Cement’s misfortunes

Cement companies are in dire straits. Cumulatively, after tax earnings fell by 16 percent in 9MFY19, but only owing to a lower effective tax. Pre-tax profits actually fell by 26 percent in 9MFY19, as per calculations made by a Topline Securities report. Combined gross margins have fallen to 24 percent from 30 percent in the 9M period. The report argues that the quarterly margins of 23.6 percent in 3Q are the lowest sector margins since 2011. Four dominating reasons are causing the sector to shrink.

The first of course is the demand. Domestic demand has been suffering due to PSDP cuts and government’s efforts to reduce infrastructure spending that was booming during the Nawaz era of expansion. Overall real estate development has also slowed down due to sobering economic outlook while the restriction on non-filers to purchase properties may also be hurting real estate transactions. Local dispatches fell by 6 percent in 9M (North: down 11%, South: up 15%).

Exports have helped with a growth of 49 percent, but the real growth is in clinker exports that are 32 percent of total exports. The sales mix is 85:10:5 for local, cement exports and clinker exports. Clinker costs substantially lower than cement in the foreign markets since it is not the final product. Where cement manufacturers could not sell cement, they made up for it with clinker but at the cost of their margins. Clinker fetches lower prices (about $32-35 per ton) compared to cement exports (about $50-55 per ton) as well as local sales (about $93-97 per ton). The growth is visibly in the low-priced commodity.

However, 85 percent of sales are still domestic, so it is not entirely bad but it could be getting there. Some companies, especially in the north have also suffered due to the completely shut down of the Indian market, and the fall in demand in the Afghan market for Pakistani cement.

The other important aspect is prices. Though over the 9M period, they averaged pretty much the same as last year, fluctuations have been pretty dramatic. They have fallen when competition between companies drew to a close. Between Feb and March, for instance, prices dropped by Rs20 per cement bag, or more than Rs30 per bag in other markets where competition was higher (read more: “cement cartel: do not resuscitate”, April 11, 2019). However, revenue per ton for the industry grew by 8 percent in 9M year on year.

Part of the reason is during the period when prices were dropping in the north, southern zone prices were going up. On average, the low-priced cement and clinker and falling prices in domestic market registered a solid growth in revenue per ton. This means, it is costs that are not keeping in line. Coal prices averaged $94 per ton in 9M against $91 per ton during 9MFY18 though they have come down recently. The trick is to manage inventories more effectively. The rupee depreciation of 13 percent between July-18 and Mar-19 and of 27 percent since Jan-18 however, has quickly wreaked havoc to margins.

Companies that were sending higher volumes overseas also saw their distribution costs balloon (cumulatively, up 20%), while companies that have just undergone expansion have also incurred higher finance costs (cumulatively, up 166%) only made higher due to rising interest rates. Expansion related tax reversal helped some companies as mentioned above.

Evidently, the business climate is not going to change. Domestic demand is unlikely to pick up, while upcoming IMF conditions may further devalue the rupee, tighten monetary policy and raise fuel prices. With that context, the outlook for cement companies remains gloomy.