EUR 30.00 For Business Accounts Only

Pakistan Cement: Sector Profits -38% YoY in 1QFY19; Export dispatches to remain strong YoY in Oct 2018

• Pakistan cement industry posted its fifth consecutive fall in quarterly profits (4QFY18 adjusted for outliers) as sector’s gross margins have now contracted to 24% (6-Year low), as compared to a high of 46% (in last 6 years) in 4QFY16. In 4QFY18, sector margins were recorded at 26%.
• We believe that further downside in margins should be limited going forward as Pakistan cement industry’s margins are now in the range of regional average of 20-25%.
• Our working is based on result analysis of 15 listed producers (out of a total of 17) which represents 99% of total cement companies’ market capitalization.
• Industry volumes grew by 4% YoY in 1QFY19 thanks to exponential growth in exports, +39% YoY while local dispatches remained almost flat. We attribute higher exports to 1) currency devaluation, 2) additional production from new capacities in South and 3) higher clinker sales to regional countries on the back of closure of some clinker production lines in China owing to strict environmental regulation.
• Gross margins fell 8.4ppts YoY to 24% in 1QFY19. Margins continued to fall amid increase in production costs on the back of 1) higher coal prices (+18% YoY in 1QFY19), 2) increase in Re-Gasified Liquefied Natural Gas (RLNG) cost due to higher international oil prices (+50% YoY), 3) currency devaluation and 4) weak pricing discipline owing to oversupply concerns.
• Financial charges were up by a considerable 2.5x YoY as producers’ books are now heavily leveraged owing to capex requirement to fund upcoming expansions coupled with higher interest rates. Benchmark interest rate has now reached to 8.5% with 2018YTD increase of 275bps.
• As per Jun 2018 accounts, cement sector’s interest bearing liabilities stood at over Rs125bn with DGKC as the most leveraged, followed by MLCF, CHCC, POWER and PIOC.
• Effective tax rate of the industry remained well below 20% due to tax benefits given under 65B of the Income Tax Ordinance, 2001 on account of investment in new cement lines and adjustment of deferred taxes, we believe.
• CHCC was the only company that recorded tax reversal of Rs0.71/sh while FECTC, LUCK, THCCL and ACPL posted effective tax rate of 13%, 14%, 16% and 17%, respectively.
• On company wise basis, FCCL remained the star performer for the second consecutive quarter. The company reported improvement in margins, up 10ppts to 27%. We believe this was on the back of normalized operations after recommencement of its damaged cement line.

Export dispatches to remain strong YoY in Oct 2018

• Pakistan cement industry to post almost flat growth during the month of Oct 2018. However, cement consumption is expected to settle at 3.9mn tons, highest in 4MFY19 with month-on-month growth of around 3%, as per our channel checks.
• We expect considerable growth in exports where we anticipate dispatches to remain over 700k tons, a growth of more than 70% YoY.
• This growth in exports is on the back of higher clinker sales to regional countries amid clinker production constraints in China due to strict environmental regulation. These constraints are expected to sustain in the near future, as per our channel checks.
• We expect volumetric decline in domestic sales in Oct 2018 amid slowdown in construction activities.
• In 4MFY19, local dispatches are expected to fall by 4%. Exports to show significant improvement of up to 49% YoY during the same period, better than our expectations.
• In the sector, we continue our liking for LUCK and DGKC due to their attractive valuations.