There exists a cement cartel

It’s an open secret that there exists a cement cartel in Pakistan. The Competition Commission of Pakistan had conducted an inquiry report in 2008 based on the prices increase in 2007, and later in 2012 the CCP did another inspection - on both counts the commission did not rule out the possibility of cartel in the industry.

But like any other cartel, cement cartel in Pakistan cannot last for long - the evidence of cartel is there for decades, but it usually breaks when the industry goes through expansion cycle. History suggests when the cement companies go for expansion, capacity utilization comes down and players start under cutting the prices to grasp more share. But after making losses for couple of years, the companies start forming carter again.

For example, there was a cartel during FY04-06, the prices kept on increasing whilst capacity utilization was around 90 percent as well. The EBITDA margins of the companies averaged at 43 percent (FY04-06) versus 28 percent in FY01-03.

FY04-06 was a booming period and parallels can be drawn to today as EBITDA margins are on average 40.5 percent in FY15-9MFY17. The companies started expanding from FY06 and continued till FY10 - the industry capacity increased from 17.9 million tons in FY05 to 45.3 million tons in FY10. That was the time when cartel broke and companies started fighting with each other on market share.

The EBITDA margins on average came down to 20 percent during FY08-11. The ex-factory prices in terms of dollars were at lowest in FY10. Cement manufacturers got their act together and probably had formed the cartel back in FY12. And CCP conducted a search of ACMA premises on 16th Jan, 2012 to probe the cartel.

The ex-factory prices in dollar terms increased by 20 percent in FY12 and companies’ EBITDA margins moved up from 19.7 percent (FY11) to 30.2 percent in FY12. Prices remained ever since and the industry is enjoying the cartel. The real boom has been observed since FY16 as economy is back in expansionary cycle and cement companies’ utilization is on the rise - from average capacity utilization of 76 percent in FY12-15, to 85 percent in FY16 and 87 percent in FY17.

Thus, higher utilization and better prices resulted in 43 percent EBITDA margins in FY16. The trend continues in FY17 (EBITDA: 39% -9MFY17) and probably high margins and full utilization cycle will remain in action in FY18 as well. The upbeat demand and expansion both in public infrastructure and private sector will continue. But the question is for how long the bonanza is there for cement companies.

The companies are again in expansionary cycle the way it happened in FY07-09. Today industry capacity is 46.9 million tons and it is operating close to 90 percent utilization. There would be no change in capacity till Jun18; thereafter new expansion will start coming online - as per plans, in 1QFY20, the capacity will increase by 15 percent to 54.2 million tons. The second round of expansion will come online by 1QFY21 when another 36 percent increase would take industry size to 73.8 million tons.

The industry would expand by 57 percent or 26.9 million tons by Sep 19. The question is by how much would the demand increase by that time. FY16 was the best time for demand as dispatches increased by 9.8 percent, but the increase is limited to 3.8 percent in FY17.

Assuming that the PMLN government would complete its term, cement demand would remain upbeat till elections. Then there would be a period of lull and demand would stagnate, if not decline in FY19. The problem is that cement exports are falling, By FY14, quarter of dispatches were exported while the exports share thinned to 10 percent in FY17. The unnecessary regulatory duty on imports has made exports unattractive as the companies can fetch higher margins from protection in domestic market.

In FY19, cement companies would need to start looking for export avenues - assuming 6 percent pick in domestic demand in FY18 and no change in FY19 and 3 percent increase thereafter, at given level of exports, capacity utilization may increase to 92 percent in FY18-19 and would decline to 81 percent (FY20) and 61 percent in FY21. Seeing the history, cartel may remain active till FY19 and after that the cement margins and prices would start heading south. The companies that develop exports market are a good bet to invest.