Company Report. Buy. Strong Pricing to Drive Growth. July 18, 2012

Transcription

1 Company Report Lucky Cement Limited Strong Pricing to Drive Growth July 18, 2012 Construction and Materials We reaffirm our buy stance on Lucky Cement Limited (LUCK) with an upwards revision in our Dec-12 target price to PKR 170/share, offering an upside potential of 32.5%. Our positive stance stems from the strong pricing scenario, softening coal prices and a healthy demand outlook with the government s renewed interest in PSDP spending. The company s strategic investments in the Democratic Republic of Congo and Iraq along with its diversification strategy of venturing into a wind power project will further unlock its potential going forward. LUCK is on a course to diversify its earnings through 40MW power sales and carbon credits. In addition, LUCK is also planning to acquire ICI Pakistan Limited, which if successful, will further diversify its earnings. LUCK the biggest beneficiary of strong pricing Economies of scale and energy efficiency make LUCK the lowest cost cement manufacturer in the country having 18.3% lower cost than its competitors. This makes LUCK the biggest beneficiary of the current pricing scenario, which is evident from its 37.8% gross margin in 9MFY12 as compared to 24.5% by the industry. With a resilient cement price outlook and softening cost pressures, we expect LUCK to earn its highest ever gross margin of 43% in FY13. Before this, such a rosy margin scenario was witnessed in FY04, when company achieved 37.8%. Power sales likely to add PKR 1.4/share in FY13 The company has entered into power sales agreements with HESCO and PESCO for 20MW each. The company has already started its 20MW power dispatch to KESC since July 02, 2012 where as commission of power sale to PESCO is expected in 2HFY13. Under the New Captive Power Policy, LUCK is expected to generate PKR 1.8bn and PKR 2.8bn in FY13 and FY14, with bottom line impact of PKR 1.4/share and PKR 2.2/share, respectively. Buy Target Price Last Closing Upside KSE Code Bloomberg Code Market Cap (US$ m) Outstanding Shares (m) Free Float 12M Avg. Daily Turnover (m) 12M High/Low (PKR) Major Shareholders Shares Shareholding Others, 14% General Public, 4 2% Yunus Brothers Group, 3 9% % LUCK LUCK PA % /70.48 Yunus Brothers NIT, 5% Softening coal prices to expand the margins further In line with crude oil, coal price has crashed in June 2012 to USD 87/ton (Richards Bay fob), lowest since October Besides fall out in commodity prices, coal prices were also affected by the sluggish demand from China. In our base case assumption we expect coal prices to cool off by 9% and 16% in FY13 and FY14, respectively. Coal is the biggest cost component of cement manufacturing process constituting around 41.2% of the total production cost for LUCK. Thus, this declining trend in coal prices will further boost the margins for LUCK going forward. Financial Highlights 2 190% 160% 1 100% 70% Stock Performance LUCK KSE100 Jul-11 Aug-11 Aug-11 Sep-11 Oct-11 Nov-11 Nov-11 Dec-11 Jan-12 Feb-12 Feb-12 Mar-12 Apr-12 Apr-12 May-12 Jun-12 Jul-12 PKR mn FY10A FY11A FY12E FY13F FY14F Net Revenues 24,509 26,018 33,100 35,436 35,814 Net Earnings 3,137 3,970 6,700 8,955 9,446 EPS (PKR DPS (PKR) PER (x) Div Yield (%) 3.1% 3.1% 3.9% 3.9% 4.7% ROE 13.0% 15.0% 22.1% 24.5% 21.4% Sources: Company Financials, AHL Research Source: Bloomberg Analyst Syed Abid Ali abid.ali@arifhabibltd.com For important disclosure and analyst certification, kindly refer to end of the report

2 Valuation Summary Our Discounted Cash Flow (DCF) based December 2012 target price for LUCK works out to PKR 170/share, translating into a striking upside potential of 32.5% from closing price of PKR 128.3/share. Our valuation is based on the market return of 18%, beta of 1.16 and a terminal growth rate of 3%. Besides this sizeable upside potential the stock is trading at FY13 PER of 4.6x, offering a deep discount of 26% from the market PE, thus forming a strong case of rerating from these levels. Risks to Valuation Cement Price Risk Our valuation is very sensitive to the cement price, evident from the fact that every PKR 5/bag change in our Ex-Factory price assumption changes our earnings forecast by PKR 0.8/share or 3.1%. International Coal Price Risk Coal is the biggest cost component of the cement manufacturing process constituting around 43% of the total manufacturing cost. We have pegged our coal price assumption with international crude oil price and we are expecting coal prices to average around USD 95/ton in FY13. Every USD 5/ton change in coal price forecast will change our FY13 EPS by PKR 0.82 or 3.3%. Gas availability Risk There is a proposal under consideration to divert gas from captive power to KESC. In such scenario, LUCK will have to use its newly built connection line to import power from HESCO rather than dispatching it. As per our calculations, if LUCK has to rely on HESCO grid for 2 months of power requirement than its electricity cost may jump by 5% and revenue from power sales to HESCO may reduce by 14%. We see lower probability of this risk materializing, nonetheless if may have an adverse EPS impact of ~PKR 1.1/share in FY13. Healthy pricing to drive earnings growth Cement prices in the domestic market have steadily withstand the hawkish stance of Competition Commission of Pakistan (CCP) and weak demand pressures during wheat harvesting; remaining unbudged around PKR per bag. Prices in the retail market averaged at PKR 419/bag during FY12, an 18.3% jump, when compared with PKR 354/bag averaging in FY11. Pricing outlook still remains attractive In our discussion with the management of cement companies, we have learned that the industry is far from any price war. Our confidence in their claim is solidified with the fact that the current pricing environment prevailed even after demand shocks and the hawkish stance of CCP. Following are a few factors, highlighting the resilience of the current pricing scenario. Retail Cement Prices PKR /bag Sep-10 Nov-10 Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11 Jan-12 Mar-12 May-12 Jul-12 Source: Pakistan Bureau of Statistics Everybody s a winner! The current pricing environment has enabled large cement manufacturers to further consolidate their position by investing in energy efficiency projects. Small and medium players on the other hand have found some breathing space after facing consistent losses for a couple of years. Thus, the industry as a whole is emerging as a winner under this scenario. 2

3 Only the big players can break it, but they can t afford it either! Breaking up of status quo or a price war could only be initiated by large cement manufacturers. However with a huge investment of PKR 5.9bn and acquisition plans of ICI in the pipeline, Lucky Cement would not like to engage in a price war. Similarly D.G Khan Cement and Bestway Cement, 2 nd and the 3 rd largest cement producers are not in this position either as both have suffered from extremely low profitability in FY11, which they would like to recover in FY12 and FY13. Small players on the other hand don t have the financial muscle to muster such a move. It worked when demand was dull, why break it when demand is picking up! Pricing consensus prevailed even when demand remained sluggish during 2HFY11. We find it highly unlikely that any price venture would take place when demand has already inched up in FY12 (8% YoY) and the momentum is likely to continue in FY13 due to renewed government interest in infrastructure spending. Cost pressures may also keep price from falling Although coal prices in the international market have cooled down by 15.2% in 4QFY12, the falling rupee has reduced the full benefit of this decline. Rising electricity and gas prices will also increase cost pressures, keeping cement manufacturers from reducing prices. This is exactly what we have witnessed with the start of FY13, when cement manufacturers did not pass on the FED cut to the end consumers due to increase in gas Cess by PKR 87/mmbtu. Thus we remain upbeat about the continuation of this pricing scenario with our Ex- Factory price assumption of PKR 360/bag and PKR 355/bag in FY13 and FY14, respectively. However it is pertinent to mention here that every PKR 5/bag change in our assumption reduces bottom line by PKR 0.8/share; as summarized in the sensitivity table below. Sensitivity Analysis of Ex-Factory Prices FY13F FY14F FY15F Target Price Base Case Prices EPS PKR Scenario1: Increment by PKR 10/bag Scenario2: Increment by PKR 5/bag Scenario3: Base Case Scenario4: Reduction by PKR 5/bag Scenario5: Reduction by PKR 10/bag Source: AHL Research Dispatch growth to remain subdued We have been witnessing a paradigm shift in LUCK s sales strategy since FY11, when the company started to increase its focus towards the domestic market due to better margins. For instance LUCK s exports accounted 47.1% of total dispatches in FY10, which has dropped considerably around 37.7% in FY12. This renewed interest in domestic sales has enabled LUCK to attain 16% share in the domestic volumes. Despite suffering a 5% YoY decline in exports, LUCK still holds the largest (26%) share in exports, followed by DGKC with 14% share of the export pie. We expect domestic volumes to grow at CAGR 4.8% (FY12-14) to 4.1mn tons, taking domestic contribution to 68.1% in total volumes. Volumetric growth at 1.6% CAGR (FY12-14) mn tons Local Exports Capacity Utilisation 84% 82% 80% 78% 76% 74% - 72% Source: Company Financials and AHL Research 3

4 Domestic Market Share (FY12) Exports Market Share (FY12) Others 44% LUCK 15% DGKC 12% Others 37% LUCK 26% Maple 8% FCCL 7% Best 14% FCCL 6% Maple 7% Best DGKC 14% Source: APCMA Revenues are expected to jump at 11.2% CAGR With strong pricing scenario coupled with healthy volumetric growth we expect the net revenues of the company to jump at 8.6% CAGR (FY11-14) to PKR 35.8bn. PKR/bag Strong pricing coupled with healthy volumetric growth is fueling the top line Ex-Factory Price Net Revenues (LHS) PKR bn mn tons Total Volumes (RHS) Net Revenues (LHS) PKR bn Source: Company Financials and AHL Research Softening coal prices to expand the margins further In line with crude oil, coal price has crashed in June 2012 to USD 81/ton (Richards Bay fob), lowest since October Besides fall out in commodity prices, coal prices were also affected by the sluggish demand from China. Coal prices are expected to remain under pressure till demand from emerging markets regain its original position. We have pegged our coal price assumption with international crude oil price because of its strong correlation (0.88) and an R 2 of Crude prices continued to remain under pressure as US and EU continue to struggle from muted growth and sovereign debt crisis, which pushed WTI crude down to USD 77/bbl level. Oil prices have regained by x% to USD 88/bbl from its recent low, mainly on account of sanctions on Iran, effective from July 1, In our base case assumption we expect coal prices (RB fob) to cool off by 9% and 16% to USD 95/ton and USD 89/ton in FY13 and FY14, respectively from USD 105.5/ton averaging in FY12. USD/ton Coal; trading at 20 months low Jan-11 Feb-11 Mar-11 Apr-11 May-11 Jun-11 Jul-11 Aug-11 Sep-11 Oct-11 Nov-11 Dec-11 Jan-12 Feb-12 Mar-12 Apr-12 May-12 Jun-12 Source: Bloomberg Our earnings forecast and valuations are very sensitive to coal price assumption, as coal constitutes around 41.2% of the total production cost for LUCK. Following sensitivity analysis suggests that every USD 5/ton change in coal price assumption increases our earnings estimates by PKR 0.8/share. 4

5 Sensitivity Analysis of International Coal Prices FY13F FY14F FY15F Target Price Base Case Prices EPS PKR Scenario1: Increment by USD 10/ton Scenario2: Increment by USD 5/ton Scenario3: Base Case Scenario4: Reduction by USD 5/ton Scenario5: Reduction by USD 10/ton Source: AHL Research TDF Plant to reduce the cost further The company has been investing in energy efficiency for past couple of years as it has completed two Wast Heat Recovery Plant (WHRP) of 25MW at both its Karachi and Pezu Plants. To take a step forward in energy efficiency, the company has invested in Tyre Derived Fuel Plant (TDFP) at its Karachi plant, which will replace expensive coal with scrap tyres. Tyres in the kiln burning yields savings on two accounts; It costs ~18% lower than imported coal It ~20-25% higher heat value than coal; thus almost 20-25% less tyres would be required to generate the same amount of energy as with coal. The company started its trial production in December 2011 and has reached replacement rate, with a target of 40% in FY13. We have incorporated a replacement rate in FY13, which is likely to have an after tax savings of PKR 1.8/share in FY13. Lowest cost production Economies of Scale and energy efficiency make LUCK the lowest cost producer in the domestic market. As per the latest accounts available, LUCK produces a ton of cement in PKR 3,402, an 18% lower than the industry average of PKR 4,166, giving it a cover of PKR 764/ ton (PKR 38/bag) if the price competition does occur in the industry. LUCK has a lead of PKR 19/bag over its closest cost competitor, DGKC, which requires PKR 3,780 to produce one ton of cement. This further strengthens our stance about competitiveness of LUCK and its ability to command the price war situation, if it arises. Producing at 18% lower cost than the Industry PKR/ ton 4,500 4,300 4,100 3,900 3,700 3,500 3,300 3,100 2,900 2,700 2,500 4,493 4,122 3,780 3,791 3,857 3,402 LUCK DGKC BWCL KOHC ACPL MLCF Source: AHL Research 5

6 Gross margin to touch highest ever! Downwards sticky cement prices, falling coal prices and energy efficiency measures like WHRP and TDFP have started to pay dividends as LUCK has already achieved 8 years high gross profit margin of 37.8% in 9MFY12. It is pertinent to mention that the company operated its TDF plant only in 2HFY12 only at a replacement rate. Thus we expect the company to post highest ever gross margin of 43% in FY13 due to strong pricing outlook, softening coal prices and full impact of TDF. Gross profit and Margins PKR bn Gross Profit Gross Margins 50% 45% 40% 35% 25% 15% 5% 0% PKR bn Gross Profit YoY Change 16 50% 40% % Source: Company Financials and AHL Research Power Sales; diversifying revenue base LUCK has started to dispatch 20MW of electricity to Hyderabad Electric Supply Company (HESCO), a local power distribution company from July 2, The Power Purchase Agreement (PPA) for this electricity sale comes under New Captive Power Policy approved by NEPRA, which guarantees greater returns for power seller in terms of higher fixed and financial charges components. The company has another agreement to sell 20MW of electricity from its Pezu plant to PESCO, which is likely to start commercial operations in 2HFY13. Assuming an 80% dispatch rate, we expect LUCK to generate additional revenue of PKR 1.5bn from the power sales in FY13, with a bottom line impact of PKR 1.15/share. Carbon credits; energy efficiency pays LUCK has qualified for Carbon Credits under Kyoto Protocol for its WHRPs. The Company will reduce carbon emission equivalent to ~ 80k CERs. Carbon credits are not expected to add much to the revenues as the carbon market in EU has plummeted since the start of CY11. A CER, which was trading above EUR 10/CER in January 2011 has dropped to EUR 3.9/CER in July Assuming a rate of EUR 4/CER, carbon credits are likely to yield another revenue stream of around PKR 31mn in FY13. Moving beyond borders LUCK is undertaking two expansion projects, a 1mn tons per annum green field project in Democratic Republic of Congo and a 0.9mn tons grinding facility in Iraq. The company is expected to bear a capital expenditure of around PKR 5.9bn in FY13 to invest in these projects. Both of these strategic investments are made in the areas which are going under reconstruction phase, where strong domestic demand and attractive pricing environment will shorten the payback period. PKR bn Power Sales Power Sales FY13 FY14 FY15 FY16 FY17 FY18 Sources: NEPRA and AHL Research PKR mn Carbon Credits Carbon Credit CER Rate Source: AHL Research Load Factor 90% 80% 70% 60% 50% 40% 0% FY13 FY14 FY15 FY16 FY17 FY18 EUR/CER

7 Venturing chemicals; eyeing to acquire ICI Pakistan LUCK is amongst the investors who are looking to acquire ICI Pakistan Limited (ICI), a company to inherit non paint businesses from Akzo Nobel Pakistan after its demerger. ICI is one of the largest PSF manufacturers in Pakistan, which goes into the textile sector. Yonus Brothers Group, the sponsors of LUCK has a significant exposure in textile, thus acquisition of ICI would create a vertical integration for the group. LUCK has a strong balance sheet, with debt comprising hardly 12% of the balance sheet size. This coupled with strong free cash flow generation of PKR 7.2bn and PKR 4.6bn in FY12 and FY13, respectively makes the company in a good position to acquire ICI without putting considerable debt pressure on its balance sheet. Earnings are expected to jump by 33% CAGR We expect the net earnings to grow at 3 years CAGR of 33% to PKR 9.4bn in FY14. Despite this strong earnings growth we are not upbeat on the dividend payout of the company. We expect the company to pay dividends of PKR 5/share and PKR 6/share at a payout ratio of 24% and 13% in FY12 and FY13, respectively. Expansion and diversification plans of the company are likely to keep payout at low levels. Profitability and Net Margins PKR bn 10 PAT Net Margin % 15% PKR/share EPS and DPS EPS DPS Payout 45% 40% 35% 25% 15% 5% 0% 45% 40% 35% 25% 15% Margins outlook Gross EBITDA Net Source: Company Financials and AHL Research About the Company Lucky Cement (LUCK) is the largest cement manufacturer in Pakistan with an installed capacity of 7.75mn tons. LUCK operates two cement plants, strategically located in Pezu, close to Afghanistan boarder and Karachi, a coastal city in Pakistan. This location gives the company freight advantage over its competitors in exporting cement to Afghanistan and through sea. The company has the largest market share of 26% in exports. Source: AHL Research The company is managed by the renowned Yunus Brothers Group, which has exposure to Textile, energy and cement sectors. Timely decisions of management regarding expansion, financial management, infrastructure development for exports and implementing new technologies has made LUCK the market leader in Pakistani cement industry. 7

8 Summary Financials and Forecasts Income Statement (PKR mn) FY10A FY11A FY12E FY13F FY14F Net Sales 24,509 26,018 33,100 35,436 35,814 Cost of Sales 16,530 17,306 20,353 20,184 20,615 Gross profit 7,979 8,711 12,747 15,252 15,199 Admin expenses Selling expenses 3,433 3,236 3,287 3,181 3,083 Other income ,264 Other expenses Earnings before Interest and Tax 3,987 4,838 8,550 11,786 12,395 Depreciation 1,411 1,571 1,655 1,684 1,717 EBITDA 5,398 6,409 10,205 13,471 14,112 Financial charges Profit before tax 3,418 4,321 8,149 11,629 12,267 Taxation ,449 2,675 2,821 PAT 3,137 3,970 6,700 8,955 9,446 Earnings per Share - (PKR) DPS Balance Sheet FY10A FY11A FY12E FY13F FY14F Share Capital & Reserves Paid-up share capital 3,234 3,234 3,234 3,234 3,234 Shares Premium 7,343 7,343 7,343 7,343 7,343 General reserve 10,000 12,500 12,500 12,500 12,500 Accumulated Profit 4,519 4,696 9,779 17,117 24,946 Shareholders' equity 25,096 27,773 32,856 40,194 48,023 Non Current Liabilities Long Term Finances 1, Other Non Current Liabilities 1,914 2,082 2,082 2,082 2,082 Total Non Current Liabilities 3,573 2,740 2,521 2,301 2,082 Current Liabilities Current Portion of Long Term Finances Short Term Financing 6,267 6,302 1,260 1,134 1,021 Trade and Other Payables 3,199 4,129 4,180 4,469 4,516 Total Current Liabilities 9,642 10,697 5,660 5,823 5,757 Total Liabilities and Equity 38,310 41,210 41,037 48,318 55,861 Assets Total Fixed Assets 31,378 31,705 31,150 29,765 29,348 Long Term Investments and Other Assets ,689 5,689 Total Non Current Assets 31,439 31,765 31,210 35,454 35,037 Current Assets Store and Spares 4,008 6,314 6,620 7,087 7,163 Stock in Trade 609 1,249 1,154 1,145 1,169 Trade Debts and Other Receivables 1,921 1,531 1,831 1,896 1,907 Cash ,736 10,585 Total Current Assets 6,871 9,444 9,827 12,864 20,824 Total Assets 38,310 41,210 41,037 48,318 55,861 8

9 Disclaimer and related information Analyst certification The analysts for this report certify that all of the views expressed in this report accurately reflect their personal views about the subject companies and their securities, and no part of the analysts compensation was, is or will be, directly or indirectly related to specific recommendations or views expressed in this report. Disclosures and disclaimer This document has been prepared by investment analyst at Arif Habib Limited (AHL). AHL investment analysts occasionally provide research input to the company s Corporate Finance and Advisory Department. This document does not constitute an offer or solicitation for the purchase or sale of any security. This publication is intended only for distribution to current and potential clients of the Company who are assumed to be reasonably sophisticated investors that understand the risks involved in investing in equity securities. The information contained herein is based upon publicly available data and sources believed to be reliable. While every care was taken to ensure accuracy and objectivity, AHL does not represent that it is accurate or complete and it should not be relied on as such. In particular, the report takes no account of the investment objectives, financial situation and particular needs of investors. The information given in this document is as of the date of this report and there can be no assurance that future results or events will be consistent with this information. This information is subject to change without any prior notice. AHL reserves the right to make modifications and alterations to this statement as may be required from time to time. However, AHL is under no obligation to update or keep the information current. AHL is committed to providing independent and transparent recommendation to its client and would be happy to provide any information in response to specific client queries. Past performance is not necessarily a guide to future performance. This document is provided for assistance only and is not intended to be and must not alone be taken as the basis for any investment decision. The user assumes the entire risk of any use made of this information. Each recipient of this document should make such investigation as it deems necessary to arrive at an independent evaluation of an investment in the securities of companies referred to in this document (including the merits and risks involved), and should consult his or her own advisors to determine the merits and risks of such investment. AHL or any of its affiliates shall not be in any way responsible for any loss or damage that may be arise to any person from any inadvertent error in the information contained in this report. We and our affiliates, officers, directors, and employees may: (a) from time to time, have long or short positions in, and buy or sell the securities thereof, company (is) mentioned herein or (b) be engaged in any other transaction involving such securities and earn brokerage or other compensation or act as advisor to such company (is) or have other potential conflict or interest with respect to any recommendation and related information and opinions. The disclosures of interest statements incorporated in this document are provided solely to enhance the transparency and should not be treated as endorsement of the views expressed in the report. AHL generally prohibits it analysis, persons reporting to analysts and their family members from maintaining a financial interest in the securities that the analyst covers Arif Habib Limited, Corporate Member of the Karachi, Lahore and Islamabad Stock Exchanges and Pakistan Merchentile Exchange. No part of this publication may be copied, reproduced, stored or disseminated in any form or by any means without the prior written consent of Arif Habib Limited. 9

10 Contact Information Equities Research Designation Telephone Faisal Khan Deputy Head of Research Syed Abid Ali Research Analyst Ext : 211 Sana Tawfik Economist sana.tawfik@arifhabibltd.com Ext : 248 Umar Hafiz Research Analyst umar.hafiz@arifhabibltd.com Ext : 248 Ovais Shakir Database Officer ovais.shakir@arifhabibltd.com Ext : 211 Domestic sales Designation Telephone Mohammed Imran, CFA, ACCA Head of Equity Sales m.imran@arifhabibltd.com M. Yousuf Ahmed Senior Vice President yousuf.ahmed@arifhabibltd.com Farhan Mansoori Vice President farhan.mansoori@arifhabibltd.com Syed Farhan Karim Vice President farhan.karim@arifhabibltd.com Afshan Aamir Vice President afshan.aamir@arifhabibltd.com Faraz Naqvi AVP faraz.naqvi@arifhabibltd.com Furqan Aslam AVP furqan.aslam@arifhabibltd.com Azhar Javaid Manager Corporate Sale azhar.javaid@arifhabibltd.com International Sales Designation Telephone Adnan Katchi Head of International Sales adnan.katchi@arifhabibltd.com Money Market & FX Designation Telephone Ziley Askari Head of Treasury askari@arifhabibltd.com Corporate finance and advisory Designation Telephone M. Rafique Bhundi Head of Corporate Finance rafique.bhundi@arifhabibltd.com Usman Saeed Research Analyst usman.saeed@arifhabibltd.com Muhammad Zeeshan, CFA Assistant Vice President muhammad.zeeshan@arifhabibltd.com Ahmad Zeeshan Senior Analyst ahmad.zeeshan@arifhabibltd.com Management Designation Telephone Bilal Amanullah Moti CEO bilalmoti@arifhabibltd.com