D.G. Khan Cement Company Limited

D.G. Khan Cement Company Limited (PSX: DGKC) was established in 1978 and is publicly listed on the stock exchange. The company produces and sells clinker, ordinary Portland cement and sulphate resistant cement. It has a current capacity of 6.72 million tons of clinker with plants located both in the north zone at Dera Ghazi Khan and in Hub. The company has begun to cover markets across the country with a dealership network of over 2200 dealers. DGKC also exports to neighboring markets such as Bangladesh, Afghanistan and overseas to Central Africa. The country signed a deal with a buyer in the United States in August 2021 to supply 100,000 tons of cement to the country. The first shipment carrying 50,000 tons left this month after meeting all of the certification requirements of the destination.

Shareholding pattern

As at June 30, 2021, nearly 32 percent shares belonged with associated companies within which the major shareholder is Nishat Mills Limited that holds 31.4 percent shares. The local general public holds 19.5 percent shares, while a little over 6 percent shares are owned by insurance companies, modarabas and mutual funds each. Another 6 percent are owned by Mr. Mian Umer Mansha and Mr. Mian Hassan Mansha, each. The directors, CEO, their spouses and minor children together own 4.3 percent shares whereas the remaining 19 percent are with the rest of the shareholder categories.

Operational performance

DGKC was mainly operating in the north zone with its plant in Dera Ghazi Khan until 2018 when it expanded into the south zone with a plant in Hub boasting a capacity of 2.7 million tons. The Greenfield project was set up at a cost of over Rs40 billion ($345.3m). The company has been exporting clinker since. Though low in value, clinker allowed the company to keep utilization high and cover its fixed costs while also availing export refinancing scheme offered by the government whilst earnings foreign exchange.

The company’s topline has grown substantially since FY18, though margins displayed a declining trend. In FY19, post-expansion, the company’s dispatches grew 34 percent that year, landing at over Rs40billion in revenue. However, circumstances changed during FY20 when nearly all cement companies were experiencing a downturn with retention prices dropping and demand remaining low. With covid, the country’s already precarious macroeconomic instability took a further hit with inflationary pressures and rupee depreciation that affected cost of production. DGKC also had a leveraged balance sheet because of the new expansion. At high interest rates, this caused finance costs to balloon for the company. In FY20, finance costs as a share of revenue was peaking at 12 percent. Since then, the company’s finance costs have dropped to 7 percent in FY21 (as discount rate came down) and down to 6 percent in 9MFY22.

A major function of costs of production is the cost of imported coal. Since coal is mainly imported from South Africa, the company’s margins—much like other cement players—depend heavily on the movement of international coal prices and rupee’s value against the dollar. When rupee depreciates and/or coal prices go up, costs rise accordingly. If the company’s retention is not in line with cost hikes, margins get affected. Cement companies’ investments in energy conservation and energy efficiency measures such as installing waste heat recovery units can also positively affect margins by reducing the energy burden. This is why in FY21 when DGKC’s waste heat recovery became operational; it provided relief to the company’s cost pressures. Margins improved.

Up till the new expansion in the south, most of the company’s exports were cross-border through road that limited markets to India, Afghanistan and Sri Lanka. With exports overseas opening up given proximity to the port, DGKC has opened itself immense opportunities when domestic or cross-border demand is low. More recently, this was witnessed because many cross-border markets dried up with political uncertainty in Afghanistan, Sri Lanka going into default and exports to India becoming unfeasible a few years ago due to massive countervailing duties on it.

Future outlook

DGKC despite prudent investments has a lot to contend with. Coal prices in the global market have been skyrocketing causing costs to skyrocket in turn. Many plants in the north have been shifting to Afghan coal which is cheaper than South African (Richards Bay) coal right now to safeguard margins. However, depreciating rupee is putting pressure on costs. Moreover, energy tariffs are hiking up too. At the same time, demand in the domestic market has been slowing down as the economy enters a new IMF program and ensuing austerity. This staged is characterized by higher interest rates, reduced public spending in form of PSDP cuts and higher taxation. The government has imposed a super tax on corporations whilst also raising other forms of taxes.

Though cement companies have been raising prices to match their surging costs, it can and will have an affect on demand moving south. Construction demand has already been hit hard due to inflating costs of building materials (including cement but also steel and other inputs). In such a scenario, exports should come to the rescue. For DGKC they have in the form of the US contract but in general, higher freight rates have made exports quite uncompetitive. A major thrust to the bottom-line recently for DGKC has come from “other income” component (includes income on bank deposits, mark-up on loans to related parties, dividend income, rental income etc.) that contributed 41 percent to pre-tax profits in 9MFY22 which means current reliance on non-business income is pretty high for the company. A major turnaround in domestic demand is crucial, though unlikely over the next few months at least. The company’s own management believes demand will grow no more than 4-5 percent during FY23.