We recommend an ACCUMULATE on the cement sector in Kenya. In 2012, the East African region produced approximately 8.4m tonnes of cement, with Kenya as the lead cement manufacturer. (Kenya- 4.6m tonnes, Tanzania- 2.5m tonnes and Uganda- 1.7m tonnes of cement). The region however suffers from a clinker capacity shortfall due to lack of sufficient cement grade limestone deposits. Kenya and Tanzania are the two countries with substantial limestone deposits along the limestone belts estimated to be well over 400m tonnes. With regional GDP expected to grow at 6.0%, 5.5% and 7.0% (In Uganda, Kenya and Tanzania respectively) in 2013, 2014 and 2015, we believe regional consumption will grow at a 3 year CAGR of 13.2%. In light of a growing regional construction sector and cement deficit in the inland export markets, Kenya and Tanzania continue to attract cement manufacturers who aim to gain domestic market share, while focusing on inland export markets where average cement prices command premiums (Uganda- 41.7%, Rwanda- 141.7%, South Sudan- 233.3%, East D.R.C- 233.3% and Burundi- 141.7%) to Kenya’s average cement price of USD 120.00 per tonne. Going forward, we expect in-house clinker production and sufficiency to be the critical core competency that creates competitive advantage. Regional cement producers however face the challenge of high energy and power costs as well as the reliability associated with cement grinding, resulting in margin compression.
Based on a 1 year target price of KES 234.42, indicating a 7.5% upside potential from the current price, we maintain our HOLD recommendation on Bamburi Cement. Our outlook is supported by a 3 year CAGR in revenue of 4.7% to FY15F driven by both domestic and export sales. Though we anticipate an increase in direct costs to compress margins, we believe cost management measures currently employed are bound to yield improved efficiency in the medium term. We estimate +124bps y/y and +66bps y/y in gross profit and EBITDA margins to 27.5% and 22.4% respectively in FY13F.
We recommend an ACCUMULATE (buy on price dips) on ARM Cement with a target price of KES 77.50, implying an upside of 10.7% from the current price. ARM Cement’s revenue growth will largely be driven by volume growth as a result of additional capacity in Tanzania (a 750,000 tonne cement plant in Dar es Salaam commissioned in 4Q12 and another 750,000 tonne plant in Tanga to be commissioned by 1Q14. The 1.2m tonne clinker plant in Tanga (by 1Q14) will result in less reliance on expensive imported clinker and, therefore, an improvement in margins (EBITDA margins up 184bps to 25.3% by FY15F). ARM Cement currently trades at a P/E and EV/EBITDA of 28.1x and 18.9x respectively compared to the regional cement sector median P/E of 16.3x and EV/EBITDA of 8.9x. With a PEG ratio of 0.9x, we believe that the 3 year forward EPS CAGR of 30.4% just about justifies the higher valuations.
We issue a BUY recommendation on EA Portland with a target price of KES 111.09. We believe that higher utilization rates will drive revenue growth going forward while increased clinker capacity, internal reorganization and cost management will lead to higher earnings. For FY13E, we expect an EPS of KES 7.48 from a loss of KES 9.13 per share. EA Portland is trading at a forward P/E of 7.2x and EV/EBITDA of 4.9x which is significantly below the regional medians of 16.3x and 8.9x respectively.
(Source: Kestrel Capital - 19.08.2013)