Of Dangote Sugar and Economic Moats

• Moats
• The Value Investing Concept of Economic Moats
• Dangote Sugar; Quintessential Economic Moat


Moats

A moat is a wide water-filled ditch surrounding a fortified place, such as a castle. It was usually installed as a form of protection to keep unwanted persons or hostile opposition out of a sovereign area. It wasn’t unusual, in those days, to find a moat equipped with wild aquatic animals and, of cause, the wider the moat the better the protection.

With a history dating back to the 11th century, Moats, which are also referred to as “water defenses”, became an essential part of Castle design for a long period of time.
But how do moats relate to investing and who could possibly find a relationship between a moat and the stock market?

The Value Investing Concept of Economic Moats

“In business, I look for economic castles protected by
unbreachable ‘moats’.”
-Warren Buffett

Engage yourself in a little mental exercise by simulating a relationship between a Castle and a business/Industry. In place of a Castle imagine a business and in lieu of ‘water moats’ imagine ‘Economic moats’ represented by creative policies or ideas utilized by the business owner to stall a proliferation of that line of business. Thus, Economic moat involves the creation/utilization of ideas and policies, by a business owner, that put up significant barriers to entry into that line of business. It is the competitive advantage a company has.

After assimilating this concept, it would not be difficult to realize that the wider the economic moat, the longer it would take for would be entrepreneurs to scale the barrier and dilute the business. The company is said to have an enduring competitive advantage. Consequentially, the profitability of that business (castle) is secure for a long period of time, sometimes 10-15years hence, and so is your investment if you happen to have invested in such a company.

I’m writing this essay to show that Dangote sugar might be such a company.

Of Dangote Sugar and Economic Moats

Intangible assets generally refer to the intellectual property that firms use to prevent other companies from duplicating a good or service. Of course, patents are the most common economic moat in this category… A strong brand name can also be an economic moat
-Matt, Warren Buffett on castles and moats, www.37signals.com


The following excerpts from the Chairman’s letter in the Dangote Sugar offer unabridged prospectus (dated November, 2006) gives a rare view into economic moats in practice…

Strong barriers to entry:
The leading position of Dangote Sugar in the Nigerian sugar business is preserved by the following barriers to entry:
 
High import duties: The import substitution strategy of the Federal Government of Nigeria is designed to promote the development of local industries by setting low tariffs on raw materials and complete knocked down parts, and high tariffs on finished goods.
Accordingly, raw sugar is taxed at 5% compared to 50% (plus 10% sugar development levy) for white sugar. This tariff differential makes imported white sugar very uncompetitive in the Nigerian market.

Vitamin A fortification requirements: Nigeria has been a pioneer in the developing world in mandating the fortification of staple foods (such as flour, vegetable oil and sugar) with
Vitamin A as a means to eradicate Vitamin A deficiency and malnutrition amongst Nigerian masses.
Dangote Sugar has perfected and patented its Vitamin A fortification technology and fully complies with the fortification requirement. Very few countries in the world have similar requirements. None of the white sugar exporting countries has this requirement. Thus, for a Nigerian importer to meet the Vitamin A fortification requirement, it has to make a special request which will attract significant additional cost because of required customized production. In addition, Vitamin A is relatively unstable and difficult to transport, which makes the importation of fortified sugar more difficult.

High investment requirements: The cost of setting up a sugar refinery in Nigeria is quite high. The Company has spent approximately US$250 million to set up its refinery at current production capacity. Lower capacity factories are possible but may be less efficient because of reduced economies of scale.

It is my sincere hope that you have been educated. But I still encourage further research on the subject. You can begin your research by studying the Buffett articles on the side-bar -->
Happy researching.