By now, all of the cement manufacturers have announced their respective financial results for FY18, and it is evident that the tumble in margins and profitability has been contagious. Some players have been hurt more than others but overall, the picture is sobering, if expected. The combined revenue for the industry rose by 6 percent, even as total industry volumetric sales increase of 14 percent—a clear play of depleting retention prices, especially in the north zone. These translated to a fall in net profits by 4 percent, and a visible erosion of gross margins, landing at 29 percent in FY18 (FY17: 38%). What happened, and will these trends continue through FY19?
Factors leading to the margin attrition and decline in the bottom lines have remained out of the control of the industry, and have had little to do demand which has remained robust. Though some risk mitigation measures can always go a long way. The first factor is the globally increasing prices of coal which is largely imported into Pakistan and remains a major source of fuel for the energy-intensive cement industry, especially those firms that are running captive power plants in-house. These prices in fact, grew by 40 percent over the span of that fiscal year, making costs of imports, thereby costs of production higher.
China is the linchpin in global commodity price movements, especially commodities like steel and coal, being the biggest supplier of both commodities in the world. The country has seen some shift in policies over the past two years. Right now, it is in the midst of reducing its coal capacity by cutting down overloaded coal units while also re-planning its production keeping in mind the country’s deteriorating environment.
Lower inventory, higher demand along with constraints in supply pushed prices upward though toward the end of FY18, prices remained steady. The second factor is the rupee weakening against the dollar. Rupee depreciated by 16 percent against the dollar making imports that much more expensive. Based on these numbers, calculations suggest costs per unit sales reduced by 5 percent in FY18 year on year for the industry.
Retention prices particularly in the north started increasing in Dec-17 when Cherat’s new expansion came through and fears of supply glut loomed. Price competition is inevitable as the industry embarks on its nearly 30 million tons of additional capacity. Capacity has already gone up by 15 percent with DGKC and Attock’s expansion coming through.
Seeing the depreciation and commodity price increase, also given that they incur higher freight due to their distance from the port, cement manufacturers in the north raised prices between 8 to 20 percent bringing them in par with south zone players. Moving into FY19, the industry will remain cautious. If China continues to restrict coal supply and itself imports the commodity while demand in some of the developing countries simultaneously moves upward, prices will pose a challenge for local cement manufacturers here. Specially now when they may not be able to increase prices of cement bags—as expansions come through, utilization of capacity will fall leading to greater competition. In August though, coal prices saw a slight dip due to Chinese government efforts to make sufficient supply. If the coal prices further come down or remain steady through the fiscal year, there will be some reprieve for cement earnings.
Further depreciation will again post a challenge. On the demand side (read: “Cement: Tentative demand trends” Sep 6, 2018) the industry may not see the growth patterns that were expected before the PTI government came into power. With Khan at the helm of the state, the country is well into an austerity drive. Gas prices have been increase, while monetary policy has been tightened further. This translates into lower investment and growth.
The demand that was witnessed in the real estate and commercial sectors may see a slowdown. If most infrastructure development projects continue as planned, cement demand may not take a massive hit. Moreover, Khan’s promised five million houses over the next five years could also be a major driver. Plans are now being mapped out for the latter and if by some miracle, this promise is pursued, an additional 20 million tons of demand is not of question.
Manufacturers need to focus on exports to counter the exchange rate volatility and have a backup plan for if local demand does not meet desired expectations. After a tough FY18, tougher times are not in the rear-end yet.
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