Cement: Three highly leveraged industry players’ right issuances are on cards?

January 23, 2020 (MLN): The current expansionary phase of the cement sector is tripping due to lower demand, higher interest rate and initiative against unregistered dealers.  

However, in the past, 2016-2018, the cement players enjoyed the superior margins due to strong price arrangements among players, lower interest rates and higher demand, reported Insight Securities research.

According to the research report, recently, cyclical stocks seem to be at a major disadvantage as govt. implemented austerity measures due to the IMF program, Export concerns in the north region and fiscal constraints, resulting in lower PSDP allocation.

Moreover, Axle Load, CNIC condition and lower private sector demand in a scenario of higher finance costs affected the cement sector. 

Since companies witnessing liquidity crunch and higher interest rates, the report underlined that companies might opt for equity financing rather than debt. In this way, companies might reduce their leverages and meet working capital requirements.

In this regard, the right issue option would be helpful for companies having high debt levels, allowing them to retire some debts to lessen finance costs. Thus, some companies have been identified as a sample which might go for right issue option based on two criteria: i) Debt to Asset levels ii) Interest coverage ratios, as per research report.

The report highlighted that Cherat Cement Company Limited (CHCC), Pioneer Cement Limited (PIOC) have higher gearing levels with debt to asset ratio at 59% and 51% respectively, whereas, interest coverage ratio turned negative for them, making them a prime candidate to issue rights.

On the other hand, Lucky Cement (LUCK), Kohat Cement Company Limited (KOHC) and Fauji Cement Company Limited (FCCL) are comparatively safer stakes and hence least affected on high-interest rate environment.

It is pertinent to mention that history suggests DGKC has remained most active in raising funds through right issuances even at low debt levels, however, D.G. Khan Cement Company Limited debt levels are not worrying but a repeat of history cannot be ruled out, as per research report.

In accordance with right share, MLCF issued right shares of 85% with Rs12 per share and raised Rs 6 billion to improve debt to equity ratio, protecting it from rising finance cost, the report added.

It is expected that industry interest coverage ratio to further worsen in FY20 as the result of DGKC and MLCF for 1QFY20, both reported gross losses. Similarly, CHCC and PIOC face the same fate on the back of high leverage level.

Though, LUCK, FCCL and KOHC posted better gross margins of 8.54%, 13.94% and 4.12% respectively in 1QFY20.

Considering the current gearing levels, high-interest rate situation, and higher operating charges might prompt right issuances cycle. Besides, the sector shows the dismal dynamics where poor cement prices, lower retention, and enhanced capacities and heightened competition hints margins recovery might be held up until a significant uptick in price is noticed, revealed the report.

According to the research report, if current price level tends to continue, companies, most likely CHCC, PIOC and DGKC might opt for equity financing for smooth debt retirement.

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