Through the use of financial ratio analysis, this month’s Technical Forum examines how Dangote Cement – the powerhouse of Africa and Nigeria – has managed to achieve a strong and sustained financial performance.
The benchmarking of a cement factory and cement company performance remains a major part of Whitehopleman and Dr Clark’s work. When such benchmarking exercises are being undertaken there are occasions when a cement company or factory is found to be at the top of the range of performance. That always makes Dr Clark sit up and take extra interest to try to understand how that cement company, or factory, manages to achieve such outstanding performance. Dangote Cement is certainly one such cement company.
When looking at the financial performance of cement companies Whitehopleman uses financial ratio analysis. This is based on the performance published in the cement company’s financial statements, ie, their income statement (profit and loss), statement of financial position (balance sheet) and statement of cash flows. Two figures from the financial statements are divided by one another to produce a ratio of one to the other. That ratio is then compared with, or benchmarked against, other cement companies.
Recent financial performance
In the case of Dangote Cement Whitehopleman was looking at its financial performance for the year ended 31 December 2020, the company’s last published accounts at the time of writing. The analysis started by looking at the Dangote Cement income statement for 2020, which was a record year with revenues growing to NGN1034bn, equivalent to ~US$2480m. A total of 25.7Mt of cement was sold at an average price of ~US$96.5/t. Cost of goods sold was NGN373bn (US$895m).
Revenues of NGN1034bn (US$2480m) minus cost of goods sold of NGN373bn (US$895m) gives gross profits of NGN661bn (US$1586m). Gross profits divided by revenues gives the gross profit margin, in the case of Dangote Cement in 2020, of 63.93 per cent, which was at the very top of the range of the cement companies in the Whitehopleman cement company business performance database, as shown in the box plot in Figure 1. This was sufficient to make Dr Clark take notice. How was Dangote Cement achieving such extraordinary profit margins?
Financial ratio analysis then peels away successive items in the income statement, rather similar to peeling away the layers of an onion. So sales, general and administration (SG&A) expenses are then subtracted from gross profits to arrive at operating profits, the earnings before interest, taxation, depreciation and amortisation (EBITDA). EBITDA profits are then divided by revenues to arrive at EBITDA margin. In the case of Dangote Cement the EBITDA margin was not quite at the top of the range of cement company performance, as shown in Figure 2, but remained in the upper quartile of performance.
How can we explain Dangote Cement falling off the top spot for EBITDA margin when they are top of the pile for gross profit margin? Well, possibly some of their sales, general and administrative expenses are really part of their cost of sales. Perhaps some distribution costs for cement. Dangote certainly has huge fleets of trucks for the distribution of its cement. Of course, there are other cement companies who are lucky enough to be able to rely on collections so do not have any distribution costs.
In the next layer of the income statement that we peel away in financial ratio analysis is the depreciation and amortisation charges. That leaves the earnings before interest and taxation (EBIT). EBIT margin is again the ratio of EBIT profits to revenues. For Dangote Cement EBIT margin returns to nearly the top of the range of cement factories, as shown in Figure 3.
The next layer of the income statement to peel away is the interest and taxation charges leaving the earnings, or profits attributable to shareholders. For Dangote Cement in 2020 these profits were NGN275bn (US$662m). The earnings margin was 26.58 per cent. Many cement companies do not achieve that margin in their gross earnings before they have started to peel away SG&A, depreciation and amortisation, interest or taxation. Dangote Cement is super profitable.
Dangote in context
Some context is perhaps required here and that creates a challenge. There is no like-for-like comparison with Dangote Cement, with its pan-African portfolio of assets centred on Nigeria. The world’s leading cement company, Holcim, in the same financial year sold 190Mt of cement, more than 7x as much cement as Dangote Cement, as well as 256Mt of aggregates and 42Mm3 of ready-mix concrete. From those sales Holcim generated ~US$1.8bn of after tax profits, less than 3x Dangote Cement’s after tax profits. While this is not a perfect comparison, Dangote Cement is clearly at least twice as profitable as Holcim was in 2020.
Assessing return on equity and ROCE
As an investor in a cement company the return on equity is what is most important, as it reflects the amount of capital tied up in the business to generate the profits. In financial ratio analysis to assess the return on equity we need to take the after tax profits from the income statement and divide by the equity in the statement of financial position. The after tax profits are the profits available for distribution to the shareholders as dividends, while the equity reflects the price of buying a share in the company. The Dangote Cement return on equity is again almost at the top of the range of cement companies, as shown in the range bar in Figure 4. Clearly this is a great cement company in which to own shares and invest.
For the executive management of a cement company the return on capital employed (ROCE) is the financial ratio most commonly considered. To assess this we take the EBITDA profit from the income statement and divide it by the total capital employed, which is the equity plus the long-term liabilities from the statement of financial position. This takes into consideration that any long-term debt is available to the executive management of the company to use to boost the returns of the company. The ROCE of Dangote Cement of 39.98 per cent is again almost at the top of the range of cement companies, as shown in Figure 5. The management of Dangote Cement are clearly making excellent use of the assets at their disposal to generate profits for the company. If we looked at return on average capital employed we would find that Dangote Cement is absolutely at the top of the range of performance for cement companies.
Sustained performance and a strong base
This story of profitable performance and effective management of Dangote Cement is not a one-off story relating to only the 2020 financial year. Figure 6 shows the rising trend of Dangote Cement ROCE for the six financial years ended 31 December 2020. From 2016 ROCE has been virtually continuously rising. This is further testament to the strong and sustained financial performance of the company.
So, Dangote Cement is right at the top of the range of performance for cement companies. Why would that be? Clearly the ownership and management had the foresight and the courage to invest strongly in rapidly-developing economies in Africa. Their main base of operations is Nigeria where more than 60 per cent of their cement sales continue to be made, and they continue to achieve their highest average sales prices.
So why does Nigeria give Dangote such a strong financial performance base? This is a good question. Even Dangote Cement did not achieve 50 per cent capacity utilisation in Nigeria in the FY20. Normally such low capacity utilisation would result in price erosion as cement companies seek to increase sales volumes by reducing prices. Clearly that did not happen in Nigeria, despite the chronic oversupply of cement. How can that be?
The distinguishing feature of the Nigerian cement market has to be its consolidation, with only three major players - Dangote Cement, BUA Cement and Lafarge Africa (Holcim). No-one could argue that these players in the Nigerian cement market are not competitive, with their aggressive capacity development on one-another’s doorstep. However, these players clearly exercise market discipline and do not enter into price wars to try to raise market share. A glowing example for cement companies in many other countries of Africa.
This article was first published in International Cement Review in March 2022.
