Cement: Is industry in crisis? - II

That cement companies will have to adjust their sales mix in favor of exports—facing reduced demand in domestic markets and increased capacity—was a recognized risk. The warning bells had been rung some time ago (read more: “Cement cartel: Do not resuscitate”, April 11, 2019). That profitability will decline had also been signaled (read more: “Cement: (Lack of) confidence signaling”, Aug 30, 2019). But perhaps, with a 6 percent growth in industry demand during the first half, no one could imagine just how much companies will rely on exports, and how far below would profitability plunge.

Smaller companies like Power Cement, Fecto and Flying Cement are in gross-losses. Mid-sized companies like Mapleleaf and Pioneer are in negative EBIT (earnings before interest and tax), while 9 out of 14 cement companies (see above) have a negative net profit margin. Evidently, market circumstances have hurt smaller companies far more than their bigger peers. Many of the firms that went into expansion were able to grow market share and reach wider markets. This allowed them to grow sales volumetrically, and provided them with a cushion against lower retention prices and higher costs.

Price competition has been a bane. It is every man for himself in the cement market as growing capacity and reduced domestic demand culminated into prices falling. Many cement companies were also selling on steep discounts to keep capacity utilization at maximum (read more: “Over-capacity, under-pressure!” Dec 27, 2019). According to a price point data reported by the Pakistan Bureau of Statistics (PBS) for key cities, cement prices on average fell by Rs85 per cement bag since Jul-19 across cities and between Rs140 and Rs150 in some locations north of the country where competition was fierce.

In percentage terms, cement prices came down 5 to 25 percent between Jul-19 and Jan-20. Naturally, this hit the combined top-lines of cement companies (-8% in 1HFY20 for the 14 companies used in this analysis) and the subsequent gross profit margins. Revenue per unit sold came down between 2 and 26 percent for cement firms with only Attock and Power Cement—both of which are located in the south zone—registering a positive growth in revenue per ton indicative of more stable price retention in southern domestic markets (which has historically hold true compared to markets in the north where there are many more cement firms that are competing and prices remain in flux) as well as abroad.

The other big component toward the gross profit decline are higher costs. Though international coal prices were steadily moving down (32% decline in average South African coal price)—which was a great opportunity for cement companies to adopt prudent inventory management practices—electricity and gas tariffs have been raised. Depreciation may have offset some of the positive effects of cheaper imported coal while overall inflation raised the cost of most raw materials. Meanwhile, companies in the north have also incurred a 160 percent higher charge on raw material (limestone and clay) royalty they pay to the government.

For companies exporting overseas, distribution costs have been greater which pushed overheads up. Meanwhile, others that have either been short-term borrowing from banks for working capital needs or have taken out fixed investment loans for their expansions of facilities and capacity have also experienced a higher finance cost as a share of total revenues. DGKC (7% to 12% in 1HFY20), MapleLeaf (6% to 10%) and Power (3% to 16%) stand out.

It is clear that nearly all the cement firms are swimming underwater, some struggling to stay afloat more than others. More aggressive exporting strategies, keeping the purse strings tighter on overheads will help in the coming months. What will help substantially is a recovery in domestic markets which the industry continues to rely on—in 1HFY20, exports were 18 percent of total dispatches, higher than the 15 percent share last year but still not the dominating contributor of volumes. Some signs of such a recovery is evident from recent dispatch numbers. Hopes are also pegged to the groundbreaking of the Naya Pakistan Housing Projects which will boost demand—if not across the country, at least in Punjab where projects have begun to take shape. Demand recovery will improve retention prices as well. For now, the future is somber.