Why S&P is upbeat on PPC

Two years in the cement industry could make or break a company’s fortunes. Take SA’s largest cement producer PPC as an example.

The company was buckling under the weight of a liquidity crisis in 2016 in which its smothering debt load ballooned to R9.1 billion at a time when competition in its SA home market intensified, and cement demand and prices weakened. The turnaround of PPC’s financial position hinged on a R4 billion capital raise, which would help it to reduce debt and expand its cement capacity in rest of Africa markets including the Democratic Republic of Congo (DRC), Zimbabwe and Ethiopia.

Its vulnerable position even attracted an opportunistic takeover proposal from rival AfriSam and Canada’s investment holding firm Fairfax, which was strongly rejected by PPC shareholders.

Read: Why the PPC, AfriSam tie-up faces shareholder rebellion

So precarious was PPC’s financial position that rating agency S&P Global Ratings cut the company’s long- and short-term corporate credit ratings to zaBB- and zaB respectively in 2016. In other words, its rating was pushed deep into junk territory. The credit ratings cut precipitated a plunge in PPC’s earnings (headline earnings per share fell 12% in 2016 and 93% in 2017), and early repayment of debt at higher interest charges.

S&P upgrade

Two years later and a more than 50% drop in PPC’s share price, a different company has emerged, even prompting S&P to upgrade its credit rating. On Friday, S&P raised PPC’s long-term corporate credit rating to zaA- and short-term to zaA-2 (both investment grade). In a note, S&P said the improved rating reflects PPC’s “broadly stable” underlying credit metrics, earnings and adequate liquidity.

The upgrade in PPC’s credit rating is largely due to its significant progress in strengthening the balance sheet by restructuring South African debt, reducing interest rate costs and with the performance of its rest of Africa operations.

PPC successfully raised R4 billion in 2016 via a rights offer, reducing group debt from R9.1 billion in the year to March 2016 to R4.7 billion in the year to March 2018. PPC also managed to negotiate a two-year moratorium for DRC project funding of R2.1 billion (representing more than 35% of its total debt) with interest payments also extended by two years.

“In our opinion, its improved capital structure and liquidity profile will help mitigate the adverse effects of cyclicality in the building materials industry, especially given the relatively depressed operating environment in SA,” S&P said.

Meyrick Barker, an investment analyst at Kagiso Asset Management, supports S&P’s view, saying PPC’s balance sheet is in a stronger position than it was two years ago.

Also helping to strengthen its financial position are the recently commissioned plants in Zimbabwe, Ethiopia and Rwanda, which are expected to add a third to its annual output of eight million tons/year and boost group profits from the rest of Africa to nearly 50% in the next three years.

Barker says PPC’s period of elevated capital expenditure is complete now that the new plants have been commissioned. “This allows PPC to devote a larger portion of its operational cash flows to paying down debt and in turn to resume dividend payments to shareholders.”

The rest of Africa plants are supporting revenue growth and earnings before interest, tax, depreciation, and amortisation (Ebitda).

The inclusion of the plants (excluding the DRC, where PPC recognised a R165 million impairment on a 69%-owned plant due to the country’s political and economic instability) saw group net cash flow improving by 69% to R1.4 billion in the year to 2018 compared with R845 million in the previous year. The group’s cash generated from operations after working capital rose 23% to R2.3 billion in the year on the back of group revenue of R10.3 billion.

More caution

Mish-al Emeran, an analyst at Electus Fund Managers, says that although PPC’s short-term liquidity position has improved, for the company to be sustainable over the medium term, profitability has to improve in the DRC. He adds that although PPC secured a two-year capital holiday for DRC funding, interest rates have increased and a R1.6 billion debt payment due in June 2018 was refinanced with two loans, one of which matures in 2022.

“Essentially the trade-off for short-term liquidity has been more expensive debt, which implies there is less margin for error and a higher profitability requirement over the medium-term,” says Emeran.

After all, S&P expects that PPC’s funds from operations in relation to its debt will be above 30% from 2019 as operating conditions in some markets are expected to remain tough.

Another area of concern shared by S&P and Kagiso’s Barker relate to difficulties in PPC repatriating cash from rest of Africa markets, including Zimbabwe and DRC, which might stunt the company’s efforts to repay its debt.

“Notwithstanding fund transfer limitations and support requirements, we believe that PPC’s southern African operations will generate sufficient liquidity sources to meet its uses over our 12-month horizon,” said S&P.

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