IS THE CEMENT SECTOR HEADING TOWARDS A CRISIS?

Capacity utilization expected to go down further due to planned expansion

By SHABBIR H. KAZMI
Mar 15 - 21, 2004

Lately the prices of scrips belonging to cement sector have gone up substantially due to investors' keen interest, mainly due to recent increase in cement off take. However, many sector analysts warn that the sector is heading towards a situation, worse than that faced in mid nineties, due to planned expansion. They also warn investors to apply restraints or be prepared for the losses.

The recent interest of investors in cement sector was mainly due to improved earnings, resulting from higher off take, lower cost and reduction in the CED. Though, cement sales are expected to remain high, the only cause of concern is the recent capacity expansion. Though, the cement cartel has remained effective so far, once the enhanced capacity comes on line, it may not remain so effective.

According to Arshad Arif, Head of Research, KASB Securities, "Cement makers are showing turnaround via high demand and managed prices. But at the same time, their usual ill visions are likely to tame this mega bull story. At the moment, almost all the cement makers are dreaming of capacity expansions. They want to exploit the current low interest rate environment and bull market sentiment to raise further capacity in a market, which is already operating at around 71% capacity utilization. Doesn't this sound familiar to what we heard during 1994 while visiting most of the Northern companies? The cartel is a temporary phenomenon, which will eventually see its logical death at the hands of players. Thus investors must not show too much excitement in the cement sector. Though there is an upside potential, the downside is more visible in the long run and in all likelihood it will be more painful compared to 1994".

The present market's romance with the cement sector is not very old. The story started with temporary developments like the cartel's formation to pressurize the government to lower its taxes, saw some fundamental logic owing to coal related efficiencies and loan re-profiling of debt. However, investors' current enthusiasm does not match with these one time changes, rather the sentiment towards this sector is much stronger, more or less similar to what was witnessed in 1994.

CEMENT OFFTAKE

According to the data released by All Pakistan Cement Manufacturers Association (APCMA) during the first 8 months of the current financial year, demand has seen an increase of nearly 13% to over 7 million tonnes whereas February was an exceptional month with 22%YoY growth. The local market was slightly less exciting with 9.5% demand growth whereas exports have shown a 195% YoY improvement. The capacity utilization figure for the year remained at around 71%. Though, demand growth is significantly positive, the momentum of this growth is slowing down slightly, particularly in the local market where the industry started with a 14% growth rate and is now experiencing a lower growth rate.

THE CARTEL

According to an analyst, "Pakistan is passing through its worst times in terms of the sanctity of trade practices. Name any industry and Pakistan appears to be setting standards of forming inefficiencies. Auto, cellular telephony, steel, synthetic, and cement are just some of the names. Despite the hue and cry from the general public and the international financial institutions, the government has failing miserably in curbing such practices. The continuation of the cement cartel is a curse and the government and its functionaries are living with it. The formation of the cartel to jack up prices to over Rs 220 per bag, not passing on any benefit to the end consumers from the CED reductions and the continued short supplies in the market are the norms".

TAIL PIECE

A perfect bull story can be made for the cement sector. The demand side is very strong whereas the manufacturers are posting healthy gains by maintaining high prices, though they are doing some cheating which the government is allowing. And the market has shown a strong positive reaction towards this so far. The only relevant question is of the sustainability of this scenario.

According to an analysts, "One of the reasons investors have been losing money in equities market is that they base their decision on past performance and mostly overlook earnings potential. The recent past of cement sector may be glorious but it may be very bleak keeping in view about 10 million tonnes addition in capacity".

The sponsors of cement companies must also think twice and must not add capacity only because interest rates are low. Adding capacity may be easy but optimizing capacity utilization may prove too difficult. The expansion being undertaken by Lucky and D. G. Khan Cement is based on export of cement to Afghanistan. Can others also emulate them?