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Pakistan Cements: Sector Profits down 24% YoY in 3QFY18; Near 6-Year low margins on quarterly basis

• Pakistan cement producers announced their Mar 2018 quarter results where profitability declined by 24% YoY vs. marginal decline of 1% YoY in Mar 2017 quarter. Decline in profits was mainly on the back of lower margins which fell to nearly 6-Year low of 28%.
• To note, margins have been on a declining trajectory since 3QFY17 (a period when CHCC’s new capacity of 1.3mn tons per annum came online and prices weakened in the North region thereafter).
• Our analysis is based on a sample of 15 listed cement manufacturers (out of a total of 17) which represents 99.7% of total cement companies’ market capitalization.
• Volumetric growth remained robust during the outgoing quarter, up 19% YoY thanks to higher local dispatches, fueled by private sector construction activities and demand from CPEC related projects.
• Despite robust dispatches, sector revenues grew by mere 4% YoY in 3QFY18, primarily owing to decline in high margin local net retention prices. We estimate that the industry’s average net retention prices declined by around 12% YoY to Rs323/bag in 3QFY18. While on sequential basis, average net retention prices were down by Rs12/bag (4%).
• Sector’s gross margins fell to near 6-year low of 28% in 3QFY18, down 8.7ppts YoY. We attribute this to 1) higher Federal Excise Duty (FED); the Govt. in last Budget increased FED by 25% to Rs1.25/kg which North producers were unable to pass on due to weak pricing power, 2) lower local net retention prices and 3) higher input costs. To note, FOB coal prices have increased to US$93.3/ton, up 13% YoY in 3QFY18. Combining the devaluation effect, coal prices in rupee terms actually increased by 19%. On sequential basis, gross margins were down 4.2ppts.
• Sector’s financial charges grew by 41% YoY during the outgoing quarter on the back of increase in producers’ debt level to fund upcoming expansions.
• While pretax profits were down 28% YoY in 3QFY18, lower effective tax rate restricted profitability decline to 24%. Effective tax rate was lower as some players like LUCK and CHCC availed tax benefit for setting up a manufacturing unit while Shariah compliance also provided tax relief to LUCK.
• During 9MFY18, revenues grew by 4% while profits were down 18% as margins contracted by 8.6ppts to 31%.
• On company wise basis, FCCL was the only company that reported profitability growth of 28% YoY in 3QFY18, primarily on the back of improved margins as a result of re-commissioning of its damaged line.
• Though prices have recently strengthened in North, manufacturers will have to pass on the increase in FED to alleviate further pressure on margins. To recall, the Govt. in its recent FY19 Budget raised FED on cement by 20%, creating a need for producers to increase prices by Rs15/bag, we estimate.