September 10, 2020 (MLN): If we look at the sales figures of the Cement sector, it doesn’t depict the true picture of the sector performance as the cement stocks have recently outperformed i.e. up by 82% since March 2020.

However, this outstanding performance yet failed to lift the profitability of the cement producers as of 4QFY20.

Since most of the factors that are currently driving the bull run in the cement stocks such as pickup in local demand led by the private sector, anticipated commencement of Naya Pakistan Housing Scheme, the recent announcement of Karachi Package by the PM, and the recovery in North cement prices, where the improvement in retention prices was also driven by less trade discounts and decrease in FED by PKR25/bag, are expected to be persistent in the medium term, thus, the profit margins are expected to remain low in 1QFY20, a report by Intermarket Securities highlighted.

The local cement dispatches during 2MFY21 posted a double digit jump of 18% YoY to 6.6 million tons. The increase was witnessed only in the North region, where dispatches rose 23% YoY to 5.9 million tons; whereas, in the South, demand ostensibly declined by 1% YoY to 0.8 million tons (12% of total sales).

August 2020 was the 18th consecutive month, in which South did not get its due share in total demand i.e. 24% according to its installed capacity. South’s exports comprised 12% of total sales compared to 9% in FY19, the report stated.

The above-mentioned trend is mainly due to North producers selling in the South.  As the report explains it all started from 4QFY19, when North producers began commissioning their new capacity. The reason behind this strategy is the wide price disparity between the two regions (nearly PKR150/bag).

This way, North producers raise their utilization levels to cover fixed costs amid inadequate North demand and dried-up exports, the report added.

Furthermore, the current soaring prices from a low of Rs 470 per bag to the range of Rs 500-515 per bag, is still not significant for the highly leveraged producers as they will remain in losses at such price level, as according to the report.

This has left the producers with no choice but to increase their volumes by selling in the South.

According to the PBS data, South prices have recently dropped to Rs 665 per bag from Rs 696 per bag in May’2020, while North prices have been rising. As per the report, North producers are selling at as low as Rs 570 per bag in the South; whereas, South based plants are selling in the range of Rs 610-650 per bag. South producers are resorting to greater exports but at compromised margins (gross margins fell 6ppt YoY in 4QFY20 in case of LUCK and Attock Cement).

With regards to demand outlook, the reports holds an optimistic view as the government’s construction package will lift the demand growth in the sector and consequently will bring the pricing discipline in the sector which can be gauged from the  gauged from the fact that prices in the north market have recently moved up.

However, the aforesaid situation in the South market shows signs of indiscipline and can delay further price recovery in the North Market, the report said.

 To resolve the existing indiscipline in the South, the report presented three scenarios;

In the first scenario, the report explained that Cement prices in the two regions can be converged, if the cement prices in South falls back to the level of prices plus freight differential in the North, to around Rs 550/bag, then North producers will naturally stop selling in the South. The additional transportation costs and trade discounts should more than erode the difference in retention prices between the regions. However, South producers will resist this option, because it may be difficult for them to raise prices in future (and maintain premium over North prices), as North producers will likely resume selling in the South.

In its second scenario, the report states that if cement prices in North surpass the Rs 550/bag level after December 2020 amid strong demand, then North producers will reduce sales in the South to sell more in their own region.

The third scenario will provide better profitability to the South producers than those in North as the report utters, if cement prices in North surpass the Rs 550/bag level after December 2020 amid strong demand, then North producers will reduce sales in the South to sell more in their own region. Also, the Rs550/bag price will encourage North producers to sell more in their own region for better retention prices.

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