Equity Analysis /
Pakistan

Pakistan Cements - Factors for a turnaround are well positioned

  • Smooth recovery in cement demand after an unexpected jolt

  • Prices will follow an upward trajectory in FY21f

  • We have an Overweight stance on the sector, with the top picks of LUCK (TP PKR623/sh) and DGKC (TP PKR94/sh)

Intermarket Securities
7 April 2020
  • We think that the present lockdown will keep cement demand below full potential until the end of 1HFY21. Thereafter, a strong rebound in demand growth and profit margins seems more probable given an earlier-than-expected start of monetary easing and government’s stimulus for the construction sector, in our view.
  • During FY21f, Cement producers will have greater willingness and ability to raise prices (or trim discounts) at the prospect of rising economic growth and government focus on low-cost housing scheme, in our view. Lower interest rates and energy costs will also lift margins.
  • We have an Overweight stance on the sector, where our top picks are (i) LUCK (Buy, TP of PKR623/sh) for its cost leadership, lack of leverage and diversified business portfolio and (ii) DGKC (Buy, TP PKR94/sh) with strong earnings growth, better positioning in both regions and a suitable investment portfolio in the present scenario.

Smooth recovery in cement demand after an unexpected jolt

We have revisited the estimates for our cement coverage, in light of the present lockdown which is expected to depress local cement demand until the end of 1HFY21. We foresee a 9% yoy decline in FY20f domestic sales, followed by a 5% yoy growth in FY21f (8% yoy growth in the ensuing years). However, total sales will decline by 5% to 44.7mn tons in FY20. Pakistan continues to have a large infrastructure deficit (houses, dams, roads etc), where fiscal constraints in the past two years stalled government spending. A substantial increase in PSDP disbursement during FY21f is likely delayed as the government has diverted significant funds towards combating the Covid-19 pandemic. This will however be mitigated by the recently announced construction package, which can revive private cement consumption and stimulate the development of low-income housing scheme on a large scale, in our view. An extended period of lockdown is a key risk to our thesis. 

Prices will follow an upward trajectory in FY21f

After two years of intense price competition, we expect retail cement prices to increase during FY21. Notably, most major expansions are online and the macroeconomic environment is more conducive. However, given the delayed uptick in demand, the industry will also take a little more time to reach consensus on prices, in our view. We expect retail prices to rise to PKR610/bag in North and PKR700/bag in South by end-FY21, from PKR510/bag and PKR620/bag respectively (March 2020). We see an even greater improvement in retention prices across the year, on the back of reduced dealer discounts and lower inland freight. Profit margins will also be bolstered by declining interest rates and energy cost savings. Average gross margins in our coverage will jump to 11% in FY21 as compared to 2% in FY20 (excluding LUCK).

We prefer LUCK and DGKC

We like Lucky Cement (LUCK) for its cost leadership, a diversified portfolio of businesses (where non-cement operations will also get a boost from greater economic activity) and lack of leverage (if the lockdown period extends, it may undermine the solvency of some of its peers). DG Khan Cement (DGKC) also has geographical diversification (can tap export markets amid lockdown) and a suitable investment portfolio (comprising a major bank MCB and textile composite Nishat Mills). Also, it can utilize its short term investment to pay off the upcoming interest payments.