Earnings Report /
Pakistan

Pakistan Cement 2QFY20 preview: Good times are not here yet

    Intermarket Securities
    27 January 2020
    • With lower retention prices, higher finance cost and infighting among North based producers, the profitability of IMS's cement universe is likely to remain depressed in 2QFY20, with the estimated cumulative net loss of PKR1.8bn showing complete profit erosion yoy.
    • Leveraged producers – namely CHCC and DGKC – are likely to book losses in 2QFY20 despite improved market share post expansions. Retention prices are expected to compress further qoq, where the impact of increased competition was exacerbated by higher FED and discounts.
    • We downgrade our stance on the sector to Marketweight, even though we are optimistic about demand and profits recovery FY21f onwards. Clarity on pricing consensus will emerge only after all new capacities are added, in our view. We prefer LUCK and DGKC for their diversified business exposures and geographical presence in both regions.

    Depressed earnings will persist the whole year 

    We expect the IMS Cement Universe to post a combined net loss of PKR1.8bn in 2QFY20, extending the period of losses for most of the sector. The complete profit erosion expected in 2Q emanates from (i) significant buildup in cost pressures due to gas and power tariff hikes and ballooning transportation costs (post implementation of axle load), (ii) higher taxes i.e. increase in FED, and (iii) failure to build pricing consensus. 

    Another quarter of losses for CHCC and DGKC

    In our cement cluster, we expect CHCC and DGKC to post losses in 2QFY20 (consecutive losses for both) while KOHC and FCCL will barely breakeven. However, we do not expect CHCC and DGKC to repeat gross loss in 2Q (expected GP margins of 4%-5%). Although volumes of these companies have shown strong double-digit growth yoy owing to increased market share post expansions; profitability is likely to deteriorate significantly mainly on account of (i) higher finance costs (significant debt burden and increased working capital requirement), and (ii) increased fixed overheads, in addition to the aforementioned factors. As per provisional data, DGKC and CHCC witnessed volumetric growth of 46% and 96%yoy respectively, while LUCK’s local dispatches declined by 1%yoy.

    GMs decline steeply yoy but recover somewhat sequentially

    Gross margins of our cement universe are likely to fall by an average of 19ppt yoy in 2QFY20 to 7% mainly on account of lower retention prices, due to higher FED (by PKR25/bag) and weak retail prices due to infighting among North producers. This was worsened by the hike in power and gas tariffs, and increased transportation cost. For new plants, fixed overheads and higher contribution of exports in the sales mix will also compress margins, in our view. Average retail prices during the quarter stood at PKR541/bag (down 11% yoy) in North and PKR641/bag (up 3% yoy). On a sequential basis, however, gross margins are expected to recover from an average 4% in 1QFY20, because of increased sales (against fixed costs) and lower realized coal prices.