Elixir Securities Limited – Elixir Insight

Karachi, August 09, 2018 (PPI-OT): Pakistan Cement Sector – 4Q Core Profitability to be dented by Rising Cost of Production

We expect 4Q earnings of Elixir Cement Universe to post a 23%YoY decline in profit before tax on the back of decline in GM. Net earnings however are expected to depict a growth of 22%YoY during 4QFY18 on the back of BMR Tax Credit incorporated in ACPL and DGKC estimates. On core earnings, CHCC isprojected to outshine with YoY EPS growth of 13% for the year.

Industry’s Gross Margins are estimated to taper off by 7pptsYoY to 28% in 4Q, primarily on the back of i) hike in average coal prices by 19%YoY, ii) average PKR depreciation against USD by 10%YoY, and iii) increase in FED by 20% effective from May-18.

GM for the quarter are expected to decline by 1pptQoQ despite 8%QoQ price recovery in North as dispatches fell by 11%QoQ, coal surged by 5%QoQ and PKR depreciated by 5%QoQ.

We remain skeptical on the sector due to i) projected slowdown in local offtakes on curtailment in PSDP spending and interest rate liftoff, ii) pressure on cement prices due to upcoming expansions, and iii) margin attrition on the back of higher coal prices and PKR depreciation. Within the sector, our preference is tilted towards LUCK.

BMR Tax Credit to Support Dwindling 4QFY18 Profitability: We expect Elixir Cement Universe to post a 23%YoY decline in profit before tax in 4QFY18 on the back of decline in GM, down 7pptsYoY (the estimates are inclusive of Lucky Cement’s (LUCK) actual financials). During the period, revenue of the sector is estimated to increase by 13%YoY to PKR45bn as total dispatches improved by 11%YoY to 11.1mtons (local dispatches up 8%YoY to 9.8mtons, exports up 43%YoY to 1.3mtons) during 4QFY18. Cumulatively, dispatches for FY18 grew by 14%YoY to clock in at a historic high of 45.9mtons. Despite the volumetric growth, gross profit margins during 4QFY18 are estimated to clock in at 28% (vs. 35% in 4QFY17); receding by 7pptsYoY primarily due to i) hike in average coal prices by 19%YoY, ii) average PKR depreciation against USD by 10%YoY, and iii) increase in FED by 20% effective from May-18. Resultantly, core profitability of the sector is expected to decline.

Net Earnings, however are expected to grow by 22%YoY during 4QFY18 to PKR10.0bn due to incorporation of BMR Tax Credit in Attock Cement (ACPL) and DG Khan Cement (DGKC) estimates. During FY18, utilization of the sector clocked in at 94% out of which North region operated at 95% capacity utilization while South showed a 91% capacity utilization (adjusted for ACPL and LUCK new plants).

Price Recovery in North but Dispatches are Down QoQ: During the outgoing quarter, dispatches showed a sharp decline of 11%QoQ to 11.1mtons (local dispatches down 14%QoQ to 9.8mtons, exports up 25%QoQ to 1.3mtons). The decline in local dispatches can be attributed to slow down in public sector spending due to Election season. Exports from South, however, served as a major breather (in-line with our forecasts) as ACPL and LUCK both tapped into low-price export markets to utilize recent capacity expansions.

During the quarter, average cement prices in North recovered by 8%QoQ to PKR548/bag in 4QFY18 (vs. average of PKR509 in 3QFY18). The recovery in cement prices came on the back of surge in coal prices (up 5%QoQ), FED hike and PKR/USD depreciation (5%QoQ). After the recovery in 4QFY18, average cement prices in North in FY18 remained flat YoY at PKR530/bag (vs. PKR536 in FY17). Southern region also depicted stability in cement prices and averaged at PKR569/bag during FY18. Owing to volumetric decline in local offtakes during the quarter, we expect a 3%QoQ decline in revenue for the sector. Although cement price recovery in North is expected to provide some respite, surge in coal prices by 5%QoQ and PKR depreciation by 5%QoQ are expected to drag GM down by 1pptQoQ.

Tax Credit BMR for ACPL and DGKC: Our conversations with the managements of Attock Cement (ACPL) and D. G. Khan Cement (DGKC) suggest that both the companies are expected to take tax credit on BMR of PKR924mn and PKR2.9bn, respectively in 4QFY18. This would transpire into per share contribution of PKR6.0 and PKR4.8, respectively.

Investment Perspective: Maintain Skepticism on Margins Going Forward: We maintain ‘Market-Weight’ stance on the sector as we anticipate slowdown in dispatches on the back of i) curtailment in Public Sector Development Program (PSDP) spending as we eye Pakistan’s entry into IMF and ii) interest-rate lift off to slow down private construction activities. We also expect pressure on cement prices on the back of upcoming expansions in North, which should continue to dent margins. Sticky coal prices at higher levels and PKR depreciation are expected to create further pressure on GM.

Referring to the bumpy ride coal prices have exhibited recently; we have updated our coal prices assumption (to USD90/ton in FY19 vs. our earlier assumption of USD80/ton). Our revised and rolled-forward investment case for Jun-19 PT also incorporates our latest exchange rate forecast (average PKR/USD at 132 in FY19) and higher risk free rate of 10% (from 8.5% earlier). Within the sector, we prefer LUCK owing to its diversification in Autos and Power.