THE CEMENT HYPE
Investors have started realizing the potential risk of investment in the cement sector
By SHABBIR H. KAZMI
Oct 04 - 10, 2004
This may be the best earning period for the cement sector but the hype in the sector is leading towards the beginning of the end owing to: (I) lower than expected sales revenue by cement companies; (II) loss of potential benefits from coal conversion; (III) increasing interest rates in the country; (IV) manipulation of earning numbers from realization of deferred tax asset; and (V) poor pay outs. Market sentiments for the cement sector are getting matured over the period while investors have started realizing the potential risk of investment in the cement sector as compared to the market.
A 20% jump in sales volume is not truly reflected in the net sales revenue reported by the cement companies. This has disappointed investors. The high expectations were based on: (I) 20% volumetric growth in sales; (II) increasing cement prices, and (III) a 25% reduction in CED announced by the government for FY04.
Most of the cement companies converted their cement plants from furnace oil to coal firing system by the end of 2003, which was expected to result in reduction in fuel cost per ton by 45-60% for the industry depending upon the plant technology. However, an almost 100% increase in coal prices gradually wiped off the net advantage expected from the conversion. This is evident from declining margins over the months.
Taking advantage of the declining interest rates, cement companies restructured their expensive foreign currency loans with cheap local credit available, resulting in a reduction of financial cost from 15-17% to 5-7% depending upon the credibility of the company. With the increase in interest rates, the potential benefit expected from the financial restructuring exercise is vanishing owing to the floating nature of interest rates on these local currency loans.
Taking advantage of the best operating year, the cement companies have manipulated their bottom line through the realization of deferred tax asset with the hope of improving profitability in future years. Meanwhile these non-cash transactions are creating confusions for the general investors.
Keeping track record of poor payouts, cement companies are not likely to share their profits with the investors. Thus, the entire sector fares poorly on dividend yields.
Market sentiments for the cement sector are getting matured over the period while investors have started realizing the potential risk of investing in the cement sector. Moreover investors can no longer rule out the short sightedness of these cement companies over the deteriorating demand supply situation in the long term with the implementation of their announced expansion plans.
Cement sales in August 2004 have increased by 24% YoY to 1.292 million tonnes compared to 1.044 million tonnes during the same period last year. Export sales as a proportion of total sales have jumped from 8% in 2004 to 12% in the month of August 2005. Capacity utilization in the first two months of 2005 has remained above 90% as compared to 73% during 2004. Going forward sales are expected to decline in October owing to Ramadan. The growing dependence on exports is likely to have negative connotations. According to sector analysts, capacity utilization in the cement industry would settle around 85% in 2005 with sales likely to touch 14.5 million tonnes per annum. Resultantly, sector earnings is expected to grow from Rs 4.9 billion to Rs 5.3 billion improving sector multiples from a current 12x to 9x.
Domestic sales whilst witnessing a YoY growth of 19% have witnessed a 17% MoM decline to 1.135 million tonnes per annum. The MoM sales growth is more reflective of growth momentum and as such a 17% decline could indicate to a slowdown in momentum of domestic sales. This figure can, however, be misleading as the quota allocation shows that whereas July 2005 started with 100% utilization and closed at 80% utilization, August 2005 closed at 91% utilization. Therefore a pickup in domestic sales was witnessed during the month of August.
EXPORTS SALES HAVE MIXED CONNOTATIONS
In terms of exports the 68% YoY growth has resulted in exports now constituting 12% of total sales rather than 8% in 2004. The 12% market share has mixed connotations, whilst the increased share of exports in 2005 is primarily from increases in exports is encouraging for sales. However, the flip side is that a larger proportion of exports sales would leave total cement sales more sustainable to a drop if exports growth stagnates. Exports are not expected to be a long-term source of growth owing to increased competition from Iran, which is putting up 30 million tonnes per annum of additional capacity due to come online within the next three years.