Sugar Is Still Sweeter Than Ever

Global Market Information and Outlook

In 2020, the 100 countries that make up the global sugar market produced 175 million metric tonnes, forecasted by analysts to reach 186 million metric tonnes by 2026. Global sugar consumption is expected to outstrip production over the same time frame (2.2% vs 1% annual growth). Historically, sugar consumption growth is positively correlated to disposable incomes and urbanization. While median income remains flat/declines in Nigeria, the urbanization rate is around 4% annually. Per capita sugar consumption is historically low across Africa, creating a lot more room for growth compared to more developed markets.

 Company Overview

Dangote Sugar Refinery (DSR) is a household name that operates throughout the entire sugar value chain. Their operations encompass cultivating and milling of sugar cane, refining of raw sugar to fortified and non-fortified granulated sugar and marketing and distribution of refined sugar. Analysts estimate that DSR controls around 55% of the local market going off the assumption that import quotas are allocated in line with market share. The other important players in the market are BUA sugar and Flour Mills of Nigeria who control 25% and 20% of the market respectively, however BUA sugar controls roughly the same share of total production capacity as DSR.

Revenue Drivers

Historically, around 65% of the firm’s revenue is generated from sales of fortified sugar to distributors who sell to small wholesalers while 35% of sales are generated from sales directly to manufacturers of confectionaries. Seven up bottling company and Nigerian bottling company account for over 10% of total sales. The company also generates marginal income providing freight services with its fleet of over 700 trucks.

Capital Structure

DSR seeks to maintain an optimal capital structure to reduce the cost of capital and maximize returns for shareholders and benefits for other stakeholders. The company tracks its capital using a gearing ratio that compares net debt to total capital which is consistent with the industry. The company currently has little to no leverage as its gearing ratio at the end of FY2020 was 1%. The company’s total borrowings comprise a single 10-year loan of N2 Billion from Zenith Bank at an interest rate of 9% p.a. secured on the assets of Savannah Sugar Ltd, one of its subsidiaries. While this capital structure is inefficient due to the high cost of equity compared to debt, the company has a large capacity to increase borrowings in the future and bring down its weighted average cost of capital.

Capital Expenditure & Upcoming Projects

The CBN has made DSR one of three companies allowed to import sugar into the country. However, the firm is in the process of executing various backward integration projects as part of a $1bn expansion. The company has put over 100,000 hectares of land under cultivation to grow sugar cane. Once completed, they will be able to source inputs locally which should boost production and increase sales all while helping to reduce the cost of production. The firm has faced slight challenges resolving conflicts with host communities, particularly with the Lau/Tau project in Taraba state and the company has had to revise its integration target to deliver 550,000MTA/PA of refined sugar by 2024.

Valuation

Currently, DSR trades at a little over 7x earnings compared to the average of 20x earnings on the NSE while other firms in consumer staples currently trade around 13x earnings, signaling that the firm may be undervalued on a relative basis. In order to arrive at a reasonable estimate of the firm’s intrinsic value, a blend of the dividend discount model and discounted cash flow using the perpetuity growth formula was applied. A modest average revenue growth of 8.5% was applied in the forecast period, in line with the company’s historical revenue growth over the last five fiscal years.

As the company is not leveraged, particular importance is placed on the cost of equity as it is the largest determinant of the discount rate. Average yields on long term FGN bonds were used as the risk free rate and sector beta was applied in place of the company’s regression beta to avoid the large standard errors. Using these modest assumptions yields an implied fair value of N24.69 and an upside of 38.3%. While no catalysts to realize this value are immediately apparent, the model suggests that the company is trading at a significant enough discount for investors with a long-term horizon to get good value, even if a large margin of safety is applied.