Sector witnesses 5 Year low margins

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1 REP 057 Pakistan Equity Cement Sector Research November 6, 20 Cement Sector Profits 3%, Pretax Profits 15% YoY YYin 1QFY18 Sector witnesses 5 Year low margins Nabeel Khursheed AC nabeel@topline.com.pk pk Tel: , Ext: 112 Topline Securities, Pakistan Best Local Brokerage House 2015 & 20 Best Local Brokerage House Brokers Poll 2011, 2012, 2013, 2014 & 20

2 Profitability marred by 5 Year low gross margins of 32% Cement Sector: Financial Highlights Rsmn 1QFY18 1QFY YoY 4QFY QoQ Sales 64,551 58,305 11% 61,825 4% Cost of Sales 43,644 34,256 27% 40,6 9% Gross profit 20,907 24,050 13% 21,659 3% Administrative Expenses 1,786 1,710 4% 2,074 14% Selling & Distribution Expenses 1,786 2,106 15% 1,769 1% Other Operating Expenses 1,260 1,524 % 1,298 3% Other Income 1,570 1,853 15% 2,286 31% Profit from Operations,645 20,563 14% 18,804 6% Finance Cost % 726 2% Profit/(Loss) before Tax,933 19,873 15% 18,078 6% Taxation 3,187 5,756 45% 5,690 44% Profit/(Loss) after Tax 13,746 14,1 3% 12,388 11% Source: PSX, Topline Research Pakistan cement manufacturers posted profitability decline of 3% YoY (pretax profits down 15%) during 1QFY18 vs. double digit growth of % and 32% seen in 1QFY and 1QFY, respectively. Our analysis is based on a sample of 15 listed cement producers (out of a total of 18) which represents 99.7% of total cement companies market capitalization. During 1QFY18, sector sales grew by 11% YoY, mainly supported by 21% growth in local dispatches (total volume up 15%). 2

3 Profitability marred by 5 Year low gross margins of 32% Performance of local dispatches remained robust thanks to increase in demand from construction and infrastructure projects ahead of General Elections next year. We highlight here that construction sector credit offtake was up by an impressive 48% YoY by Sep 20. Gross margins were recorded at 32% (down 9ppts YoY) in 1QFY18, the lowest in 21 quarters. Last lowest margin of 33% was seen in 1QFY13. We attribute this to higher input costs (coal prices averaged US$87/ton, up 34% YoY while hl gas prices increased byaround 25% YoY in 1QFY18) and lower locallnet retention prices. This stresses our thesis that the high profitability growth period of cement producers no longer holds as price pressure kicks in owing to upcoming capacities and inability of manufacturers to pass on rising input costs. During 1QFY18, net retention prices of producers were down by avg. 4% (Rs13/bag) to Rs312/bag. Volatility in prices was mainly due to price pressure in North region (~82% of the total profitability of our sample companies) post commissioning of Cherat Cement s (CHCC) 1.3mn tons of brownfield expansion in Jan 20. While pretax profits were down 15% YoY in 1QFY18, net earnings of cement producers declined by only 3%. This was mainly due to 10ppts YoY lower effective tax rate which contained the decline in profitability. Huge tax benefits given to DGKC on account of plant expansion (tax benefit is also expected in the remaining quarters of FY18) led to lower effective tax rate. If we exclude DGKC, net earnings of our sample actually declined by 11%. 3

4 Company wise profit analysis Pki Pakistan Cement Sector: Profits (Rsmn) Company Name Symbol 1QFY18 1QFY YoY 4QFY QoQ Lucky Cement LUCK 3,0 3,237 7% 3,270 8% Bestway Cement BWCL 2,996 3,202 6% 2,724 10% DG Khan Cement DGKC 2,837 1,908 49% 1,689 68% Maple Leaf Cement MLCF 1,049 1,223 14% % Kohat Cement KOHC % % Cherat Cement CHCC % % Attock Cement ACPL % % Fauji Cement FCCL % % Pioneer Cement PIOC % % Gharibwal Cement GWLC % % Dewan Cement DCL % % Fecto Cement FECTC % 153 % Thatta Cement THCCL % 32 4% Power Cement POWER % 52 63% Flying Cement FLYNG % 48 56% Total 13,746 14,1 3% 12,388 11% Source: PSX, Topline Research On company wise basis, CHCC reported the highest profitability growth of 50% YoY in 1QFY18, followed by 49% growth in DGKC. CHCC s growth was attributable to additional volumes from its new capacity while DGKC s profitability grew on the back of lower effective tax rate. We have a market weight stance on Pakistan Cement Sector. We believe thatt with upcoming capacities of ACPL, DGKC and LUCK (cumulative addition of 5.3mn tons per annum) in South in 2HFY18, price pressure might appear soon in South, which so far has remained unaffected, and therefore warrants a cautious approach to the sector. 4

5 Quarterly analysis at a glance Sample Companies: Sales Sample Companies: Gross profit and gross margin (Rsmn) Sales Growth (Rsmn) GP GP margin 67,000 30% 30,000 50% 57,000 47,000 20% 10% 0% -10% 24,500 19,000 13,500 45% 40% 35% 30% 37,000-20% 8,000 25% 1QFY 2QFY 3QFY 4QFY 1QFY 2QFY 3QFY 4QFY 1QFY18 1QFY 2QFY 3QFY 4QFY 1QFY 2QFY 3QFY 4QFY 1QFY18 Source: Company Accounts, PSX, Topline Research Sample Companies: Profitability Source: Company Accounts, PSX, Topline Research Sample Companies: EBIT and EBIT margin (Rsmn) 22,000 PAT Growth 40% (Rsmn) 31,000 EBIT EBIT Margin 45%,000 12,000 7,000 20% 0% -20% 26,000 21,000,000 11,000 40% 35% 30% 2,000-40% 6,000 25% 1QFY 2QFY 3QFY 4QFY 1QFY 2QFY 3QFY 4QFY 1QFY 18 1QFY1 2QFY1 3QFY1 4QFY1 1QFY1 2QFY1 3QFY1 4QFY1 1QFY1 18 Source: Company Accounts, PSX, Topline Research Source: Company Accounts, PSX, Topline Research 5

6 Analyst Certification and Disclosures The research analyst(s), denoted by an AC on the cover of this report, primarily involved in the preparation of this report, certifies that (1) the views expressed in this report accurately reflect his/her personal views about all of the subject companies/securities/sectors and (2) no part of his/her compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this report. Furthermore, it is stated that the research analyst or its close relative have neither served as a director/officer in the past 3 years nor received any compensation from the subject company in the past 12 months. Additionally, as per regulation 8(2)(i) of the Research Analyst Regulations, 2015, we currently do not have a financial interest in the securities of the subject company aggregating more than 1% of the value of the company. Rating System Topline Securities employs three tier ratings system to rate a stock, as mentioned below, which is based upon the level of expected return for a specific stock. The rating is based on the following with time horizon of 12 months. Rating Expected Total Return Buy Stock will outperform the average total return of stocks in universe Neutral Stock will perform in line with the average total return of stocks in universe Sell Stock will underperform the average total return of stocks in universe For sector rating, Topline Securities employs three tier ratings system, depending upon the sector s proposed weight in the portfolio as compared to sector s weight in KSE 100 Index: Rating Sector s Proposed Weight in Portfolio Over Weight > Weight in KSE 100 Index Market Weight = Weight in KSE 100 Index Under Weight < Weight in KSE 100 Index Ratings are updated daily to account for the latest developments in the economy/sector/company, changes in stock prices and changes in analyst s assumptions or a combination of any of these factors. Valuation Methodology To arrive at our 12 months Target Price, Topline Securities uses different valuation methods which include: 1). Present value methodology, 2). Multiplier methodology, and 3). Asset basedmethodology. Research Dissemination Policy Topline Securities endeavors to make all reasonable efforts to disseminate research to all eligible clients in a timely manner through either physical or electronic distribution suchas ,faxmailetc. Nevertheless, all clients may not receive the material at the same time. Disclaimer i This report has been prepared by Topline Securities and is provided for information purposes only. Under no circumstances this is to be used or considered as an offer to sell or solicitation of any offer to buy. While reasonable care has been taken to ensure that the information contained therein is not untrue or misleading at the time of publication, we make no representation as to its accuracy or completeness and it should not be relied upon as such. From time to time, Topline Securities and/or any of its officers or directors may, as permitted by applicable laws, have a position, or otherwise be interested in any transaction, in any securities directly or indirectly subject of this report. This report is provided only for the information of professional advisers who are expected to make their own investment decisions without undue reliance on this report. Investments in capital markets are subject to market risk and Topline Securities accepts no responsibility whatsoever for any direct or indirect consequential loss arising from any use of this report or its contents. In particular, the report takes no account of the investment objectives, financial situation and particular needs of investors, who should seek further professional advice or rely upon their own judgment and acumen before making any investment. The views expressed in this report are those of Topline Research Department and do not necessarily reflect those of Topline or its directors. Topline asafirm may have business relationships, including investment banking relationships, with the companies referred to in this report. All rights reserved by Topline Securities. This report or any portion hereof may not be reproduced, distributed or published by any person for any purpose whatsoever. Nor can it be sent to a third party without prior consent of Topline Securities. Action could be taken for unauthorized reproduction, distribution or publication. 6