Alt - Cement Sector Call - Sept 28'16

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Sector Update - Cement

AsiaPac | Pakistan | Equities Construction & Materials

Equity Research Analyst Ali Shah Jumani [email protected]

Wednesday, September 28, 2016

This report has been prepared by Alternate Research and is provided for information purposes only. Under no circumstances it is to be used or considered as an offer to sell, or a solicitation of any offer to buy. This information has been compiled from sources we believe to be reliable, but we do not hold ourselves responsible for its completeness or accuracy. All opinions and estimates expressed in this report constitute our present judgment only and are subject to change without notice. This report is intended for persons having professional experience in matters relating to investments.

Pakistan Cement Sector

Industry dispatches FY16 & Industry Sales Mix

The Pakistan cement sector has been amongst the most significant contributors to market buoyancy during FY15 – 16 considering the political and economic stability, the country has embarked to in the recent times. Although, afflicted to many trials since the dropping demand of the cumulative effect of the global financial crisis of 2008, anti-dumping duty imposed by South Africa and hindered exports as cheap Iranian cement ruled over the show, until the sector finally took off after FY14.

Incorporating the following interrelated demand triggers i.e. 1) CPEC, 2) PSDP utilization, 3) Mega housing development projects, and 4) Expansions, we derive that the sector has potential but if all the announced expansions materialize this might ignite price war cutting the margins in future.

Local demand – Growth prospects Security measures taken by the GOP and overall economic stability could be triumphal for all industries, whereas the local demand surging due to high Public Sector Development Program (PSDP) allocation, Mega development projects and implementation of China Pakistan Economic Corridor (CPEC) has made the sector a good catch for any investor. As per FY16 the overall dispatches expanded by +9.81%YoY in comparison to last year, while the local dispatches grew by 17%YoY. Regional wise local dispatches in North increased by 15.39%YoY while South witnessed exceptional growth of 24.9%YoY.

Export demand subdued The imposition of anti-dumping duties by South Africa, international capacity expansion and availability of cheap Iranian cement are major culprit for shrinking exports. Total export dispatches clocked at 5.87MT depicting a decline of 18.38%YoY. North contribution to this decline was restricted to -13.77%YoY owning to higher demand from India (+43%YoY). However, with a number of key export markets (Nigeria, Tanzania, Mozambique, Iraq, Ethiopia and DR Congo) for South players where local industry are expanding their capacity in conjunction with anti-dumping duties imposed by SA resulted in decline of 25.92%YoY.

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Source: APCMA, Alt-R Team

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Export Sales Mix


Stock Current Price TP-June’17 Upside%

ACPL PKR 259/sh PKR 316/sh 22%

MLCF PKR 96.5/sh PKR 115/sh 19%

DGKC PKR 188/sh PKR 233/sh 24%

KOHC PKR 257/sh PKR 330/sh 28%

LUCK PKR 670/sh PKR 777/sh 16%

Source: Alt-R Team

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Sector Update - Cement



Supply/Demand Outlook


Historically, cement demand has strong positive correlation with PSDP investment, property presales, as well as infrastructure development. Of these determining factors, infrastructure development on back of CPEC and higher PSDP allocation is positive in the near term, as we expect robust economic growth. However, as far as housing sector is concerned we expect slight slowdown in the construction activities for limited time owning to tax policies introduced by government in Budget FY17. Since the arrival of Nawaz government construction spending have been on the rise with CAGR of 11.89% for the period FY12-FY16. Government continuing the trend has allotted federal PSDP amounting to PKR 800bn in FY17. We expect this trend to continue in future as well as Nawaz government have always focused on developing infrastructure in order to boost the economy. Large housing backlog + growing middle-class = robust long term demand; but there are headwinds in the near-term. The property sector will remain bullish over the long term supported by the large housing deficit, a young population, and urbanization.

we expect total cement dispatches, mainly domestic dispatches, to increase robustly in near future. Considering both historical growth and future scenario we expect total cement dispatches to grow at CAGR of 6.6% from FY17 till FY21 against CAGR of 4.6% from FY12 till FY16. Currently cement industry is operating at capacity utilization of 85%, we expect this utilization rate to increase to 88% in FY17 with increasing demand but will start dwindling once expansion from different players starts to materialize and reach 70% in FY19 and move upwards from there. Exports have been shrinking over the last few years and outlook over the next 2‐3 years is not particularly bright. We expect exports to shrink further in future resulting in industry sales mix of 90:10 with 90% being domestic market.

Construction spending as % of GDP

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Industry Production Capacity, Dispatches and Utilization MT

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Sector Update- Cement



The Cement/GDP multiplier Theory Cement demand has historically grown in tandem with economic growth owing to high correlation with gross domestic product (GDP) growth - directly as well as indirectly. Directly, because infrastructure investment and construction activity, accounting for +40% of cement demand, are the key components of GDP. Indirectly, because housing (both rural and urban), again a key determinant accounting for ~60% of cement demand, depends on agricultural productivity and income levels, which in turn are the key components of GDP. Cement demand in Pakistan historically during expansionary phase has increased at 2.6x the GDP growth rate. The Cement demand/GDP growth ratio has remained highly volatile throughout, expanding to 5.6x of GDP during the upcycle and contracting to -2.3x of GDP during the downcycle. This growth multiplier has been hovering near 0.78x over FY12-FY15 but with high allocation in PSDP and boom in construction activities, the multiplier reached 2.1x in FY16.

Cement/GDP multiplier to recover from lows

Source: APCMA, PBS, Alt-R Team

Given the new government's significant focus on large infrastructure development, Pak-China corridor, Orange Line Metro Train, "Apna Ghar Housing Scheme", Smart cities projects, etc in addition to GDP growth to further expand in future, we expect the Cement/GDP multiplier to bounce back sharply to its last expansionary phase average of 2.6x over FY17-21. If cement sector reaches multiple of GDP 2.6x, the cement demand is expected to clock at 57 million tons by FY21. Historically we have witnessed similar demand pull in 2003 owning to 60% higher Public Sector Development Projects (PSDP) allocation, 4.7% GDP growth, and increasing number of real estate development projects for commercial and residential use.

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Significant new capacity in the next four years

*Green Field Projects **Undecided Projects Note: DGKC and LUCK has undertaken both Green Field and Brown Field Source: APCMA, Company Notice, Alt-R Team

Owning to positive future outlook of demand, many players in the industry announced their plans for expansion. We believe the new supply will be twice that of cement demand growth, utilization will drop below 70% by 2019. Between 2001 and 2021F, we note 4 distinct stages in the demand and supply dynamics of Pakistan cement industry. From 2001 to 2005, supply was more or less constant while demand grew at CAGR of 13% with increasing GDP growth, lifting utilization gradually from 64% to 91%. Between 2006 and 2010, a period of aggressive expansions, the unexpected property boom drove cement demand to the roof (17% CAGR). During that period, incremental supply (27.43m tons) was more than of incremental demand (17.87m tons), pushing domestic utilization rate to under 80%. A price war was witnessed, during which retail cement prices fell 23%, which ended up with no conqueror. Then came the period of stagnation from 2011 to 2014 as cement dispatches registered CAGR of just 3% owning to worst ever floods in northern region in 2010 resulting lower investment by government in PSDP consequential sluggish GDP growth. What added fuel to fire was power shortage and increased tariffs imposed by government on manufacturing sector.

We are now entering the fourth phase, where incremental supply will be significantly more than incremental demand. We forecast new supply in the next four years to reach 21.8m tons compared to only 11.4m tons forecast incremental demand. The biggest incremental supply will come in 2019, which would push utilization to 70% for the first time since 2003. By 2020, we estimate utilization would start increasing given no new player enter the market or any further announcement by remaining industry players. Moreover, we believe the history might repeat itself and a possibility of price war can be foreseen in FY19 especially if China acquires a cement company or establish a new cement production facility in Pakistan. Once the expanded plants come on stream a margin erosion could take place as large players try to gain market share.

Incremental Supply Outpaces New Demand

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Capacity almost flat for 5 years, Demand growing in line with GDP

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Floods, power shortage, & low PSDP spending

Aggressive expansions and high demand on back of high PSDP, CPEC and booming housing sector

Cement Supply, Demand and Utilization rate

*Production Capacity accounts for Expansion of LUCK, DGKC, POWER, ACPL, MLCF, CHCC, KOHC, FECTO, GWLC and PIOC Source: Industry sources, Alt-R Team

Existing Capacity

Existing Additional Capacity

Total Capacity

After Expansion

Year of Completion

ACPL 1.80 3.9% 1.20 3.00 4.4% FY17 CHCC 1.10 2.4% 1.30 2.40 3.6% FY17 DGKC* 4.22 9.3% 4.90 9.12 13.5% FY18 FECTC* 0.82 1.8% 0.95 1.77 2.6% FY18 GWLC 2.11 4.6% 2.40 4.51 6.7% FY18 KOHC** 2.68 5.9% 2.30 4.98 7.4% FY19 LUCK* 7.39 16.2% 3.55 10.94 16.2% FY18 MLCF 3.37 7.4% 2.10 5.47 8.1% FY19 PIOC* 2.03 4.5% 2.10 4.13 6.1% FY19 POWER* 0.95 2.1% 0.95 1.90 2.8% FY19 Others 19.16 42% 19.16 Total 45.62 100% 21.75 67.37

Source: APCMA, BR, Alt-R Team

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South NorthSource: APCMA, Alt-R Team

Pre & Post Expansion Capacity Share

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Manufacturing Costs & Margins

Source: Company Accounts, Index Mundi, Alt-R

Manufacturing costs to remain subdued due to soft Coal & FO prices As the whole cement industry relies upon Fuel & Power which owns around 68% of the total manufacturing cost, any fluctuations amongst the prices of Coal, FO and Gas shakes the sector profoundly. It has been noticed during the current period that the key players inclusive of (KOHC, MLCF, CHCC and LUCK) took a shift utilizing FO based Captives to reap the profits through subdued furnace oil prices while the ones deprived of FO or Coal based captive power plants or having heavy reliance over national grid such as PIOC and ACPL were also benefitted through a cut in national grid/unit cost during the current period. Cement sector margins have recovered strongly post the last price war, improving to 44% in FY16 from 21% in FY10, pricing discipline having lasted for the last 5 years coupled with subdued coal prices (‐51% over since FY11). Considering local cement prices are already at an all‐time high of PkR540/bag and positing that the coal price slump has largely played out (even as China and EU see lower coal demand), industry margins are likely to stabilize close to current levels where we believe the existing pricing discipline should persist. Recently a rise in coal prices were witnessed hitting average price of USD 63/ton in July from low of USD 49/ton in January. The main reason for the price rise was China’s decision to limit its coal mines to producing just 276 days a year – instead of the previous 330 days. Nonetheless, we do not expect the high coal prices to be sustained for longer period as coal prices above USD 70/ton could trigger production resumption spree among small coal mines who stopped production due to sluggish prices. We believe oil prices will spike for short time owning to expected decision of OPEC and non-OPEC member production freeze but the price will come down and average between USD 50 - USD 60 for the next 3 years.

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Relative Valuation

Stock Performance Stock performance of Alt-R cement universe (LUCK, DGKC, ACPL, KOHC, MLCF and CHCC) since start of CY16 has yield 27.05% on weighted average basis against 20.8% yield of benchmark 100 index showcasing tremendous performance of cement sector. The high performance of these stocks was attributed to higher cement dispatches (+9.82%YoY) in FY16 and positive outlook of local dispatches on back of materialization of CPEC, higher PSDP allocation and booming housing sector. Besides tremendous uplift in dispatches, inclusion of Pakistan in MSCI helped cement sector, especially stocks part of MSCI Emerging Market index, to climbed new highs. However, due to aggressive expansion plans by almost all major players in cement sector along with interest of China to invest in Pakistan’s cement sector caused a fume of over capacity build-up, a possibility of price war in future and breakage of cement cartel dejecting some of the gains earned from previously mentioned factors. In our cement universe ACPL comes out to be the leader so far in CY16 posting incredible return of 48.7% in just 9 months. Following ACPL, CHCC yields 37.7% supported by strong fundamental on being the first player to come online with expansion.

K-100 LUCK DGKC MLCF ACPL KOHC CHCC W. Avg

Price (Jan 1) 33,229 517.8 154.7 78.3 174.4 243.1 92.9

Current Price 40,135 667.4 188.1 96.0 259.4 258 127.9

CYTD 20.8% 28.9% 21.6% 22.6% 48.7% 6.1% 37.7% 27.05%

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Source: PSX, Alt-R Team

Cement Universe Relative to KSE-100





LUCK: Currently stock is trading at PKR 670/sh and at P/E(ttm) of 16.56x. The stock has generated return of 28.9% since the start of CY16. The P/E(ttm) of Alt-R cement universe trades at 13.83x which presents that Lucky Cement is trading at premium of 19.7%. We believe that as LUCK is the market leader such high P/E is justified however we anticipate that it will remain between the band of 14x-16x in near future. Furthermore, with expansions underway in South and North, investment into power sector and joint venture investment in cement plant in DR Congo the future looks bright for LUCK.


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DGKC: Currently stock is trading at PKR 188.25/sh and at P/E(ttm) of 9.38x. The stock has generated return of 21.6% since the start of CY16. The P/E(ttm) of Alt-R cement universe trades at 13.83x which presents that D.G Khan Cement is trading at discount of 32.2%. We believe, based on relative valuation, there is high upside potential in DGKC scrip. Furthermore, with Captive Coal Power Project about to complete, DGKC has undertaken to establish Greenfield project in South along with Brownfield project in North which will help DGKC to increase its margins and market share further in future hence supporting our valuation.

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Relative Valuation





MLCF: Currently stock is trading at PKR 96.5/sh and at P/E(ttm) of 10.37x. The stock has generated return of 22.6% since the start of CY16. The P/E(ttm) of Alt-R cement universe trades at 13.83x which presents that Maple Leaf Cement is trading at discount of 25.1%. We believe, based on relative valuation, there is high upside potential in MLCF scrip. Moreover, following the footstep of LUCK, MLCF has also diversified its business by investing into Maple Leaf Power Limited (MLPL) for setting 40MW imported coal-fired power plant at its plant site. MLCF has also announced to undertake expansion of its current plant taking total capacity to 5.47MT by FY19.


ACPL: Currently stock is trading at PKR 259.39/sh and at P/E(ttm) of 10.28x. The stock has generated return of 48.7% since the start of CY16. The P/E(ttm) of Alt-R cement universe trades at 13.83x which presents that Attock Cement is trading at discount of 25.7%. Our DCF valuation showed a TP of PKR 322/sh for June’17 showing upside potential of 24.14%. Further, valuation based on P/E analysis show that there is high upside potential in ACPL scrip as it is at discount of 25.7% from average universe P/E hence supporting the DCF valuation. Moreover, the expansion of ACPL plant is on fast-track and expected to come online by end of CY17 which will make ACPL to increase its market share further until other players in South comes online.


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KOHC: Currently stock is trading at PKR 257/sh and at P/E(ttm) of 9.04x. The KOHC performance has been substandard as it has generated return of just 6.01% since the start of CY16. The P/E(ttm) of Alt-R cement universe trades at 13.83x which presents that Kohat Cement is trading at discount of 34.6%. We believe, based on relative valuation, there is high upside potential in KOHC scrip. Moreover, the installation of new WHR and decision of expanding its production facility will help KOHC to witness good margins in future to come.


CHCC: Currently stock is trading at PKR 127.52/sh and at P/E(ttm) of 16.07x. The stock has generated return of 37.7% since the start of CY16. The P/E(ttm) of Alt-R cement universe trades at 13.83x which presents that Cherat Cement is trading at premium of 16.2%. We believe the premium is justified as CHCC is the first player to come online with expansion in North making CHCC a potential candidate to absorb major chunk of increasing demand until other players enters the race with their new capacities. The CHCC has moved from 12x-14x band to 14x-16x recently and we believe that it will hover near P/E 16x in near future.


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Economy & Finance

Alt - Cement Sector Call - Sept 28'16