Sector Analysis: Macro dynamics turn their back on the Cement industry

April 25, 2019 (MLN): Lest someone has missed out on current updates, a lot has been going on with the Cement industry lately. From dwindling local demand to excess supply, lower public spending and private construction, ongoing expansions and burdening finance costs, the industry seems to be stuck in a frenzy. Given this setting, the sector’s subtleties are expected to jeopardize the future profitability.

A report by EFG Hermes suggests that FY19-20 is going to be tough on Cement sector for the very same reasons mentioned above. The industry is undergoing an expansionary cycle, where c16mn more tonnes capacity is in the pipeline, in addition to c10mn tonnes already added during FY17-FY19TD. This is the major reason why market participants are so doubtful on the sector, as any major uptick in local dispatches over the ST to help absorb the incremental supply does not seem probable.

Don’t judge a book by its cover

Sadly, we have been severely conditioned by the statements given by certain authoritarians over and over, regarding how our country is nothing less than a la-la land. In news articles, media reports, social platforms, everywhere we see the “plans” of Prime Minister Imran Khan to bring a change to the economy through his Naya Pakistan Housing Project, which is apparently under implementation, or is it?

While the “Naya Pakistan Housing Scheme” promises generation of significant demand for cement, its implementation is still doubtful mainly because of lack of visibility on the project funding.

Similarly, even though the construction of Mohmand Dam and Diamer Basha dams is expected to generate considerable demand, the financing and time frame of completion of these projects have casted a serious doubt on the same. Therefore, the possibility of it being a game-changer for the sector is zilch.

Hence, the domestic demand does not seem very promising in the near term as any quick progress with regard to the construction of dams or the low-cost housing scheme seems dawdling, given the government’s repeated fiscal miseries.

The Domino-effect

When there aren’t enough buyers to sustain the equilibrium, it eventually leads to problem of severe pricing instability. On top of that, a weakening PKR has meant that the sector is not making the most out of declining international coal prices.

Furthermore, gross margins for industry are likely to fall on the back of PKR devaluation, lower cement retention prices and fixed cost (depreciation) owing to capital expenditure of plant expansion. Net margins are also estimated to stay even on the back of higher financial costs. However, the bottom-line would have some backing from tax credits.

Stability of cement pricing remains critical for profitability; however, this is unlikely to be easy, as colossal supply will start to take its toll, especially if dispatches fail to recover, EFG Hermes stated in its report.

The graph above shows the impact of oversupply and diminishing local demand via a declining price trend over six months. Moreover, the prices were at their lowest in the month of April.

Cement sector becomes an audience to the Indo-Pak melodrama

Post Pulwama attack which took place on February 14 2019, the Indian government immediately retorted by increasing duties on imports from Pakistan to 200 percent. As a result, the Pakistani cement exporters were forced to recall their containers from Wagah border.

While the growing tensions between the two neighboring countries may have eased out to some extent, the possibility of cement exports reverting to their original state seems less likely.

However, given that India is currently undergoing a change of government, the situation might reverse or even become better if a sensible office-bearer comes into power.

With every bad comes good

Ever heard of the saying  ‘with good comes bad’? Outlandishly, it’s the other way round in the context of cement industry. While success on internal front may have been limited, the cement sector is most definitely thriving and realizing its potential on external front. This can be easily deciphered via recent trade numbers published by Pakistan Bureau of Statistics, which show that the exports of cement from the country have witnessed an increase of 32.81 percent during the first three quarter of the current fiscal year against the export in the corresponding period of last year.

In terms of quantity, the export of the cement also witnessed an increase of 55.44 percent by going up from 3,338,065 metric tons to 5,188,661 metric tons.

The momentary solution

With inflated operating costs and finance charges, the industry will have to re-engineer the marketing agreement by means of reverting to older lines at lower utilization, which allows companies to dispatch in the local market in accordance with their capacity-based market share.

However, there is still a slight hope that the LT fundamentals will recover as the country still lacks cement consumption, development projects will pick up pace as economic rebalancing matures and, most importantly, players will adapt accordingly by underutilizing their older lines, which will support prices, the report said.

While hike in interest rate may have led to lower demand locally, the demand is however anticipated to be on an upper trajectory in the international markets as PKR devaluation will make Pakistani cement cheaper.

Moreover, experts have forecasted cement demand to surge in FY20, as the government will have some relief on fiscal deficit to build five million houses.

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Posted on: 2019-04-25T13:56:00+05:00