The sustained economic growth entered into third consecutive year, the cement sector to perform well and profits of the sector might grow as much as 55 percent in the current fiscal year, as the government has planned to build infrastructure, roads, dams and bridges to overcome the shortcomings.
Over the past two months the cement scrip listed on the local bourses have out-performed the KSE-100 Index as their market capitalisation has increased by 28 percent compared to the Index rise of 6 percent. Upbeat 1st quarter results along with the October 8th, 2005 earthquake in Pakistan have been the main reason behind this rally.
Going forward, however, profitability of the cement sector is a concern, as the industry is undergoing hefty expansions.
Atif Malik, research analyst at Jahangir Siddiqui Capital Markets, said that historically, the local cement sector has been one of the most volatile sectors in terms of earnings. It was a decade ago that the cement sector was enjoying good profitability with economy growing and hardly any excess capacity existing. But then came the capacity expansions by the producers in which almost all the major players leveraged themselves (some even beyond their means) in order to keep up pace with their peers. Thus, this along with stagnant demand, economic turmoil in the country and steep hike in furnace oil prices led the industry to incur record losses of around Rs 4 billion in FY99.
PROFITS: Nevertheless, with economic turnaround in the country, rising cement demand and close co-ordination among the producers, the industry picked itself up and portrayed decent profits during the last three fiscal years. As from a loss in FY02, listed cement companies earnings reached Rs 343 million in FY03, followed by Rs 4.0 billion in FY04 and finally a 76 percent jump in FY05 to reach Rs 7.1 billion.
Once again as if history is repeating itself, almost all the major producers have undertaken expansions by which capacity of the industry is expected to double by FY09. Thus, again there exists fear among investors about an over supply situation. Nonetheless, this time around, it is believed demand would remain upbeat amid booming economy. Lower cost of debt will further differentiate the situation from the 1990s.
For the current fiscal year FY06, it is expected cement sector to continue with its magnificent growth thereby posting a profit growth of around 50-55 percent. Increase in profitability in FY06 is expected mainly due to upbeat cement demand on the back of the government's enhanced focus on infrastructure development and strong pricing power by the manufacturers.
Going forward, in FY07 and FY08, profits are expected to stabilise. This is due to the fact that new capacities will start to come online during these two years. For FY07 we expect profitability to grow by 12 percent whereas it would fall by 7 percent in FY08 following a price decline assumption that we have incorporated within our analysis. For FY07 and onwards we expect prices to increase by 2.5 percent annually except for FY08 when it would fall by 3 percent. Capacity utilisation is also assumed to be of 73 percent and 60 percent in FY07 and FY08, respectively.
Beyond that from FY09 and onwards, we expect the sector profitability would once again start increasing although at a lower pace. For FY09 & FY10 we expect profitability to grow by 11 percent and 13 percent respectively.
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