UNCERTAINTIES ABOUT PAKISTAN'S CEMENT SECTOR

It is in the benefit of cement manufacturers not to repeat the past mistakes, while the government should also strictly monitor any undue hike in the prices above the current levels.

SHAHZEB KHANZADA
Senior Anchor Business Plus

Mar 19 - 25, 2007

Cement is a very important commodity in any developing economy as its rising consumption reflects the overall economic development of the country. It is one of those few products in which Pakistan turned from an importing to an exporting country. Pakistan imported cement from 1947 to 1985, then this industry attracted local investment and now the sector not only meets local demand but also earns foreign exchange due to a significant rise in cement exports in the last couple of years.

In the beginning of this decade, the cement industry witnessed its worst years. The number of manufacturers has risen due to a predictable demand in the foreseeable future, however, low capacity utilization coupled with lower prices due to break up of cartel brought a crisis-like situation for entire cement industry. During the fiscal year ending June 30, 2003 the industry had suffered a loss of Rs88 million and it operated only at 66 percent of the installed capacity. The industry recovered in the next immediate year and again became profitable and this profitability showed phenomenal growth until 2005-06, as is evident from table-1, which shows the growth in sales and its impact on the growth in profitability in each year. The disparity between the growth in sales and the growth in profitability portrays the changing trends of cement per bag prices.

In the first half of 2006-07, though the decline in profitability is largely attributable to the low per bag prices, rising financial charges due to debt financed huge expansions and rising interest rates scenario also contributed to this decline. Capacity utilization also remained 75% due to lower demand in the winter season, but it was not only the demand-supply situation that resulted in a price crash. It reminded the altercation within manufacturers that resulted in a price war in 2002-03, thus showing that manufacturers do not believe in learning from history even when they themselves made that history just four years back.

Situation has improved since January this year. Prices that had touched as low as 180 rupees per bag in December last year have rebounded to as much as 250 rupees per bag. This has also created doubts in the minds of the concerned people. Demand has risen due to increase in construction activities and also export as in February the cement export saw biggest single month exports of .32mn tons, but still the capacity utilization by the industry is 75%, thus showing no imbalance between demand and supply situation in favor of demand and hence the sudden rise of 50 rupees per bag in a few days is questionable.

Mr. Inayatullah Niazi, CFO DG Khan Cement, says: "Local demand is driving the prices and it is expected to remain upbeat in the near future. The prices will settle down in the range of Rs.255-260 per bag". This seems difficult after continuous monitoring of market prices by the government and also due to the continuous protests and strike threats by Association of Builders and Manufacturers (ABAD).

The supply situation is very satisfactory from government's viewpoint, when it comes to its plans for infrastructure development as envisaged in public sector development program and also evident from its rising proportion in annual budget. The manufacturers could foresee the economic growth that has actually taken place and hence heavily invested in the expansions. The approach was no doubt in the right direction but later it turned into a tussle. The leading manufacturers wanted to maintain their market share in order to remain at the top. Getting highest quota in a scenario of low capacity utilization was another reason for the huge expansions; hence except initially announced expansions the latter were not feasible for the sector and therefore it stands at 7mn tones of surplus capacity out of total 30mn tons capacity. The capacity will further increase by the end of this calendar year to 33mn tones and to 43mn tons by the end of 2008. Local demand though has been rising at a buoyant pace and has seen double-digit growth in last five Years. In Pakistan there is an estimated shortage of 6mn houses and this shortage is increasing because rate of increase in houses is lagging behind the rate of population growth. Per capita consumption of cement is also very low as compared to the regional countries as shown in table-2, however, rising land prices and also expansive mortgage financing are the main impediments in housing. An increase in per capita income is usually associated with people's well-being and future cement demand, nevertheless it is insignificant in real terms hence demand on this front is expected to remain subdued.

TABLE-1

COUNTRY

PER CAPITA CONSUMPTION (KG)

Pakistan

120

India

135

Thailand

450

Taiwan

650

China

800

South Korea

960

Recently, the big UAE construction groups such as Emaar, Nakheel and Alghurair have shown their interest in Pakistan. They announced multi billion dollar construction plans in future, and if materialized these will definitely boost cement demand. The dams have been announced by the government, which will consume a reasonable portion of expanded capacity. But still all these projects cannot be expected to meet the future cement surplus capacity.

Then comes the export market. Manufacturers are very optimistic about future cement exports both through sea and land routes. In the last five years, the exports have been continuously rising except 2005-06, when manufacturers faced ban on exports due to hike in local prices and higher local demand. It is shown in the table-3.

TABLE-2: MN TONS

YEAR

LOCAL

EXPORT

TOTAL

2002-03

10.95

.43

11.4

2003-04

12.51

1.12

13.63

2004-05

14.78

1.565

16.35

2005-06

16.9

1.5

18.4

2006-07(Jul-Feb)

13.46

1.76

15.23

Afghanistan is the main destination for Pakistani cement exports through land route and contributes 70% of Pakistan's total cement exports. Pakistani exports are expected to rise there due to infrastructure development taking place as Afghanistan is expected to get more American aid in the future. Cement shortage in India and Indian government's decision to allow cement imports has created another opportunity for the Pakistani cement exports. DG Khan Cement has recently exported 1500 tones of cement to India and manufacturers confirmed that many enquiries are being made by Indian cement importers for importing more cement from Pakistan. Exports through sea have also risen. Lucky Cement played a major role by becoming the only cement manufacturer to have plants both in the southern and northern regions. Southern plant not only caters to local market there but is also viable for exports through sea by saving freight expenditures. However, the government despite so many promises for providing bulk handling facility on the port, failed to do so. It is therefore very difficult to make exports through sea.

According to Mr. Abid, Director Finance, Lucky Cement, "Exporting through sea is definitely a problem. However, we have invested ourselves to capture the export market and hence Lucky Cement has been able to utilize its southern plant for exports through sea".

Another important aspect of upcoming expansions is that, most of them will be in northern region, which constitutes 84% of the total cement sales. Local demand is a very important factor for the northern region plants as exports through sea route is not a viable option because cost increases due to freight charges.

If we ideally assume that the government provides storage and bulk handling facilities on the port, even then Pakistan will not be able to compete with the upcoming Iran's expansions which will increase to 72mn tons in next couple of years with a surplus of 25mn tons. Cost of production in Iran is much lower as compared to that of Pakistan due to indigenous cheap oil, and as a result cement per bag price is much lower as compared to Pakistan. Consequently, it will be very difficult for Pakistani cement to maintain its market share in the Middle East and other regional countries through sea.

Cost of production is higher for new plants due to depreciation and financial charges and lower for old depreciated plants. It is therefore possible for big companies to achieve economies of scale even at lower capacity utilization, but very difficult for smaller plants relying on their new capacities. The survival for the industry at lower capacity utilization of 70% is only possible if prices remain in the vicinity of current levels of Rs.240 per bag. This price level not only ensures reasonable margins for the manufacturers but keeping in view the average historic trends, this level of prices is also acceptable to consumers.

The decline in cement prices doesn't have a linear relationship with the profitability and a few rupees decline in the prices can completely deteriorate the earnings and vice versa. This becomes more evident if we look at the facts and figures given in the table-3. Due to hike in prices in the first half of 2005-06, profitability growth heavily surpassed the growth in sales numbers, however, in the next immediate year i.e. in the first half of 2006-07, crash in cement prices in the second quarter and particularly in the month of December due to so called price war situation and cartel break up, the profitability decline heavily surpassed the decline in sales numbers. The impact of prices worsened the profitability up to the extent that despite 64% increase in the sales for Lucky Cement and economies of scale due to leading market share, the profitability declined by 7%.

TABLE-3: HALF YEAR

COMPANY

% SALES GROWTH

% PROFIT GROWTH

% SALES GROWTH

% PROFIT GROWTH

 

2005-06

2005-06

2006-07

2006-07

Lucky

77

112

64

-7

DG Khan

30

76

-12

-25

Maple Leaf

12

57

-28

-80

Fauji

22

118

-12

-35

Sector

44

82

-3

-62

It is in the benefit of cement manufacturers not to repeat the past mistakes over and again and reach a consensus; however, the government should also strictly monitor any undue hike in the prices above the current levels.