Equity Analysis /

Pakistan Cement: Q1 FY 20 preview – Awful start to FY 20

    Intermarket Securities
    18 October 2019
    • With significant buildup in cost pressures, weak domestic demand and infighting among North-based producers, profitability of the IMS cement universe is likely to take a hit in Q1 FY 20, posting an NLAT of PKR778mn.
    • Leveraged producers, namely CHCC, MLCF and DGKC, are likely to book losses in Q1 20 despite improved market share post expansions. Borrowing cost is expected to jack up by 2.6x yoy amid increased working capital requirement and debt financing of expansions.
    • We maintain our Underweight stance on the sector given the headwinds ahead. We think clarity on pricing consensus will arise only after all new capacities are added. We prefer LUCK (TP: PKR543/sh) and KOHC (TP: PKR83/sh) in the space due to lower breakeven price levels.

    Declining earnings streak to continue in FY 20 

    We expect the IMS Cement Universe to post combined NLAT of PKR778mn in Q1 FY 20. The sharp decline is expected on account of (i) significant buildup in cost pressures emanating from higher gas and power tariff hikes and higher transportation cost (post implementation of axle load), (ii) higher taxes ie increase in FED (up PKR25/bag), and (iii) failure to build pricing consensus in the North. Moreover, the documentation drive initiated by the government also depressed frail demand. On a sequential basis, declining trend in profitability is unlikely to reverse where continued pressure on prices (lower retention) will more than offset the fall in coal prices.

    Leveraged producers to book losses in Q1

    In our cement cluster, we expect CHCC, MLCF and DGKC to post losses in Q1 FY 20 (consecutive losses for CHCC and DGKC). 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 cost (significant debt burden and increased working capital requirement), and (ii) increased fixed overheads. As per provisional data, MLCF and CHCC witnessed volume growth of 82% and 46% yoy, respectively, while LUCK’s local dispatches declined by 19% yoy. 

    No respite in GMs…

    Gross margins of our cement universe are likely to fall by an average of 7ppts yoy in Q1 FY 19 to 9% mainly on account of lower retention prices due to higher FED and weak retail prices due to infighting among North producers. This was exacerbated by 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 compress margins, in our view. Note that regional cement prices declined in Q1, which will keep a check on export margins despite PKR devaluation. We expect unlevered players like LUCK to post the highest gross margins of c20%. However, margins of MLCF post commissioning of new plant are likely to fall to 6% (from 15% in Q4 FY 19) owing to above factors.

    …and local demand

    In Q1 FY 20, local cement sales remained flat at 9.1mn tons; however, export sales increased by 12% yoy to 2.0mn tons. The strong growth in exports is mainly led by South producers taking advantage of proximity to port for sales in regional markets (mainly clinker). Overall industry utilisation stood at 75% (vs. 80% in the same period last year). Domestic sales growth pattern across North and South have reversed during Q1 FY 20, where dispatches in North picked up by 9% yoy (7.8mn tons) while the South region depicted a substantial decline of 32% yoy (1.3mn tons). Post commissioning of new capacities in North (MLCF and CHCC, cumulatively 4.5mn tpa), some players are now selling in South (mainly MLCF) to capitalise on wide difference in cement prices between the two regions.

    Expansions ahead will keep prices in check

    Expansions of LUCK and KOHC are around the corner (slated to come online in Dec’19) with cumulative capacity of c5.0mn tons. However, PIOC’s expansion (2.6mn tons) may get delayed to H2 FY 20. Since these are all North-based expansions, utilisation levels in the North may continue to come off significantly in coming months owing to limited scope for growth in exports. Though cement prices in the North have improved lately (up cPKR30/bag to PKR530/bag), possibility of run down in prices cannot be ruled out particularly as local demand in Q2 FY 20 will face challenges from a seasonal slowdown and influx of new capacities.

    Risks: (i) Breakdown in pricing arrangement, (ii) PSDP cut leading to slowdown in domestic demand and (iii) rise in interest rates.