Event

In its recently released financial statements for Q1 2022, Dangote Sugar Refinery (DSR) recorded a 7% YoY increase in profit after tax to N8.87bn despite a 40% YoY revenue growth to N94.45bn.

Higher Commodity Prices Exert Margin Pressures

The rising cost of raw sugar in the global market amid higher crude oil prices and global supply chain disruptions – both developments majorly driven by geopolitical tensions in the Eastern Europe resulted in cost pressures for DSR. Raw material costs, which accounted for 85% of total cost of sales, grew by 59% YoY to N63.57bn in Q1 2022.

In response to the higher input cost, we believe that DSR partially raised prices to ease the burden. However, from our analysis, we posit that the entire cost burden was not passed on to consumers. Hence, gross margin declined by 600 basis points to 21% in Q1 2022. (Q1 2021: 27%) We attribute the inability to pass on overall burden to consumers to rising competitive pressures amid capacity ramp-up by competitors in the industry.

Profit before tax margin declined by c. 300 basis points to 15%, despite the Group’s operating efficiency efforts (evidenced by c.100 bps reduction in operating expense margin).

Outlook

Uncertainty about how long the geopolitical conflict between Russia and Ukraine poses a significant downside risk to the earnings growth capacity of DSR. A prolonged stand-off could keep crude oil prices higher, and that implies a sustained scarcity of raw materials for DSR as raw sugar suppliers tend to produce less in times of higher oil prices.

This major challenge informed the Group’s decision to invest in backward integration, which is still ongoing. The Group is expected to benefit from these investments in the long term.

Valuation

Following appropriate adjustments, we have a revised forward EPS of N2.37 (previously: N2.61) informed by higher cost. Our reviewed fair value estimate of N20.62 trades 21% discount to the current market price. Incorporating a forecasted dividend yield of 7% sums up to a total return of 28%. Hence, we recommend a BUY.

Please follow the link “Dangote Sugar Q1 2022 – Sticky Cost Weigh Down Earnings Growth”  to view the whole report.