Moody's Downgrades Dangote Cement Plc Ratings to B2, Outlook Negative

Sunday, November 07, 2021 / 07:25 AM / byMoody's Investors Service / Header ImageCredit: Dangote Cement plc

Moody's Investors Service ("Moody's") hasdowngraded DangoteCement plc ("DCP") long term corporate family rating (CFR) to B2from B1, the national scale long term corporate family rating to Aa3.ng fromAa2.ng and the probability of default rating (PDR) to B2-PD from B1-PD. At thesame time, Moody's has affirmed the (P)B2 local currency rating and Aa3.ngnational scale rating assigned to the NGN300 billion domestic medium-term noteprogram (DMTN) and the B2 local currency and Aa3.ng NSR to the senior unsecurednotes issued by DCP. Moody's has also changed the outlook to negative fromratings under review.

"The downgrade of the CFR to B2 is driven by theincrease in dollar debt in DCP's capital structure which was not initiallycontemplated in the B1 rating. This exposes DCP to increased currency risksbecause most its cash flow are generated in naira and other African currenciesand the fact that all the dollar debt has maturities of less than a year. Thiscurrency risk is captured under Moody's B2 foreign currency ceiling of Nigeriawhich is limiting the ability of DCP to be rated higher", say Dion Bate(Vice President - Senior Analyst), the lead analyst for Dangote Cement."The downgrade however is not driven by concerns around the cementfundamentals in Africa or the business, which continues to performstrongly", adds Mr. Bate.

This rating action of November 5^th 2021concludes the review for downgrade, which was initiated on 5 August 2021.

Ratings Rationale

The downgrade to B2 reflects the increased amount ofdollar debt to around 230 billion naira equivalent, representing 43% of totaldebt as of 30 September 2021, up from 71bn naira equivalent in 2019. While DCPhas begun generating dollar revenue through exports and repatriations of dollarcash flow from its other African operations, it is still reliant on the CentralBank of Nigeria for dollars, which remains restricted. The high proportion ofdollar debt in the capital structure exposes DCP to currency risk, whichincluded among others access to dollars and naira weakness, that is captured byNigeria's foreign currency ceiling of B2 instead of Nigeria's Ba3 local currencyceiling assigned by Moody's. Under Moody's methodology approach, Nigeria's B2foreign-currency ceiling, limits the ability of a domestic corporate, that hasmeaningful foreign currency obligations, to be rated higher which constrains acompany's rating. It is management's expectation that over time as dollarexport revenue grow (currently around 4% of revenue) DCP would be able tointernally fund its demand for dollars and eliminate the need for dollarfacilities.

The affirmation of the B2 ratings assigned to the DMTNprogram and senior unsecured notes reflect Moody's position that the previousnotching considerations of one notch below the CFR is no longer appropriate.This is because of the low secured debt in the capital structure, sustainablylow group leverage and high unencumbered asset base in Nigeria that providesufficient recovery protection for senior unsecured lenders.

DCP's B2 and Aa3.ng CFR's are supported by thecompany's (1) strong market presence in Nigeria and other African markets in whichit operates; (2) high gross margins of above 60% on a Moody's-adjusted basis;(3) low leverage of 0.9x, as measured by gross debt/EBITDA, and high interestcoverage of 10.8 x, as measured by EBIT/interest expense, for the last 12months (LTM) ending 30 June 2021; and (4) prudent financial policies thatensure credit metrics remain strong through operating and project build cycles.

The ratings also factor (1) the relatively small scalelevel of cement production when compared to global peers, with production of25.7 million tons (mt) for 2020; (2) single product exposure being cement; (3)a concentration of production in Nigeria (Government of, B2 negative),representing 70% of revenue for LTM 30 September 2021; (4) high reliance onshort term debt funding and an aggressive dividend policy that exposes thecompany to liquidity risk.

DCP's liquidity profile is adequate but is exposed toongoing refinancing risks because of the large portion of short term debt equalto NGN343 billion, representing 64% of total debt as of 30 September 2021.While DCP has strong cash generation with a cash balance of N179.1 billion, itpay large dividends (N272 billion in May 2021) which temporarily weakens itsliquidity. Moody's recognises that DCP has a good track record of accessing thelocal funding market given its low leverage, blue chip corporate status inNigeria and strong local banking relations. Furthermore, its main shareholderDIL could support DCP as done in the past, if required.

The negative outlook mirrors the Nigerian sovereign'snegative outlook, reflecting our view that DCP's credit quality ispredominantly tied to the economic and political developments in Nigeria. Thenegative outlook further reflects DCP's reliance on short-term funding and itshigh annual dividends, which expose the company to a potential liquidityshortfall over the next 12-18 months.

Globally, the building materials sector has highcredit exposure to environmental risks. The cement industry is energy intensiveand the mining and manufacturing process for cement production consume largeamounts of coal, electricity and water. DCP's production meets domesticemission standards and the company has implemented measures to improve energyefficiencies and transition to cleaner natural gas for its power needs.

Factors That Could Leadto an Upgrade or Downgrade of the Ratings

A rating upgrade is unlikely, because DCP's B2 ratingis constrained by the Nigerian government's foreign currency ceiling of B2.Because of the high revenue contribution from its domestic operations, there isa strong link between DCP's rating and the sovereign rating, which prevents DCPfrom being rated higher than the foreign currency ceiling of Nigeria. If thesovereign rating or foreign currency ceiling were to be upgraded, DCP wouldneed to demonstrate a track record of good liquidity management for an upgradeto be considered.

DCP's ratings are likely to be downgraded in the caseof a downgrade of the Nigerian government rating or foreign currency ceiling. Adowngrade could also occur if (1) DCP's liquidity is weak; (2) the Nigeriangovernment introduces special taxes, levies or other punitive measures thatnegatively impact DCP's profit or cash flow, such that operating margins fallbelow 20% on a sustained basis and adjusted debt/EBITDA trends above 4.0x oradjusted EBIT/interest expense trends below 2.5x; and (3) DCP moves away fromits policy of matching the currency of its underlying cash flow with that ofits debt.