Not too long ago, the cement sector had everyone on their toes. The sector was riding on the wave of what can only be called an infrastructure boom. Housing and construction demands were both expected to increase manifolds. The sector clocked in 38.87 million tons of dispatches in FY16 and grew it to 40.3 million tons in FY17, running at over 86 percent of existing capacity—where some months during the fiscal year enjoyed 99 percent utilization. Demand prospects necessitated capacity expansion within the sector with manufacturers planning nearly 30 million tons of additional cement production capacity. Market confidence had soared.
But since July, as market came down; cement scrips fell worst even as cement sales remained optimistic. In the July-Sep period, average stock price for cement scrips fell by 30 percent as the index fell by 19 percent. Did the market jump the gun?
Historically, each time the sector has entered an expansion cycle, capacity utilization came down as demand could not absorb all of the capacity and players started under cutting the prices to grasp more market share. The same is expected to happen during this expansion cycle. Total sales of cement grew by merely 4 percent in FY17, because even as local dispatches grew by 8 percent; exports fell by 20 percent.
So what are our projections going forward? The sector can only maintain capacity utilization upwards of 85 percent if total demand goes up by 10 percent which is extremely optimistic and highly unlikely. Our earlier calculations (read our story: “There exists a cement cartel”, July, 11, 2017) show that realistically, if FY18 sees a 6 percent growth, and later years see a year on year growth of 3 percent, capacity utilization would start falling from FY19 signaling a drop in prices and EBIDTA, and thereby the end of the cartel as we know it.
The recent market reaction it seems is anticipating what may not be too far away. Let’s also couple that with the less than exciting financials during FY17. Despite remaining profitable, margins for nearly all of the cement manufacturers dropped as coal prices went up, when they averaged at 43 percent during FY16. Case in point—DG Khan Cement: 43% in FY16 to 39% in FY17; Bestway: 46% to 44%; Lucky: 48% to 47% and so on.
The worse news is that exports are not expected to rebound any time soon, and for multiple reasons (read our detailed story: “Cement’s growth myths”, Sep 5, 2017). The burden to drive the sector then falls entirely upon local demand. Exports had maintained a healthy share of 15 percent to 20 percent over the years. However, this has fallen to 12 percent in 3MFY18 which is troubling as the sector moves into expansion mode. The decrease in exports would have been fine if it was a mere adjustment of the sales mix by cement manufacturers, but that is not the case, because there is a visible reduction in Pakistani cement demand overseas.
As this column has said earlier “exports allow manufacturers to keep becoming more efficient in order to compete. Having a diversified market portfolio also allows them to adjust for the ups and downs in domestic demand that are expected in an economy like Pakistan which is far from stable”.
As the cheaper Iranian cement takes over Pakistan’s primary market Afghanistan, the sector should start building relationships in emerging markets; and spend on marketing outreach in order to shield itself from any dramatic fluctuations in domestic demand. That’s the only way forward.
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