Equity Analysis /

Pakistan Cement: Valuations are attractive despite imminent risks

  • We are revising IMS Cement Universe estimates led by elevated coal prices, slower demand growth & other certain factors

  • We remain Overweight on the sector and our top picks are LUCK, MLCF and PIOC

  • The sector is presently trading at significant discount to its last 5yr average replacement cost

Intermarket Securities
31 March 2022
  • We are revising estimates for our Cement coverage led by (i) elevated international energy prices, (ii) slower demand growth amid rising construction cost and lower government spending, (iii) inclusion of new expansions, and (iv) potential resumption of monetary tightening.

  • We assume that local cement demand growth will be flat in FY22f and expect an increase of 3%/5% yoy in FY23/24f, much lower than our previous growth estimates and also past 20yr average. Besides demand, major threat to profitability is coal prices continuing to rise.

  • We remain Overweight on the sector but suggest to focus on those producers, which are either less exposed to slower demand, suppressed cement prices and higher interest rates, or have availed concessionary-rate loans. Within our coverage, we believe that LUCK, MLCF and PIOC will stand out.

Price increases to counter weak demand and coal prices 

We maintain our liking for the Cement sector, which can sustain recent profitability, in our view. Key supporting factors are (i) recent jump in local cement prices (up 31% FY22td) to match the sharp rise in coal prices, (ii) North based producers having shifted to Afghan and local coal, and (iii) global coal prices have halved from recent peak of c.US$450/ton to post sustainable earnings in 2HFY22 and FY23. These factors should help the industry withstand suppressed demand – we now assume growth of 0%/3% for FY22/23f, down from our previous estimates of 7%/5% – PKR/USD devaluation and other inflationary pressures, in our view. We have also rolled over our valuation to June 2023 and have a Buy rating for all the stocks in coverage. But our top picks are LUCK, MLCF and PIOC, where our liking stems from relatively strong balance sheet position (LUCK), financing of new expansion with concessionary loans such as TERF (LUCK, MLCF), or not expanding in current cycle (PIOC). On the other hand, cement producers in the South look more vulnerable to higher coal prices, as they cannot benefit from Afghan coal and export prices have not moved in tandem with coal prices, amid weak utilization levels.

Coal prices have come down but will remain elevated

Higher coal prices remains the biggest threat to industry’s profitability as it is a major source of fuel (also used for power by some). However, coal prices have come down significantly to USS$255/ton from its recent all-time high of US$455/ton. In the long run, we believe that global coal prices will remain elevated, amid Russia-Ukraine conflict and surging demand from European countries trying to substitute Russian gas with coal. Hence, we have assumed coal prices of US$170 and US$150 per ton for FY23 and beyond – up from our previous estimates of US$120/110 per ton – vs. prior 5yr average of c.US$77/ton (during FY17-21). Apart from fuel consumption, coal is also used for captive power generation by some producers – including DGKC, PIOC and MLCF. Amid weak demand outlook, further surge in coal prices will erode the margins of the latter group faster than for the rest of the industry. Refer Page 6 for a table on earnings sensitivity of each producer to different coal prices.

Afghan coal and inventory pile up have rescued so far

Most of the North producers – including MLCF, KOHC, CHCC, FCCL and PIOC from our coverage – have been using Afghan coal for about past three months. The price of Afghan coal started from PKR19,000/ton (c.US$110/ton) and is now trading at PKR43,000/ton (c.US$240/ton). Notably, usage of Afghan coal has increased to as high as 70%-80%.

So far, imports of coal from Afghanistan have been in smaller quantity. The supply network was established by certain agents who were previously engaged in importing coal from South Africa or Indonesia. Afghanistan has almost 73mn tons of coal reserves, as of 2017, but it employs manual techniques of mining. Hence, future supply of coal from Afghanistan may not be reliable, in our view. The calorific value of Afghanistan coal is almost similar to Richard Bay coal

Apart from Afghan coal, most of the producers had imported good quantity of coal, when it was priced US$150-200/ton on C&F basis. Many still hold inventory worth 2-5 months of production. This has also helped in minimizing cost of coal, while international prices were skyrocketing to over US$400/ton. Lastly, KOHC, PIOC, MLCF and few others are also using local coal – majorly coming from Darra Adam Khel – but it has low heating value and high sulphur content. Other two local sites are Kallar Kahar and Dukki, Quetta, but they also have low heating value.