Detailed Report Pakistan ResearchPlease refer to the last page for Analyst Certification and other important disclosures. The cement industry in Pakistan has experienced several alternating phases of pricing arrangements and wars in the last decade. Even though the current pricing arrangement has remained strong to date, recent events compel highlighting the risks involved. Why the current arrangement has held strong: Increase in industry capacity was the principal trigger for igniting price wars in the past. These pricing-cycle experiences have provided valuable lessons to cement manufacturers: (1) Decreasing price does not necessarily imply an increased market share (2) Even if market share is successfully enhanced, reduction in margin is most likely to offset the benefit from higher production (3) Overall, it is extremely risky to break out of collusive agreements in hopes of higher earnings. Recent events have raised concerns: We had recently raised concerns regarding the sustainability of the pricing arrangement among cement manufacturers after the resignation of LUCK from APCMA. In addition to this, DGKC’s announcement regarding plans to expand production capacity in the south made the situation even worse. But the situation has been salvaged for now: Short term concerns regarding the sustainability of the pricing arrangement were recently alleviated after LUCK decided to rejoin APCMA. Cement players made several important decisions in order to bring LUCK back on board including formalizing protocol for expansion decisions and deferring current expansions until Mar-14. These initiatives, in our opinion, shall be sufficient to hold the pricing arrangement for now. We flag higher risk of a price war in future: Even though we believe that the current pricing arrangement shall remain intact for now, DGKC and CHCC’s announcement to expand production capacity hints that several industry players are eyeing expansions given the favorable demand expectations going forward. This, in our opinion, is a serious long term threat to the pricing regime as other major players will also follow in the footsteps of DGKC and announce capacity expansions if DGKC decides to go through with its plan post Mar-14. Incorporating price war scenario in our estimates: We expect that there is a high likelihood of DGKC going through with its expansion plans post Mar-14 and believe that several other large cement players will also follow suit. Despite this belief, we expect that the current pricing arrangement will hold until new capacities come online in FY18. However, after these capacities come online, it is more likely that cement players will disagree over utilization levels leading to a price war. Nevertheless, we do not expect the price war to last very long and believe that prices shall start picking up again within 12-18 months as they have in the past. Downgrade to market weight: We have revised our price targets for Elixir’s cement universe downwards after incorporating for a possible price war in FY18. We maintain our BUY call on LUCK, DGKC, KOHC and CHCC. However, we downgrade our investment case on FECTC, ACPL and FCCL from BUY to HOLD. We also downgrade our investment case on LPCL and MLCF to SELL.Construction & MaterialsCements: Retracing history for finer stock selection P Price Target: PKR290/Share Closing Price: PKR230.5/Share DGKC PA Price Target: PKR100/Share Closing Price: PKR72.4/Share KOHC PA Price Target: PKR150/Share Closing Price: PKR93.2/Share CHCC PA Price Target: PKR65/Share Closing Price: PKR50.8/Share ACPL PA Price Target: PKR135/Share Closing Price: PKR135.4/Share FECTC PA Price Target: PKR40/Share Closing Price: PKR41.0/Share FCCL PA Price Target: PKR11.5/Share Closing Price: PKR11.1/Share MLCF PA Price Target: PKR21/Share Closing Price: PKR22.3/Share LPCL PA Price Target: PKR6.2/Share Closing Price: PKR7.3/ShareSyed Nasir Rizvi AC [email protected](+92-21) 3569 4679Sohaib Bin Shahid AC [email protected]September 30, 2013
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Please refer to the last page for Analyst Certification and other important disclosures
The cement industry in Pakistan has experienced several alternating phases of prici
arrangements and wars in the last decade. Even though the current pricing arrangement h
remained strong to date, recent events compel highlighting the risks involved.
Why the current arrangement has held strong: Increase in industry capacity was the princip
trigger for igniting price wars in the past. These pricing-cycle experiences have provid
valuable lessons to cement manufacturers: (1) Decreasing price does not necessarily imply
increased market share (2) Even if market share is successfully enhanced, reduction in marg
is most likely to offset the benefit from higher production (3) Overall, it is extremely risky t
break out of collusive agreements in hopes of higher earnings.
Recent events have raised concerns: We had recently raised concerns regarding t
sustainability of the pricing arrangement among cement manufacturers after the resignatio
of LUCK from APCMA. In addition to this, DGKC’s announcement regarding plans to expan
production capacity in the south made the situation even worse.
But the situation has been salvaged for now: Short term concerns regarding the sustainabil
of the pricing arrangement were recently alleviated after LUCK decided to rejoin APCM
Cement players made several important decisions in order to bring LUCK back on boa
including formalizing protocol for expansion decisions and deferring current expansions un
Mar-14. These initiatives, in our opinion, shall be sufficient to hold the pricing arrangement f
now.
We flag higher risk of a price war in future: Even though we believe that the current priciarrangement shall remain intact for now, DGKC and CHCC’s announcement to expan
production capacity hints that several industry players are eyeing expansions given th
favorable demand expectations going forward. This, in our opinion, is a serious long ter
threat to the pricing regime as other major players will also follow in the footsteps of DGK
and announce capacity expansions if DGKC decides to go through with its plan post Mar-14.
Incorporating price war scenario in our estimates: We expect that there is a high likelihood
DGKC going through with its expansion plans post Mar-14 and believe that several other lar
cement players will also follow suit. Despite this belief, we expect that the current prici
arrangement will hold until new capacities come online in FY18. However, after thes
capacities come online, it is more likely that cement players will disagree over utilization leve
leading to a price war. Nevertheless, we do not expect the price war to last very long abelieve that prices shall start picking up again within 12-18 months as they have in the past.
Downgrade to market weight: We have revised our price targets for Elixir’s cement univer
downwards after incorporating for a possible price war in FY18. We maintain our BUY call o
LUCK, DGKC, KOHC and CHCC. However, we downgrade our investment case on FECTC, AC
and FCCL from BUY to HOLD. We also downgrade our investment case on LPCL and MLCF
SELL.
Construction & Materials
Cements: Retracing history for finer stock selection
The cement industry in Pakistan has experienced several alternating phases of prici
arrangements and wars in the past decade. Pricing agreements broke down in the past owing
disagreements among manufacturers relating to fair utilization levels for each company, wi
large players trying to gain a higher than allocated market share by disregarding quo
restrictions. The phase of price determination prevalent in the market is a decisive factor
shaping the earnings outlook of the industry and is therefore critical to any analysis concernifuture earnings of cement manufacturers. Even though the current pricing arrangement h
remained strong to date, recent events compel highlighting the risks involved.
Cement prices in Pakistan over time exhibit a predominant pricing cycle with arrangements a
wars alternating every 12-18 months. The only exception to this cycle is in fact the curre
pricing regime with the pricing arrangement remaining intact for the past 37 months.
Pricing Over Time Beginning Ending Highest Lowest Average
Jul-05 to Apr-06 267 323 323 267 287
May-06 to Nov-07 323 235 301 201 240
Dec-07 to Jul-08 235 380 382 235 273
Aug-08 to May-09 380 350 380 345 364
Jun-09 to June-10 350 302 350 265 290
Jul-10 to Present 302 501 504 302 415
Source: PBS, Elixir Research
Strong arrangement: Jul-05 to Apr-06 (10 months): Prices opened at PKR267/bag in Jul-0
increasing sharply to peak in Apr-06 at PKR323/bag. Dispatches increased during this time peri
(FY06), with stable costs of production allowing high profits for the industry.
Price war: May-06 to Nov-07 (19 months): Prices followed a negative trend after Apr-0
bottoming out at PKR201/bag in Jan-07. Following this downtrend, prices immediately jumped
Feb-07, sustaining around PKR235-240 levels for the next 9 months. This period was marked
minimal profits with most manufacturers reporting losses between 2QFY07 and 2QFY08.
Weak arrangement - Increasing coal prices: Dec-07 to Jul-08 (8 months): Following Nov-0
prices increased sharply by PKR145/bag to reach PKR380/bag in Jul-08. However, this w
primarily due to a large uptick in international coal prices. Coal prices surged 1.4x fro
USD81/ton in Nov-07 to USD193/ton in Jul-08. Industry posted higher aggregate losses betwe
3Q-4QFY08 since cement price increments did not offset the surge in coal cost.
Weak arrangement - Decreasing coal prices: Aug-08 to May-09 (10 months): Coal pricplummeted after Jul-08 from USD193/ton to USD60/ton by Mar-09. Even though costs reduce
substantially, cement manufacturers did not pass all the benefit to consumers. Aggregate profi
improved during this period, with only a handful of small manufacturers posting losses in FY09.
Price war: Jun-09 to Jun-10 (12months): Following Jun-09, cement prices witnessed anoth
round of sharp reductions. Prices bottomed at PKR265/bag in Dec-09 and continued to hov
between PKR270-285 between Jan-10 and Jun-10. Aggregate industry losses were close
PKR6bn in this period (FY10).
Strong arrangement: Jul-10 to Present (37 months): Cement prices have followed a consiste
upward trend following Jun-10. Market prices increased by PKR96/bag, PKR40/bag an
PKR45/bag in FY11, FY12 and FY13. Cement prices have jumped by PKR11/bag during FY14
date.
Cement manufacturers have not gained much from price wars
Increase in industry capacity was the principal trigger for igniting price wars amon
manufacturers in the past as larger players disregarded quota restrictions post-expansion
Industry statistics verify that the past price wars were accompanied with or preceded b
significant expansions in capacity. During FY07 LUCK, ACPL, MLCF, PIOC and CHCC expanded the
production capacities. The total expansions that came online during FY07 amounted to 46%
aggregate industry capacity (9.7mn tons). Similarly, during FY08-09, LUCK, MLCF, KOHC a
We had raised concerns regarding the sustainability of the pricing arrangement among ceme
manufacturers after the resignation of LUCK from APCMA on Aug 29, 2013 (Refer to our fla
note titled “Cements: Dark Clouds” dated: August 29, 2013). LUCK’s management highlight
that it had pointed out several issues related to management of the APCMA body. This includ
not keeping LUCK in the loop for critical decisions like price changes and capacity expansion
LUCK had also raised concerns in relation to the pricing arrangement in Afghanistan and passion of the impact of the recent power tariff increase (Refer to our report titled “Cements: Pow
tariff hike may hurt earnings” dated: August 29, 2013). In addition to this, DGKC’s announceme
regarding plans to expand production capacity in the south made the situation even worse. U
till now, LUCK and ACPL were the only major players in the south and we saw this announceme
as a clear threat to LUCK’s market share.
But the situation has been salvaged for now
Short term concerns regarding the sustainability of the pricing arrangement were recent
alleviated after LUCK decided to rejoin APCMA on Sep 16, 2013. An informal meeting was he
between several cement players where the issues raised by LUCK were addressed and
compromise was struck regarding the management of the APCMA body. The body made sever
important decisions in order to bring LUCK on board including: (i) Building consensus on nami
Muhammad Ali Tabba (CEO of Lucky Cement) as the chairman of APCMA (ii) Making it imperati
for companies to take authorization of APCMA before deciding to pursue capacity expansions (
Forming a committee to review demand and supply dynamics before authorizing any expansi
(iv) Deferring current expansion plans (DGKC and CHCC) until Mar-14. These initiatives, in o
opinion, shall be sufficient to hold the pricing arrangement for now. Our discussions wi
industry sources also suggest that cement players have decided to pass on the impact of t
recent power tariff increase by the end of Oct-13.
We flag higher risk of a price war
Even though we believe that the current pricing arrangement shall remain intact for now, t
events surrounding the resignation of LUCK have in fact shed light on serious weaknesses thhad emerged within the APCMA body. APCMA, despite its tampered history, had remaine
strong with things going smoothly and no conflicts emerging for more than three years. Rece
events have however, significantly increased the chances of the body succumbing
disagreements over time and falling into an all-out price war. We have already established th
the last two price wars were primarily triggered by capacity expansions and believe that anoth
expansion-cycle may not be too far away. DGKC and CHCC’s announcement to expa
production capacity hints that several industry players are eyeing expansions given the favorab
demand expectations going forward. This, in our opinion, is a serious threat to the pricing regim
as other major players may also follow in the footsteps of DGKC and announce capaci
expansions if DGKC decides to go through with its plan post Mar-14.
Incorporating price war scenario in our estimates
Owing to the high possibility of an expansion cycle and price war, we have opted to take
conservative stance and incorporated these prospects in our estimates for cement companie
We expect that there is a high likelihood of DGKC going through with its expansion plans po
Mar-14 and believe that several other large cement players will follow suit. Despite this belie
we expect that the current pricing arrangement will hold until new capacities come online
FY18. However, after these capacities come online, it is more likely that cement players w
disagree over fair utilization levels and disregard quota restrictions leading to a price wa
Please refer to the last page for Analyst Certification and other important disclosures
With production capacity standing at 7.8mn tons per annum, Lucky Cement is the large
cement manufacturer in Pakistan and holds the highest market share (18%) in the countr
We highlight LUCK as one of the safest bets in the sector due to sizeable cost advantage ov
peers.
Leading operational efficiencies: LUCK remained the lowest cost producer in our sample of
large companies (98% of industry capacity) during 9MFY13. Despite having a larger share
low margin exports in its sales mix, LUCK managed to outperform industry peers on th
EBITDA margin front as well. EBITDA margin for LUCK clocked in at PKR116/bag in 9MFY1
13% higher than industry average of 103/bag.
WHR and RDF/TDF in place to hedge margins: Lucky Cement’s 25MW Waste Heat Recove
(WHR) projects are expected to make up around 23% of its total electricity requirement
FY14. In addition to this, TDF/RDF project at Karachi site which was completed during 3QFY1
helped LUCK replace 20% of its coal requirement. Combined, these projects are expected
contribute savings of PKR8/bag in FY14, yielding an EPS impact of PKR1.83/share. Th
company is also planning to set a TDF plant at Pezu as well as 5MW WHR plants at both site
These projects will further help LUCK maintain cost leadership in the industry.
Expanding footprint: LUCK led a consortium of other group companies to acquire ICI Pakist
Ltd in 2012. LUCK also has a strong portfolio of international projects lined up including
cement plant in Congo and a joint venture for a 0.9m tons grinding facility in Ira
Furthermore, LUCK started supplying surplus electricity to HESCO during FY13. The companyalso in process of negotiation with PESCO to provide surplus electricity from its Pezu plant.
Valuation: LUCK currently trades at FY14 PER of 6.5x and offers a total return of 31% to o
Jun-14 PT of PKR290/share. We believe that the Congo project, electricity supply to PESCO a
investment in Yunus Energy Limited and other efficiency projects will add further upside to o
Please refer to the last page for Analyst Certification and other important disclosures
Attock Cement Pakistan Limited (ACPL) is a dominant player in the southern region and se
its cement under the premium ‘Falcon’ brand. However, ACPL is a relatively inefficie
player with COGS of PKR221/bag during 9MFY13, 10% higher than industry average and th
second highest in our cement universe. Since the plant runs at full capacity, earnings grow
will be a function of margins which have remained on the lower side compared to peers.
Higher utilization, lower margins to suppress growth: ACPL has been operating at an avera
capacity utilization of 101% during the past five years. Owing to inefficiencies, ACPL’s EBITD
margin clocked in at PKR83/bag during 9MFY13, 19% lower than industry average
PKR103/bag. ACPL seems to be a major loser in our price war scenario owing to high utilizatio
and lower margins. Earnings growth can only be achieved on the back of efficiency projec
that will help ACPL survive amid lower retention levels.
Investing in cost efficiencies: Various initiatives are currently underway to counter the rece
cost hike. These include investing in a coal-based power plant and replacement of cement m
internals. Coal-based power project is expected to cost ~USD1.4mn per MW and sh
generate electricity at a cost of ~PKR9/Kwh (at current coal prices). On the other han
replacement of cement mill internals is expected to cost PKR750mn and would reduce pow
consumption by 9.0Kwh/ton. While we have factored in the impact of cement mill internals
our estimates, we await further clarity on implementation of the coal project.
Strong cash position to support efficiency investments: ACPL possess a debt-free balan
sheet with cash balances of PKR2.7bn (including short term investments). This shall allow tcompany to undertake efficiency investments without needing external finances.
Valuation: ACPL trades at FY14 PER of 5.5x and offers total return of 10% to our June-14 targ
price of PKR135/share. Owing to low production efficiency and limited surplus capacity, w
downgrade our stance on the company from BUY to HOLD. However, implementation co
based power generation project may improve our investment case.
Please refer to the last page for Analyst Certification and other important disclosures
FECTC is among the smallest cement plants in the country with production capacity standi
at 0.82mn tons per annum. The company is a relatively inefficient player with 9MFY
COGS/ton 14% higher than industry average and highest among Elixir’s Cement Univers
Owing to low production efficiency, we believe FECTC is a very risky bet in the event of
reversal in price trend and downgrade our stance on the stock from BUY to HOLD.
High costs to limit margins: FECTC is a relatively inefficient player with 9MFY13 COGS clocki
in at PKR230/bag, 14% higher than industry average of PKR201/bag. In fact, FECTC is the lea
efficient producer among Elixir’s Cement Universe. Owing to high costs of production, FECT
generates the lowest EBITDA margin in our cement space as well. 9MFY13 EBITDA marg
clocked in at PKR70/bag, PKR33/bag lower than industry average of PKR103/bag.
Small size to bound investment in production efficiencies: Even though FECTC holds a 6M
WHR plant and generates ~30% of its power requirement from the project, it has no RDF/TD
project to mitigate potential fuel costs increases. We believe that company’s small size lim
its ability to aggressively invest in production efficiencies after the recent increase in pow
tariff. This places the company at a considerable disadvantage to other players in the indust
with cash-rich balance sheets and significant room to invest in efficiency enhanceme
projects. Owing to this we expect FECTC to face margin attrition even under a price-u
scenario. We expect EBITDA margin for the company to clock in at PKR84/bag, PKR80/bag a
PKR76/bag during FY14, FY15 and FY16.
Valuation: FECTC currently trades at FY14 PER of 2.6x. Weak production efficiencies alimited ability to reduce costs lead us to believe that FECTC shall be a major loser in the eve
of a price war. Our price target of PKR40/share offers total return of 13%. We downgrade o
Please refer to the last page for Analyst Certification and other important disclosures
LPCL is a mid-sized cement plant with annual production capacity of 2.04mn tons. Th
company has been marred with poor performance in the past, and incurred losses betwee
CY06-11. Owing to high operating and financial leverage, the company is a relative
inefficient player with EBITDA margins among the lowest in our cement space. Aft
incorporating for a possible price war in FY18, we have downgraded our investment case o
LPCL from HOLD to SELL.
Low retention prices and high costs have restricted margins: On the back of low retentio
prices and high operating costs, LPCL has one of the lowest EBITDA margins in our ceme
space. LPCL posted an EBITDA of PKR81/bag during 9MFY13, significantly lower than indust
average of PKR103/bag. Retention prices during the same period clocked in at PKR305/ba
lower than industry average of PKR311/bag.
Complete reliance on the national grid to cause margin attrition: With no WHR or capti
power plant, LPCL is one of the few companies in our cement space that is completely relia
on the national grid to fulfill its power requirement. Owing to this, we believe that t
company has been a key loser under the recent ~60% increase in power tariff. Even though w
expect prices to increase by PKR20/bag by the end of Oct-13 to pass on the cost hike, LPCL w
face margin attrition during 2HCY13 with costs increasing by PKR25/bag.
Deleveraging to offer some relief: Owing to strong expected debt repayments, we expe
finance costs for the company to clock in at PKR515mn and PKR463mn during CY13 and CY1
down 51% and 10% YoY. This shall offer some relief to profitability after the recent cost hiand allow LPCL to post consistent earnings growth through FY16.
Valuation: LPCL is currently trading at FY14 PER of 5.2x. With high operating and financ
leverage, we believe that the company is a risky play in the event of a price war. Our pri
target of PKR6.2/share offers negative total return of 10% and we downgrade our stance o
Analyst Certification The research analyst(s) denoted 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 and (2) no part of his/hercompensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this report. Disclaimer The report has been prepared by Elixir Securities Pakistan (Pvt.) Ltd and is for information purpose only. The information and opinions containedherein have been compiled or arrived at based upon information obtained from sources, believed to be reliable and in good faith. Suchinformation has not been independently verified and no guaranty, representation or warranty, expressed or implied is made as to its accuracy,completeness or correctness. All such information and opinions are subject to change without notice. Descriptions of any company or companies
or their securities mentioned herein are not intended to be complete and this document is not, and should not be construed as, an offer, orsolicitation of an offer, to buy or sell any securities or other financial instruments. Research Dissemination Policy Elixir Securities Pakistan (Pvt.) Ltd. endeavors to make all reasonable efforts to disseminate research to all eligible clients in a timely manner
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time. Company Specific Disclosures Elixir Securities Pakistan (Pvt.) Ltd. may, to the extent permissible by applicable law or regulation, use the above material, conclusions, research oranalysis in which they are based before the material is disseminated to their customers. Elixir Securities Pakistan (Pvt.) Ltd., their respectivedirectors, officers, representatives, employees and/or related persons may have a long or short position in any of the securities or other financialinstruments mentioned or issuers described herein at any time and may make a purchase and/or sale, or offer to make a purchase and/or sale of any such securities or other financial instruments from time to time in the open market or otherwise. Elixir Securities Pakistan (Pvt.) Ltd. may
make markets in securities or other financial instruments described in this publication, in securities of issuers described herein or in securitiesunderlying or related to such securities. Elixir Securities Pakistan (Pvt.) Ltd. may have recently underwritten the securities of an issuer mentioned
herein. Other Important Disclosures Foreign currency denominated securities is subject to exchange rate fluctuations which could have an adverse effect on their value or price, or theincome derived from them. In addition, investors in securities such as ADRs, the values of which are influenced by foreign currencies effectivelyassume