Bridging Nigeria’s Infrastructure Gap

Lekki-Ikoyi Link Bridge, constructed by Julius Berger Nigeria Plc

Nigeria’s Infrastructure Gap

Three trillion dollars. This is the amount of money that Nigeria needs to spend to plug its infrastructure gap, as estimated by the World Bank and International Finance Corporation. In order to achieve this, the country would need to spend over N40 trillion annually ($100bn) for the next quarter of a century. For context, the total budget for the federal government is only around N10 trillion annually. Furthermore, Nigeria’s external debt stock stands at around N33 trillion, so if the country’s total foreign debt was channeled towards infrastructure, there would still be a deficit of N8tn and that is just one year of spending.

Further compounding this issue, the federal government was only able to fund 62% of its budgeted N2.6tn for capital expenditures, or about 4% of the estimated spending needed to bridge the infrastructure gap. At the very least, the government is aware of the huge deficit and appears to be taking steps to generate more revenue and seek external financing for capital expenditure. The government also plans to launch a N1 trillion infrastructure company in Q4 2021 and plans to grow the company’s assets to N15 trillion over the course of a decade. While the country is a long way away from $3 trillion, it seems to be gearing up to address the gap.

Nigeria’s Construction Industry

Given that annual infrastructure spending needs to increase by over an order of magnitude, it is not unreasonable to assume that the construction industry should see significant growth backed by increased public spending. The construction industry in Nigeria is forecasted by analysts to record a CAGR of 16.6% to reach N13.2 trillion over the next three years backed by government spending and increased Public-Private Partnerships (PPP). Given this macroeconomic backdrop, local companies operating in the sector could see significant growth in revenue and earnings in the medium to long term.

It is, however, important to mention the China factor. As explained above, the government has had to finance a significant portion of its capital expenditures through external financing and 10% of the country’s external debt is a $3.4bn bilateral loan with China specifically earmarked for infrastructure projects. Part of these agreements require much of the construction to be completed by Chinese firms and sometimes require these firms to operate the infrastructure for 10-15 years. If the government enters into similar agreements to receive more financing in the future, it could severely limit how much of the public spending trickles down to local firms. However, as annual spending needs to increase by over an order of magnitude, local construction firms should still see significant growth despite competition from foreign firms.

Company Overview

Julius Berger Nigeria Plc. is a leading integrated construction solutions company with a long track-record of executing complex civil construction and building works often requiring levels of technical expertise provided by very few other local companies. The company has been operating in Nigeria for five decades and has completed some of the most iconic industrial and civil infrastructure projects in the country, including:

§ Tin Can Island Port
§ Nnamdi Azikiwe International Airport Phase 1
§ Central Bank of Nigeria Head Office
§ Lekki-Ikoyi link Bridge
§ Third Mainland Bridge

While the company’s principal activities are providing construction solutions, they have established and acquired several subsidiaries that operate across synergetic industries such as; aluminium and glass manufacturing, engineering/design services, port management, medical services and investments. Given the company’s long and successful history in Nigeria, they are extremely well positioned to benefit from the overall growth in the construction sector.

Revenue Drivers

Figure 1.1 – Last 5 years FY Revenues for Julius Berger (in billions of Naira)

Julius Berger generates around 75% of its revenues from civil works, which is the engineering, construction and maintenance of infrastructure such as roads, harbours/jetties, airports and auxiliary buildings for factories, power plants and oil and gas installations. The company generates another 15% of its revenues through the design and construction of administrative buildings, commercial and industrial buildings, hospitals, hotels and residential facilities. The rest of the firm’s revenues are generated through its other services such as facility management, furniture production, port operation services and activities of its subsidiaries.

Taking a further look at revenues, it is important to note that 75% of the firm’s revenues are from government related construction contracts while only 25% of revenues come from private sector contracts. Perhaps even more importantly, the firm has three clients who individually are responsible for over 10% of revenues, but jointly contribute around 70% of total revenues. This presents, in our eyes, a huge concentration risk. The firm approved and began implementing its first diversification case in 2020 and the board of directors see diversification as a key pathway to advancing their growth potential.

Capital Structure

Figure 1.2 – Historical Total Debt and Total Debt/Total Capital

The firm’s overall capital risk management strategy is to thrive on quality in offering its construction solutions while trying to maintain efficient working capital management with a low cost of funds. The firm tracks its gearing ratio by comparing net debt to equity which is consistent within the industry. It’s Net debt to equity ratio was 0.17 at the end of 2020, giving the firm a lot of room to increase leverage in the future and further optimize its capital structure. The firm’s debts consist of bank overdrafts and a term loan. The firm’s overdrafts are various facilities which are used to meet import financing and working capital requirements. The firm secured and has drawn down a 5-year loan of €25m at 6.2% obtained from Zenith Bank in 2019 used to finance the importation of various construction equipment.

Valuation

Figure 1.3 – Valuation Summary

Given that there are few other publicly listed companies operating in the same industry in Nigeria, most relative valuation models would not yield particularly useful insights. It is, however, useful to mention that the firm currently trades at 5x earnings as opposed to its median P/E ratio of 3.3x over the last 5 fiscal years. In arriving at a fair value for Julius Berger, the Discounted Free Cash Flow model was applied. We forecasted a very conservative 5-year CAGR of 7.8% given our outlook for fast growth in the industry over the long run.

A beta value of 0.26x was applied based on the 5-year share price return and the NSE All Share Index as the market benchmark. The 10-year government bond yield of 11.2% was used as the risk-free rate and an average implied equity risk premium over 10 years of 8.3%, although we must disclose the significant standard errors (6.22%) that arose due to the short forecast period. A tax rate assumption of 37% was selected in calculating the after-tax cost of debt, consistent with the firm’s historical taxation. These assumptions yielded a weighted average cost of capital (WACC) of 17.7% and an implied fair value of ₦30.12. At the current price of ₦25.00, this presents a moderate upside of 20.5%. However, for investors who prefer a particularly large margin of safety, the company may not be trading at a significant enough discount.