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Pakistan Cement: Sector Profits +4% YoY in 2QFY19; 1HFY19 Profits -18% YoY

• In today’s note, we review 2QFY19 profitability of Pakistan cement industry. As per our analysis, cement producers posted profitability growth of 4% YoY during the quarter (vs. 26% YoY decline seen in 2QFY18), mainly on the back of lower effective tax rate as pretax earnings were down by 15% YoY.
• Our working is based on result analysis of 13 listed producers (out of a total of 17) which represents 97% of total cement companies’ market capitalization. Other companies have not yet announced their result or are in losses.
• Interesting observation for 2QFY19 result was the significant contraction in effective tax rate of the industry where effective tax rate fell 15ppts to 14%, which was the only reason for the sector’s profitability growth. This was amid tax benefits given under 65B of the Income Tax Ordinance, 2001 on account of investment in new cement lines to select companies in addition to adjustment of deferred taxes.
• DGKC and CHCC booked tax reversal, cumulatively amounting to more than Rs700mn due to aforesaid reasons, we estimate. We highlight here that DGKC booked investment credit on its new line (carried forward from last year) and benefit of deferred tax asset arising in 2QFY19. Moreover, the company is still left with huge deferred tax assets on account of depreciation on new (South) cement line which DGKC can avail in coming quarters.
• Industry volumes grew by 5% YoY in 2QFY19 thanks to exponential growth in exports, +60% 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 6ppts YoY to 26% during the outgoing quarter. Margins contracted amid increase in production costs during the said period, on the back of 1) higher coal prices amid currency devaluation, 2) increase in Re-Gasified Liquefied Natural Gas (RLNG) cost due to higher international oil prices (Arab Light +16% YoY), and 3) inflationary pressure.
• However on QoQ basis, gross margins improved due to higher net retention prices and lower depreciation charge (DGKC), we believe. As per channel checks, DGKC has extended useful life of some of its PP&E that led to lower depreciation charge during the quarter.
• Top three cement producers that saw improvement in their gross margins on QoQ basis were KOHC (+7ppts), DGKC (+6ppts) and FCCL (+5ppts).
• Financial charges were up by a considerable 2.5x YoY as producers’ books are now heavily leveraged owing to capex requirement to fund new lines or upcoming expansions, coupled with higher interest rates. Benchmark interest rate has now reached to 10.25%, up 450bps since Jan 2018 to date. Amongst heavy leveraged companies are DGKC, MLCF, CHCC, POWER and PIOC, as per Sep 2018 accounts.