Equity Analysis /

Egypt 2020 Cement Sector Outlook: The winner takes it all; the loser has to fall

    Al Ahly Pharos Securities Brokerage
    20 October 2019

    Three potential solutions to current sector dilemma

    In our view, the fastest solution at the moment is government intervention in terms of setting a minimum price for cement and allocating market shares to each player in the sector. While we have been strong advocates of sector consolidation, the market only witnessed one M&A activity in late 2015 where MCQE acquired Asec Minya and it could be explained by companies electing to maintain control. If the above-mentioned solutions didn’t materialize, operations will improve in tandem with growing demand and/or inefficient players exiting the market such as National Cement and Tourah. We expect north of 6.0mn tons to exit the market in the coming 18 months. 

    What margins do current stock prices reflect?

    The market is currently factoring in perpetual EBITDA margins of 15.3% for ARCC vs 10.6% in 1H19, 11.5% for SUCE vs -8.9% in 1H19, 11.3% for MBSC vs 13.7% in 1H19, and 12.3% for MCQE vs 13.6% in 1H19. We believe that the current margins cannot be sustained even if demand didn’t grow because it will force several players out of the market which will reflect positively on overall sector run rates and accordingly, lead to margin recovery.

    Demand to improve on cooling inflation

    We expect FY 19 local demand to reach 48.0mn tons, implying per capita consumption of 484kg, per capita spending of USD23, and the supply/demand gap to reach 33.2mn tons. Afterwards, we expect demand to improve on the back of cooling inflation coupled with accelerating GDP growth rate. We expect demand to record a CAGR of 4.5% between FY19-24. It is worth noting that Arish-Beni Suef plant and Arish plant run rates recorded 34.6% and 36.6%, respectively, in September. 

    Cement is a long term trade 

    Based on our estimates, current dynamics could possibly force north of 6mn tons out of the market and if we factor in our estimates for demand CAGR, the run rate will reach its healthy levels by FY24 (c. 82%) assuming no new additional capacities. While we realise that the valuation gap at the current prices is huge, we believe that the value will not be unlocked until sector dynamics improve namely improving sector run rate either through exits or demand growth, assuming no government intervention takes place.

    Which companies to trade?

    Currently, we prefer companies that 1) generate healthy cash flows (ie ARCC), 2) have strong financial position (ie MBSC), and 3) operate towards the lower end of the cash cost curve (ie ARCC). That said, our top picks are currently ARCC, MBSC, and SUCE if the company managed to monetise the Tourah land plot. We terminate coverage on SVCE given its inefficiency and historically poor investment decisions.