DG Khan Cement

Next to market leaders Lucky and Bestway Cement is DG Khan Cement Company Limited (PSX: DGKC) which is third largest manufacturer of cement in Pakistan. Before its latest expansion, the company had the capacity of 4.22 million tons-capturing nearly 9 percent of the domestic industry capacity, but adding another 2 million tons only a few months ago, the company boasts a market share of 12 percent.
According to the company's official website, it has 2200 dealers spread out and 10 exporting destinations including Afghanistan, India, Kenya and other African countries with majority of exports going to India by road. The company manufactures clinker, Portland cement and sulphate resistant cement.
The company was established in Dera Ghazi Khan under the control of State Cement Corporation of Pakistan Limited (SCCP) in 1978, started operations in 1986 with a production capacity of 2,000 tons per day, about 0.6 million tons annually. The company was acquired by Nishat group in 1992 after the government's privatization scheme where many other cement companies were deregulated and privatized.
At that time, the company became the larger of two cement producers. More capacity was added to the plan through the years. Capacity of the existing plant was raised to 6700 tons per day or 2 million tons annually and another plant in Khairpur was added with an equal capacity. Together the company had 4.22 million tons annually to work with. The company went public after privatization.
Group, shareholdings and investments
DG Khan Cement is part of the Nishat group of companies. According to the company's website, Nishat's total assets are about Rs2 trillion, with a net worth of Rs440 billion and an approximate revenue generation of about Rs275 billion in 2017.
The group has diversified not only in cement but also into power with Nishat power, Laligen and Pakgen limited, in textile with Nishat Mills and Nishat Linen, in banking and financial services with MCB bank as well as in paper, real estate and hospitality, agriculture and livestock, insurance, automobiles and aviation. The group's latest investment comes in the automotive sector in its partnership with South Korean Hyundai. The company plans to launch Hyundai cars into Pakistan.
DGKC's shareholders pattern is pretty straightforward with the highest shares held by Nishat Mills-31.4 percent in FY17 where Mian Umer Mansha and Hassan Mansha together holding over 12 percent of the company's share giving them voting rights in DGKC. The rest of the shares are spread out across banks, modrabas, insurance companies, joint stock companies, and mutual funds. At the end of June 2017 (the latest FY18 annual report has not come out yet), the general public held 14 percent of the company's shares.
On March 23, 2018, the company announced in a PSX notice that its new plant in Hub was completed channeling a capacity of 9000 tons per day, or 2.7 million tons. The location was favoured due to its close proximity to the port, and this expansion allows DGKC to officially enter the South side of the market, already having its presence in Central and North of Pakistan.
The grinding mill, cement silos and packing plant have started trial operations and the cement was being sold to customer, though commercial production will start later. Raw material, crushing, transportation and storage commissioning was also done, while the mining areas for raw material such as limestone were leased out earlier. The company's plants and mills come from Germany and Denmark.
Financial and operational performance
DGKC has been trailing the top three spots in the sector for a number of years now and enjoys a strong market share. Since FY10, the production capacity has remained same as most of the industry's demand has fluctuated over the years and it is only since FY16 that infrastructure, real estate and commercial as well as residential development have picked up, which has allowed cement industry to be at the front lines and reap the fruits. Though demand in the north and central Pakistan is always more, the competition in that market given the number of players operating there has been higher as well, but DGKC has held its own.
The company raised capacity utilization over the years, from 89 percent in FY11 and 85 percent in FY14, the capacity utilization was raised to 94 percent in FY16 and 102 percent in FY17. Local demand has been the primary driver, since exports have had quite the opposite growth trajectory-downward, as domestic demand took off. Exports share for DGKC too fell from 31 percent in FY12 to 16 percent in FY16 and 13 percent in FY17. This is still not as bad as some other players who saw their export share plummet.
Part of the reason of the falling export share is the falling demand in key markets such as Afghanistan and South Africa, but another reason is an exchange of sales mix. Given limited capacity, and higher local demand, the company may have diverted focus from exports to local markets. After all, local sales give them a much better margin and cost them less in freight and transportation as well.
The company has installed captive power generating units in its facilities using and furnace oil to reduce reliance on a single fuel. Another coal based captive power plant is installed at the DG Khan site while the company also has plans for a solar and wind plant, latter of which is under study. The captive power generation in both factories has a combined capacity of over 100 MW where each factory has Waste Heat Recovery with a combined capacity of 19 MW. The company used a number of alternate fuels including rice husk, poultry waste, corn cob, corn stick, cotton dust and cotton sticks.
These have allowed margins to slowly improve-they have grown from 24 percent in FY12 to 36 percent in FY15 and 43 percent in FY16. In fact, FY16 was a great year for the cement industry's bottom-line-commodity prices were low that allowed costs of production to decline significantly. Costs per unit sold show that costs have grown by 48 percent between FY10 and FY17. However, another function of margins are the selling prices.
Though costs have grown, selling prices have also grown, keeping up with increases in costs and taxes like the FED. This is why costs per unit sold were at the peak in FY14, and have declined, only to go up again during FY17 when global dynamics started to shift.
This shift continued well into and in full force during FY18, flipping the script to a great extent. For one, retention prices started to head south, as capacities started to come online. Overcapacity tends to result price-competition.
Though the company has not announced its financial year results, the past nine months have given strong indicators as to the performance of the sector. While domestic demand remained really strong (15% year on year), coal prices in the global markets were moving north since FY17, and rupee depreciation against the dollar by nearly 15 percent together cost cement companies to lose a huge chunk of their margins they were enjoying during FY16. Alternative fuel usage by DGKC may have cushioned a little bit of the blow in 9MFY18, the company's margins dropped from 41 percent to 31 percent back at 2012-13 days.
In its annual report, the company says it takes steps to hedge against possible foreign exchange losses, but the fall in margins suggests that the company was hit hard by exchange fluctuations, coupled with higher costs of fuels, not unlike other peers. The company has dual fuel plants and uses alternative fuels which may have saved costs from falling even further.
With expansion, the company saw its finance costs rise dramatically during FY17 but it's a bearable expense. The company has managed to keep its indirect expenses as a share of revenue the same in 9MFY18 as last year. Net margins decline (21% from 29%) almost entirely comes due to the rising costs of production.
Opportunities and outlook
There are several challenges the company has faced and will face over the next few years but many may be entirely out of its control. Though it can hedge against exchange losses and plan inventories better, the company like other cement players will see costs rise when coal prices in the global markets increase. Meanwhile, exchange rate changes may also hurt the costs side.
Coal prices are projected to remain stable in the upcoming months which may allow cement players to adjust their inventories. If the company can reach to more exporting markets, it can hedge against some of the exchange rate losses it may incur in the future when importing.
On the demand side of the equation, it's all hail with few chances of storm. The new government plans to stick with the CPEC infrastructure projects, though news circulating in the market was suggesting that Pakistan could enter into renegotiation. Even if that were the case, some renegotiation may not be too bad. Even so, many of the infrastructure projects are already underway. Projects may see a shift in timelines or priorities, but tone from the top seems positive that CPEC projects will not be disrupted.
If that demand persists, the company is on track with the rest of the industry as planned. Meanwhile, the constructing of five million new houses in the country that is one of Khan's plans is another major demand driver for cement that the industry can look forward to - if it materializes. However, since the economy is going into austerity, there are chances that demand coming from the commercial or real estate development and high end construction may see a slowdown. This could affect sales in the major urban centers of the country even if infrastructure development plans remain intact.
The company's new capacity allows it to now have a breathing space in all three regions of the country and reach more markets, not only domestically but also abroad due to the proximity of the ports. Freight costs will be lower and DGKC has a chance to retain its capacity utilization to the maximum.

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DG Khan Cement Company Limited (unconsolidated)

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Rs (mn)                          9MFY18    9MFY17     YoY

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Sales                            23,375    22,633      3%

Cost of Sales                    16,206    13,418     21%

Gross Profit                      7,169     9,215    -22%

Distribution and selling exp        691       728     -5%

Administrative cost                 455       395     15%

Other operating expenses            656       715     -8%

Finance cost                        318       272     17%

Other income                      1,639     1,617      1%

Profit before taxation            6,688     8,272    -19%

Taxation                          1,718     2,268    -24%

Net profit for the period         4,970     6,454    -23%

Earnings per share (Rs)           11.34     14.73    -23%

GP margin                            31%       41%

NP margin                            21%       29%

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Source: PSX

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Shareholders Holding (as at June 2017)            %

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Directors, CEO, their spouses and children    4.27%

Mian Raza Mansha                              2.90%

Mrs. Ammil Raza Mansha                        1.34%

Mrs. Naz Mansha                               0.03%

Associated Companies and related parties     32.04%

Nishat Mills Limited                         31.40%

Adamjee Insurance Company Limited             0.59%

Security General Insurance Company Limited    0.05%

Mutual Funds and Modarabas                   10.86%

Banks, DFIs, NBFIs                            2.44%

Insurance companies                           3.82%

Others                                       19.90%

NIT and ICP                                   0.24%

General public                               14.08%

5% or more voting interests

Nishat Mills Limited                         31.40%

Mian Umer Mansha                              6.23%

Mian Hassan Mansha                            6.14%

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