Equity Analysis /

Pakistan Cement: Upgrade estimates on significantly weaker cost pressures

  • We have upgraded the estimates for our cement coverage (target prices increase c25% on average)

  • We think cement demand and prices will rebound strongly from H2 FY 21 onwards

  • We have an Overweight stance on the sector, where our top picks are LUCK, DGKC and KOHC

Intermarket Securities
1 June 2020

Despite a slow demand outlook, the cement sector’s profitability is expected to re-surge in FY 21/22f due to significant cost savings, which back an average 6ppts expected increase in the sector’s gross margins. Key supporting factors are lower international oil and coal prices (energy cost savings) and steep decline in interest rates.

We think cement demand and prices will rebound strongly 2HFY21 onwards when the Covid-19 pandemic will likely be more manageable and the government would likely have greater fiscal space to push construction activity – low-cost housing scheme especially will pick up.

We have an Overweight stance on the sector, where our top picks are (i) LUCK for its cost leadership and diversified business portfolio, (ii) DGKC for strong earnings growth and suitable investment portfolio and, (iii) KOHC for better profitability than North peers and cheap valuations.

Cost pressures have eased off significantly

We upgrade the estimates for our cement coverage (target prices increased c25% on average), in light of the steep declines in international coal and oil prices, along with abrupt and large cuts in interest rates. We have increased our gross margins estimates by an average 6ppts over the next two years. They have jumped to an average of 22% in FY21f as compared to 4% in FY20f (excluding LUCK). Lower coal prices (down 26% yoy in 4QFY20) is a boon, as coal remains the biggest input cost; also, shift to furnace oil (for power) has become more feasible. The latter is more beneficial for CHCC, DGKC, KOHC and FCCL (MLCF benefits the most from lower coal prices give a 40MW coal-fired CPP). Secondly, as most of the companies in our coverage are highly leveraged (post recent expansions), the decrease in interest rate by 525bps will drastically reduce finance costs and boost bottom-line (average 3-4ppts improvement in net margins as a result). 

Prices will increase in earnest 2HFY21 onwards

We remain conservative on demand growth outlook until end-1HFY20, however, and foresee c5% yoy growth in FY21f (7-8% yoy growth in the ensuing years). During FY19/20 the sector saw intense price competition, where even the larger players pushed sales at low prices. We believe that the government could have better fiscal space to push infrastructure 2HFY20 onwards (potentially the outbreak will be more manageable paving way for greater private demand); and thus cement prices will start recovering more strongly. We expect retail prices to rise to PKR610/bag in North and PKR700/bag in South by end-FY21, from PKR480/bag and PKR620/bag respectively (March 2020). However, we see even greater improvement in retention prices across the year on the back of reduced dealer discounts and lower inland freight. 

Risks have not completely subsided

Having said that, the risks of lower cement prices and depressed demand have not been completely allayed. Weakness can emanate from lack of increase in government spending from FY20 levels (flattish budget allocation or PSDP), delay in start of low cost housing scheme and concurrent slowdown in exports. Prolonged lockdown conditions can lead to severe liquidity issues for some producers, in our view. Companies will thus be forced to resort to additional debt to meet working capital needs, diluting the gains from lower interest rates.