Cement: BESTWAY CEMENT COMPANY LIMITED - Analysis of Financial Statements Financial Year 2003 - H Year 2009

Bestway Cement Company Limited (BWCL) is a subsidiary of Bestway Group of United Kingdom. Bestway Cement was listed on Karachi Stock Exchange in February 2001. The company is a major manufacturer and seller of cement. It has a market share of 8% in the domestic market.
Bestway has been a major exporter to Afghanistan and recently it began exporting to India, Africa and Middle East. Bestway Group decided to set-up its first cement plant in Pakistan in 1992. The company commenced work on its first cement plant at Hattar, Haripur in NWFP with an initial investment of US $120 million. The plants initial capacity was 0.99 million tonnes per annum. Hattars capacity was enhanced to 1.17 million tonnes per annum in 2002 owing to increased domestic demand. In 2005, the plants capacity was further increased to 1.20 million tonnes per annum of clinker. During FY07, the clinker production at Hattar reached at 1.14 million tonnes and cement production at 1.17 million tonnes.
Initially, the cement plant at Hattar used furnace oil as fuel. Around 2001, the plant was converted to operate on natural gas. This was a prudent step towards achieving cost efficiency as a hike in petroleum prices was anticipated. In 2003, the plant was converted from gas to coal with an investment of around US $10 million. Now, the Bestway Cement Hattar can operate on all the three major fuels. These measures have reduced the energy cost component, which at times constituted about 65% of the total production cost of the company.
In 2004, BWCL set up a new cement plant near Village Tatral of District Chakwal in Punjab to meet the growing cement demand in the domestic market. The plant had a cement capacity of 1.8 million tonnes per annum and cost US $140 million. The plant was fully functional and production started in June 2006. In FY07, cement production and clinker production at Chakwal was 1.119 million tonnes and 1.061million tonnes, respectively.
In an attempt to increase its presence in the cement industry, BWCL bought 85.3% stake in Mustehkam Cement Limited in 2005. The plant had a capacity of 0.63 million tonnes per annum and was close to BWCLs plant at Hattar. BWCL planned a project of upgrading and modernizing Mustekham plant to a capacity of 0.9 million tonnes per annum.
In May 2006, the company announced plans for setting up of a second 1.8 million tonnes per annum capacity plant adjacent to the plant in Chakwal at a cost of US $180.0 million. With such major capacity expansion plans the companys cement manufacturing capacity was set to exceed 6.0 million tonnes per annum by FY08, making Bestway the second largest cement producer in the country.
Bestway Cements capacity expansion has been in line with the trend of the entire cement sector. The overall production capacity of the cement sector increased substantially to 38.95 million tonnes at the end of 3QFY08 as compared to 30.1 million tonnes at the same time in FY07.
The cement sector of Pakistan showed an impressive growth of 24.3% in the cement dispatches during FY08. Total cement dispatches grew from 24.22 million tonnes in FY07 to 30.11 million tonnes in FY08. There was a 6.5% growth in local cement dispatches as demand for cement in the domestic market rose due to increased construction activity and government spending on infrastructure development.
However, the substantial growth in the cement dispatches in FY08 was boosted mainly by a 142% increase in exports. Pakistans cement sector greatly benefited from the shortage of cement in the regional countries. Pakistani companies were actively exporting to Afghanistan and India. Cement demand in Afghanistan is expected to be 1.5m-2.0m tonnes per annum for the next four years at least and local companies can be expected to export 3.0m-4.0m tonnes per annum over the next few years. Also rising construction activity in the Middle East and Africa have made them lucrative markets for our cement sector to tap.
In line with the industry trend, Bestway Cement also experienced an increase in its cement dispatches during FY08. It posted a growth of 16% in the cement dispatches (increase of approximately 360,000 metric tonnes) during FY08 as compared to the same period in FY07. BWCL was able to retain 11% of the market in the north zone and its position as one of the largest cement producers in the country during FY08. The company was also one of the largest exporters of cement to Afghanistan. The industry as a whole exported 7.7 tonnes during FY08 as against 3.2 tonnes during FY07. Bestway Cements share stood at 7.3% of total exports at 565,716 tonnes as against 304, 001 tonnes in 2007 which represents an increase of 86%.
The overall capacity utilization of the cement sector failed to improve. Slower growth in domestic market and additional capacity were the main reasons for the decline in capacity utilization to 78% in FY08 as compared to 81% in FY07. BWCLs capacity utilization improved to 81% and was better than the industry average. This shows that the management of the company has been able to increase the efficiency of its operations. Improvement in the efficiency is of utmost importance for the entire cement sector especially during the current situation of rising costs of production.
PERFORMANCE DURING FY08
During FY08 the cement sector experienced strong growth in cement dispatches but had to face declining profitability. The profitability of the cement sector fell by 73.6% to Rs 562 million till March 2008 from Rs 2,133 million in the corresponding period of FY07. Although the sales volume in the sector increased, the net sale revenue did not increase to an equal extent due to decrease in net retention prices in the sector. Over the years all cement manufacturers undertook huge capacity expansion plans. This created a situation of excess supply in the market. Companies resorted to price wars and this led to a fall in prices. The average cement price during the Jul-Mar FY08 was Rs 128.3 per bag as compared to Rs 133.6 per bag same period in FY07.
The reason for the fall in the cement sectors profitability in FY08 was the 44.8pc rise in the finance charges faced by companies. Finance charges rose due to higher interest rates. Higher input costs, increased coal prices and higher depreciation also hampered the cement sectors profitability.
The cement manufacturers in the industry were faced with rising fuel and power costs during FY08. The cost of production for the entire cement sector of Pakistan went up due to rise in the prices of imported coal. The cement companies in Pakistan have shifted from oil to coal or gas during the past few years. Coal is now used as a basic fuel by all cement manufacturers. Pakistan has huge reserves of coal, but cement companies import it, as local coal has high sulphur content.
Crude oil prices shot up during FY08 and had its impact on prices of coal and natural gas. The rise in the costs of international coal prices has been one of the biggest reasons behind the dampening of gross margins of cement companies during FY08. Along with the hike in the international coal prices, the depreciation of rupee against the US dollar also added to the cost of imported coal.
The operating expenses of the company increased, as there was a 16% increase in administration and general expenses. However, the distribution/selling costs of the company increased manifold in FY08, from Rs 38.3 million in FY07 to Rs 300.8 million in FY08. This large increase in the distribution costs of the company was due to the inclusion of freight and handling costs of exports worth Rs 225.9 million in the total distribution costs in FY08. This expense was not present previously. Also, the freight and handling costs for local dispatches also increased to 38.8 million in FY08 from Rs 7.37 million in FY07. Thus the operating profit fell by 33% during FY08 as compared to in FY07.
RECENT RESULTS HY09
The slow down of the economic activity in the country and the slash in the government spending (PSDP), the local cement dispatches (sales volume) decreased by 18%, from 10.9 million tonnes during HY08 to 9.25 million tonnes in the current period HY09. However, the export sales of cement showed a healthy growth of 70% during HY09 as the industry exported 5.1 million tonnes of cement and clinker as against 3 million tones exported during HY08. The capacity utilization of the sector fell from 77% during HY08 to 69% during HY09 due to lower local demand and sales during the period.
The companys production of both cement and clinker increased during HY09. Cement production increased by 22% while clinker production increased by 33%. Cement production was boosted partly due to commencement of production at Chakwal line II. The companys capacity utilization was 68% during the period. The total cement dispatches of BWCL increased by around 41% and the companys market share in the north zone increased to 15%. BWCLs share in total exports of the cement sector was 10% during the period.
The increase in sales volume led to higher sales revenue for the company. BWCLs net sales revenue stood at Rs 7,420 million for the period as compared to Rs 2,783 million during HY08. Along with higher sales volume, the companys revenue was further boosted by higher sales prices of cement and export earning (due to rupee depreciation). The sales turnover of the company increased by 167%.
As the companys sales performance improved during HY09, the profitability also increased. The company posted a profit after taxation of Rs 555.968 million during HY09 as against a loss of Rs 344.991 during HY08. This was despite a 94% increase in cost of production and a substantial hike in distribution and finance costs of the company.
The companys distribution costs increased as the companys freight charges rose due to higher exports during the period. Finance charges increased due to higher interest rates and charging out of borrowing costs relating to Chakwal Line II to profit and loss account consequent to its capitalization.
Bestway Cement Company Limited announced 15% right shares issue at a premium of Rs 25 per share during 1QFY09. The equity funds will help reduce the leveraging. The company seems to be burdened by high cost of debt and its debt servicing ability was declining due to increasing interest rates in the economy.
PROFITABILITY
Profitability ratios of BWCL have shown a rapid upward movement through the years under review, owing to realization of better cement prices and higher capacity utilization, which consequently boosted the net income of the company. However, the companys profitability ratios worsened after FY06. The first half of FY07 was characterized by a declining trend in profitability, despite a healthy growth in cement dispatches. Overall cement dispatches during FY07 registered an increase of 32%. This growth was a result of 24% growth in the domestic market and a 112% growth in exports demand.
FY07 witnessed a decline in profitability of the cement sector for a number of reasons. The most significant of these was a sharp decline in cement prices due to a supply overhang for most of the year. The prices in the South Zone exceeded the prices in the North Zone by a considerable margin, whereas prices in international market exceeded the prices in the domestic market. There was rise in fuel costs. Also, the interest charges on money borrowed for the acquisition of Mustehkam Cement, increased borrowing for running Chakwal Line-I and the higher cost of borrowing resulted in a 158% rise in financial charges of the company. This further aggravated the profitability position of the company, resulting in a net profit margin of 0.91% in FY07 compared to 27% in FY06. Profit after taxation declined 96% in FY07 to reach Rs 52 million, compared to Rs 1,226 million in FY06.
These factors continued to take a toll on the profits of Bestway in FY08 as well as gross profit margin of the company sharply declined in FY08 as the low retentions and high energy costs drove the gross profit of the company down. BWCL posted a loss before taxation of Rs 419 million as compared to Rs 56 million profit earned in FY07. The profit after taxation amounted to Rs 169 million as compared to Rs 52 million profit of last year, which is an increase of 227%. Owing to this the net profit margin and return on asset and return on equity ratios of the company improved.
LIQUIDITY
The liquidity position of BWCL improved only marginally over the years from FY03 to FY05. The current ratio remained well below the industry averages signifying the liquidity crunch that the company faced. However, constant expansion in the form of new plants as discussed above is a reasonable justification of this liquidity downturn. Owing to the new plant set-up, Bestway has done reasonably well in managing its liquidity position. The recent decline in the current ratio can be attributed to the subsequent pay-off of the long-term loans acquired for Mustehkam Cement and Chakwal Plant-II. Consequently, the current liabilities soared up in the same year resulting into a decline in current ratio.
The current ratio had shown an improvement during FY07 but its liquidity position remained unsatisfactory, lingering below the minimum requirement of one. Much of the current assets of the company were held up in the form of inventory. On the liabilities side, a large part of the amount came from the current portion of long term debt.
During FY08, the companys liquidity position went down owing to 57% increase in the current liabilities of the company and a less than proportionate increase (33%) in the current assets of the company. The major reason for such rise in the current liabilities is the increased short term borrowing by the company. In FY07 short term borrowing amounted to Rs 756.4 million but by the end of FY08 this figure reached Rs 1,507.7 million. The interest payables and trade payables also increased significantly for the company.
BWCLs liquidity position seems less favorable because the less liquid assets such as stock in trade and stores and spares constitute major portion of the companys current assets. The share of bank balances shrunk during FY08 while portion of trade debts increased.
ASSET QUALITY
The company has managed to improve its capacity utilization over the years and due to the companys ambitious capacity enhancement projects, which have increased the production capacity greatly. This has resulted in accumulation of inventory (raw material and work-in-progress) for BWCL.
Since inventory forms such a major part of the companys current assets, it is important to analyze the management of this asset. The inventory turnover ratio of the company declined considerably during the FY08 showing that the inventory of the company was sold less number of times during the period as compared to in previous years. Thus, the days to sell average inventory increased from around 23 days in FY07 to 41 days in FY08.
Accounts receivable are the other major current assets of the company. The rising Days sales outstanding ratio shows that the number of days within which the management is able to recover accounts receivables is increasing. Thus the operating cycle of the company also increased indicating that it took the company longer to convert its inventory into cash. The longer operating cycle supports our assertions about the unfavorable liquidity position of the company. The lengthening of the operating cycle during FY08 means that quality of the BWCLs working capital has deteriorated. Strategic planning to control excess supply can cushion the turnover ratio.
Sales/equity has been erratic and worse than the industry averages. Lately, the ratio increased due to a large percentage increase in the sales revenue generated by the company in FY08. Although the net retention prices were mostly low during the year, it was the increase in the volume of sales that led to a 33% increase in the net sales of the company. Higher sales resulted in the rising trend of total asset turnover ratio of the company. This shows that the companys management has been able to generate higher revenue in FY08 with regard to the increase in the asset and equity base of the company.
DEBT MANAGEMENT RATIOS
The debt situation of the company had deteriorated in FY07 as the debt to assets and debt to equity ratios continued to rise due to an increase in long term loans taken by the company. However, in FY08, the debt to asset and debt to equity ratios declined to the same level from which they had risen in FY07. Thus, the debt situation was brought under control by the management. The total assets increased by 12% while the liabilities increased by 8.5%. The increase in loans, compounded with an increase in the cost of borrowing has had an adverse affect on the financial position of the company, as the TIE ratio dropped to a dangerous level. The 158% rise in financial charges and a decline in profitability of the company resulted in a TIE of below 1.
BWCL is a highly leveraged company in the industry as evident from its enormously high long-term debt to equity and debt to asset figures. Considerable part of financing comes through long-term debt mainly from banks, modarbas and syndicate financing. Long-term debt to equity jumped up in FY06 with the acquisition of 85.3% stakes in Mustehkam Cement, which was totally financed through long-term debt.
Thus, the financial expenses for BWCL are at a higher side, in consequent of constant expansions on loan and set-up of two Greenfield projects at Chakwal. Financing comes mainly through debt as shown by greater than 1 debt-equity ratio trend. As a result interest-paying ability of BWCL has dampened considerably in FY06. On the whole, debt management of the company is not better than the industry and thus BWCL constantly faces the interest rate risk.
FUTURE OUTLOOK
In the budget FY09 the central excise duty on cement was increased to Rs 900 per ton from current Rs 750 per tonne. On each bag the CED increased by Rs 7.50 per bag (from Rs 37.5 per bag to Rs 45 per bag). But this increase is not expected to impact the profits of the cement sector because this increment in CED will be passed on to the consumers. However, the rise in the GST by 1% will increase the local cement prices and may dampen the demand for cement.
Local cement dispatches are expected to remain depressed due to slow down in economy led construction activity in the country and also due to inflation. In the budget FY09, the government had announced that Rs 550 billion will be allocated to PSDP in the country, however owing to budgetary deficit the government later decided to cut PSDP expenditure.
Cement consumption is correlated to GDP growth and as the economic condition now stands, we can predict a grave slow down in the GDP growth of the country. Thus the per capita cement consumption will also fall during FY09.
Exports have so far shown a strong growth and supported total cement dispatches. Cement manufacturers have been focusing on the international markets to achieve growth in sales. Pakistan has been exporting to Afghanistan. Regional shortage of cement had presented a favorable opportunity for our cement manufacturers. Cement demand in Afghanistan is expected to be 1.5m-2.0m tonnes per annum for the next five years. Cement manufacturers have growing opportunities in Middle East and African countries. New export markets like Russia and European countries have been identified.
Growth in export sales may boost the margins of the industry and reduce the negative impact of rising costs on its profitability. However, the effects of global recession have started to impact international demand for cement. Indian market, which was a window of opportunity for Pakistani cement manufacturers, has been closed as India banned import of cement from Pakistan due to escalating tensions between the two countries.
Expenses are expected to increase for cement manufacturers. This will negatively impact the gross margins of the cement sector. During the past, our cement manufacturers shifted production from oil to coal or gas. Pakistan has huge reserves of coal but manufacturers need to import coal due to high sulphur content. The coal prices in the international market have fallen from their peak level of US $210 per ton. But the depreciation of Pakistani rupee will neutralize the impact of decreasing international coal prices. Also the government has raised the power tariff by nearly 50% with variable rates for peak and off peak hours. The gas prices have also risen. This will increase the cement manufacturers cost of production and impact their profitability in FY09.
Bestway cement seems to have taken notice of further rise in cost of production in the future and has started work on a waste heat recovery project. Implementation of Waste Heat Recovery Power Plant will significantly reduce BWCLs dependence on external source of electricity and will also result in reduction in cost of production. Cost of production and operating expenses will be critical in determining the profitability of the cement sector in FY09.
As the cement sector has undergone huge capacity expansion during the recent years and with more production capacity coming online within the region, the market for cement will become highly competitive.
COURTESY: Economics and Finance Department, Institute of Business Administration, Karachi, prepared this analytical report for Business Recorder.
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