presence in Tanzania where its subsidiary manufactures lime. Despite
the challenges of the credit crisis, ARM has secured financing from a consortium of foreign banks to the tune of USD 100m to finance the project. We expect a considerable strengthening of shareholders funds
either through a recapitalization or a quasi equity deal that would bring
down the company’s gearing ratio. The ratio is currently at 45.9% and with new projects, will increase it to 166.2%, if done with pure debt financing. The company intends to eventually list Maweni Limestone in the Dar es Salaam stock exchange.
26
Kestrel Capital (East Africa) Ltd Member of the Nairobi Stock Exchange
Athi River Mining Company Update
Fertilizer
The fertilizer division was expanded from 15,000 tonnes to 65,000 tonnes capacity in 2007 (Compared to a total East Africa demand of about
650,000 tonnes per annum). ARM has been not exploited the full
potential of the division largely due to the seasonal nature of fertilizer and the high working capital requirements of the division. Nevertheless, as the Kenya government plans to set up a fertilizer plant at Mazeras: Mombasa, with an initial capital of Kshs 3 billion to produce between
300,000 and 500,000 tonnes, we expect ARM to be well positioned to
assist. As per management guidance, ARM is the only company in Kenya with the technical capacity to manufacture fertilizer using local content.
Industrial Minerals
ARM currently has over 70% market share in the region. The growth of the industrial minerals sales have been driven mainly by increased investments in new plant capacity for the year ended 2006, which grew
30% and further in 2007 by 23.4%. The subsidiary produces high value
products for paint, plastics and food industry and is expected to boost
margins for the segment.
Risks
ARM has an 8.1% market share in cement which places the company
as a price taker.
Limited shareholder capital raising ability is likely to trigger an
accelerated leverage in view of a more aggressive expansion planned for Tanzania. We however foresee a strategic investor taking a position in one of the subsidiaries to inject capital and drive further
growth in the longer term.
Whereas competition is likely to get tougher especially in cement, a
demand slump is likely to worsen the competitive position of ARM as a price taker in Kenya. It is noteworthy that ARM is the most efficient at utilizing capital and also quite competitive at per unit cost of production compared to its peers. We expect the dividend payouts to be less at than 50% over the next
four years in view of the investments that the company has to
undertake. We expect benefits to shareholders to come in the form of capital gains.
27
Kestrel Capital (East Africa) Ltd Member of the Nairobi Stock Exchange
Athi River Mining Company Update
Strategies
Setting up separate financing arrangements for specific projects such
as the USD 120m Tanzanian cement plant is likely to reduce risks of
leverage. The listing of various subsidiaries in the respective stock markets could unlock value to shareholders. This is a possible scenario in the coming three to five years as ARM operates semi-autonomously in
various markets across the continent under separate subsidiaries.
ARM plans to construct a 30MW coal fired power plant next to the Kaloleni clinker plant is likely to improve the quality of power and marginally reduce energy costs. The plant is likely to cost USD 45m and is estimated to start by end of 2008 with financing expected from lines of credit from commercial banks among other equity
shareholders. Benefits to ARM would include a lower cost and better
quality of power relative to existing sources and the production of
coal ash to be used as a binder in the cement production process. ARM is exploring new markets for sodium silicate and lime in view of their wide application and rising demand. New markets are
important with capacity expansions and the unlikely possibility of a
decline in local market demand.
28
Kestrel Capital (East Africa) Ltd Member of the Nairobi Stock Exchange
Athi River Mining Company Update
Financial Summary (Kshs 000) Year ending 31 Dec Income Statement FY2007 FY2008E % ch FY2009F FY2010F Sales 3,882 4,662 20.1 5,276 6,919 Gross profit 1,399 1,608 14.9 1,873 2,456 Operating profit 765 881 15.1 961 1,219 Finance cost/income (144) (145) 0.3 (104) (112) Profit before tax 621 736 18.6 857 1,107 Taxation (199) (221) 10.9 (257) (332) Profit after tax 422 515 22.2 600 775 Minority interest 1 - - - - Attributable income 422 515 22.0 600 775 Dividends 124 151 22.0 176 227 Retained earnings 299 364 22.0 424 548
Balance Sheet FY2007 FY2008E % ch FY2009E FY2010E Fixed assets 3,303 5,372 62.6 10,044 17,569 Other non-current assets 18 18 - 18 18 Current assets 1,183 8,138 587.9 3,021 2,394 Total Assets 4,505 13,529 200.3 13,083 19,981
Shareholders equity 1,772 2,250 27.0 2,699 3,298 Non current liabilities 1,666 9,569 474.2 8,006 5,931 Current liabilities 1,066 1,710 60.4 2,378 10,751 Total equity and liabilities 4,505 13,529 200.3 13,083 19,981
Cash flow Statement FY2007 FY2008E % ch FY2009E FY2010E Cash generated by operations 969 1,121 15.7 1,363 1,922 Working capital (30) (431) 1,325.9 (127) (338) Operating Cash Flow 939 689 (26.6) 1,236 1,584 Net interest received/(paid) (171) (145) (15.3) (104) (112) Cash taxes - (221) - (257) (332) Net cashflow before investing 768 324 (57.8) 875 1,140 Net cash invested (342) (2,346) 585.3 (5,073) (8,228) Free cash flow 425 (2,023) (575.4) (4,198) (7,088) Net financing cash flow (270) 8,501 (3,251.2) (1,115) (688) Net cash flow for the year 156 6,479 4,061.0 (5,313) (7,776) Opening cash balance (147) 9 (105.8) 6,487 1,174
Closing cash balance 9 6,487 75,898.0 1,174 (6,602)
29
Kestrel Capital (East Africa) Ltd Member of the Nairobi Stock Exchange
Recommendations Guide
STRONG BUY: Highly undervalued/ strong fundamentals BUY: Good value/ strong fundamentals ACCUMULATE: Buy on price dips HOLD: Correctly valued with little pricing upside or downside LIGHTEN: Overvalued by the market/ Reduce exposure/Declining fundamentals/ Industry concerns SELL: Weak fundamentals and challenging operating environment/Highly overpriced
Note: Readers should be aware that Kestrel Capital (EA) Ltd does and seeks to do business with companies covered in its research reports. Consequently, a conflict of interest may arise that could affect the objectivity of this report. This document should only be considered a single factor used by investors in making their investment decisions. The reader should independently evaluate the investment risks and is solely responsible for their investment decisions.
The opinions and information portrayed in this report may change without prior notice to investors. This publication may not be distributed to the public media or quoted or used by the public media without prior and express written consent of Kestrel Capital (EA) Ltd.
Directors, staff of Kestrel Capital (EA) Ltd and their family members, may from time to time hold shares in the company it recommends to either buy or sell and as such the investor should determine for themselves the applicability of this recommendation.
This document does not constitute an offer, or the solicitation of an offer, for the sale or purchase of any security. Whilst every care has been taken in preparing this document, no representation, warranty or undertaking (express or implied) is given and no responsibility or liability is accepted by Kestrel Capital or any employee of Kestrel Capital as to the accuracy of the information contained and opinions expressed herein.
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