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Dangote Cement shows uncommon resilience to Nigerian economic headwinds 16 Aug 2016

Barely four economic quarters after recording one of the highest GDP growth rates in the world in 2014, Nigeria's GDP data for the second quarter of 2016 is expected to confirm the economy has slipped into a recession. Nigeria's GDP growth rate – which averaged 6 percent in the ten years to 2014 – contracted by 0.36 percent in the first quarter of this year and it is expected to contract further in the following quarter.
    
It would have been impossible to predict this turn of events some 20 months ago. It was the dawn of an election year, and there was high optimism about the opposition party's candidate whom his supporters expected would win at the polls and herald a new dispensation of economic prosperity. Unfortunately, a perfect storm of low oil prices in the international market, a fall in output due to attacks on oil installation by the Niger Delta militants, a foreign exchange crisis owing to depleted government revenues all culminated in the decline of productive capacity and quickening inflation.

Giving this evolving scenarios, we were eager to find out the performance of the country's corporate sector as the season for reporting the 2016 second quarter and half-year results of the listed companies on the Nigerian Stock Exchange (NSE) approached last month. Importantly, we wanted to know the state of the banking sector and some of the largest conglomerates at a period when inflation is at an 11-year high and GDP has contracted.

Surprisingly, a number of the corporate entities have reported stronger-than-expected half-year results, indicating they have so far weathered the storm. The largest quoted company, Dangote Cement, reported a 20.6 percent year-on-year rise in its half-year revenue.

The company was able to boost its top line growth to N292.2 billion after it slashed its cement prices last year by 40 percent. By finding the scope to respond to Nigeria's weak consumer demand and low government spending, Dangote Cement gained market share and bolstered its total cement sales by 59.5 percent.

Indeed not unexpectedly, Dangote Cement's strong performance weighed heavily on the outlook of the company's much smaller rival, Lafarge Africa, which reported a N30.2 billion loss for the first half of this year. Although Lafarge Africa slashed its cement prices in response to Dangote Cement's price cut, the move failed to lift the company's sales. As a result, revenues of Lafarge Africa declined by 30 percent to N107.4 billion.

As the country faced a prolonged period of foreign exchange liquidity challenges, the Central Bank of Nigeria (CBN) left its capital controls in place to protect the foreign exchange reserves which had depleted from $29.1 billion reported on December 31, 2015 to $26.4 billion recorded on June 30, 2016. The CBN resorted to unconventional measures to restrict access to forex including banning some 41 items from access to forex at the official window. The pressure on the naira continued amid unrelenting calls for its devaluation by investors and market professionals alike.   

On June 20, the CBN abandoned the naira peg to the dollar, a move that effectively devalued the naira by over 40 percent in one fell swoop. The naira depreciated from its hitherto official exchange rate of N197 against the dollar to N281.85 per dollar on June 20. The CBN's decision had divergent impacts on Nigerian entities. On the one hand, companies with foreign exchange revenue streams from offshore assets recorded substantial foreign exchange gains; on the other hand, institutions with foreign exchange liabilities recorded massive forex losses.

Lafarge Africa's loss was partly attributed to huge foreign exchange losses on the $400 million worth of debts associated with its subsidiary, the Calabar-based United Cement Company of Nigeria (Unicem). Lafarge Africa completed the acquisition of Unicem from Flour Mills of Nigeria last year in a deal worth about N55 billion. Conversely, Dangote Cement benefited from the naira devaluation as it recorded 107 percent year-on-year rise in forex gains from N20.6 billion in the first half of 2015 to N42.7 billion in a comparable period of this year.

It was not all hurrah for Dangote Cement. The company incurred high energy costs amounting to N51.2 billion as it relied on more expensive fuels due to dwindling gas supplies from the Niger Delta where militants have been destroying oil and gas pipelines. The 81 percent rise in energy costs led to a decline in Dangote Cement's bottom line. Compared with the first half of last year, the company's after-tax profit fell by 15 percent to N103.4 billion in the first six months of this year.

Amid the economic upheavals in Nigeria, the financial system was also thought to be in some kind of peril. Fitch revised the outlook on the long-term foreign currency Issuer Default Ratings (IDRs) of three Nigerian banks; namely, First Bank of Nigeria, United Bank for Africa, and Guaranty Trust Bank – from stable to negative. The rating agency's downgrade decision which took place in February was hinged on Nigeria's faltering GDP growth, a weaker naira, and uncertainties in policy response to the difficult macroeconomic environment.  

Subsequent events also raised concerns over the health of the banking industry. For instance, the CBN dismissal of the Board and management of Skye Bank, a tier one bank, for breaching regulatory limits on Non-Performing Loans (NPLs), capital adequacy, and liquidity made some people wonder if this was 2009 all over again.

A CBN report on the banking sector also highlighted a dismal performance. Over a one-year period (April 2015-April 2016), there was a 5.6 percent or N1.029 trillion drop in total deposits; total assets of Deposit Money Banks (DMBs) also decreased by N154 billion; NPLs increased above the prudential limit of 5 percent to 10.1 percent; among other challenges.

However, results declared by Nigerian banks thus far for the half-year period have surpassed analysts' expectations. First Bank of Nigeria, the country's second largest bank by assets, did not declare a loss, despite its rising NPLs – currently at 18 percent. The bank's gross earnings fell marginally by 1.3 percent to N267.9 billion, compared with N271.3 billion a year ago. Its after-tax profit was down 10.5 percent to N35.9 billion. First Bank and a number of the banks have large exposures to the oil and gas sector exposure, with First Bank's at about 40 percent of its loan book.

Diamond Bank, a tier-two Nigerian bank, also posted half-year results that beat estimates. Its stronger-than-expected earnings were underpinned by a significant growth in the bank's trading income from the newly-revived interbank forex market. The bank's top and bottom lines performance was still weaker than First Bank's. Revenue and after-tax profit of Diamond Bank declined by 8.5 percent and 25 percent, respectively, in the first half of this year, compared with a similar period of last year.

Union Bank on the other hand reported a significant growth in gross earnings, a result which the bank said partly reflects the rebranding efforts it embarked upon following its acquisition by a consortium of investors led by African Capital Alliance and Atlas Mara. Union Bank's N55.39 billion gross earnings for the 2015 half-year period was up 8.4 percent to N60.67 billion in H1 2016.

Despite facing what is perhaps one of the worst economic downturns in the country's history, the Nigerian banking sector seems to have been coping well under the immense pressure. But there are lingering risks, especially with the outlook of oil prices which remains low. Although the International Energy Agency (IEA) has said demand and supply in the global oil market is currently more balanced, large oil stocks are still weighing on prices.

Nigeria's low oil output concerns are yet to be addressed despite efforts by the government to negotiate a ceasefire with aggrieved Niger Delta militants. Exxon Mobil's force majeure on exports is a major concern. The disruption caused by the suspension of oil exports at the Forcados terminal has caused Seplat Petroleum Development Company, a leading Nigerian independent oil and gas exploration and production company, to declare an after-tax loss of $61.17 million for the half-year period ended on June 30, 2016.  

The potential flow of capital that is expected due to the CBN's latest interest rate hike might not materialise in as much as there is a depressed outlook in the oil market. Forex illiquidity would send the naira spiraling further downwards, resulting in increased inflationary pressure as a result of higher input costs caused by shortage of FX.

These and other factors are what informed the International Monetary Fund's (IMF) eerie projection that economic production in Nigeria will contract by 1.8 percent by year-end. Nevertheless, the recession might not linger for much longer given the resilience Nigerian businesses have exhibited. An increase in government spending – as capital projects in the 2016 budget gets implemented – would also improve the business environment and cause the economy to rebound from this recession.