July 28 - Aug 03, 2008

Pakistan cement industry, comprising of 26 companies with a total capacity of approximately 34mln tons, has modified significantly over time. The risk of substantial falls in profitability of the sector has been minimized, thanks to the cartel arrangement. Most of the existing companies are integrated backward, thus little or no worries from the suppliers' side. Meanwhile, the main hurdle to the new entrants is the intact cartel operations. The cartel allocates utilization quota and pricing arrangements to operate in particular markets. The high capital cost, high economies of scale by the biggies, price setting by the cartel and other operating efficiencies already achieved by most companies would not allow more companies to come into play so easily. Thus we can assume that the overall industry forces go in favor of the existing players, suggesting threat for the sector's profitability standing at moderate/minimal level.

At the same time, none of the cement producers enjoys any material product differentiation because of highly commoditized nature of product. Consumers thus usually regard price as a key determinant. In this scenario, producers are left with no option but to effectively manage input costs to improve the earnings margins. In this regard, size of plant, its age, origin and integration of various components and above all, the expertise of the management team are important.


Most of the companies have come up with their mega expansion projects, and about 60-70% additional capacity has already been added for the industrial expansion underway since the inception of FY06 to date. Owing to the demand growing at the slower pace than the capacity growth, the industry is currently facing the supply overhang position. The excess supply is being sold in the export market at relatively better margins what local market is offering. Over the recent years, Pakistan's cement export growth has increased by more than two-fold, and the trend is likely to continue.


With each month going by in FY08, cement exports are making headways. A number of factors fueled the sectors exports, which include acute cement shortage in both developing and developed countries, continuous staggering demand in our traditional cement thirsty markets. Strong UAE demand coupled with the removal of cement custom duty in the region is the key reason for the higher exports from Pakistan, where alternate markets like India and South Africa will remain the smaller pockets of opportunity, given logistic constraints. UAE is currently facing a serious cement shortage, triggered by a sudden and sharp increase in demand. Looking ahead, export to UAE is likely to continue at the same level at least in the near term, given the temporary closure of four cement factories there. Further, the current regional supply deficit expected to continue till 2010, creates an immense opportunities to explore exports prospects to untapped areas.


The cement sector showed another fall in profitability during nine months ended of ongoing financial year (FY08). The overall subdued earnings of the sector was attributable to three main factors (i) increased cost of sales owing to an unprecedented rise in international coal prices, as most of the companies have converted their plants to coal, (ii) higher depreciation charges, an outcome of increasing expansion spree in the sector and (iii) mounting interest cost. Meanwhile, during the first nine months of the recently ended financial year, the capacity additions combined with the winter season, led to a sharp fall in cement prices, which also proved to be a key dampener to the bottom line. It is interesting to note that only five biggies of the sector were in the profitability-zone, with Lucky Cement alone taking the largest slice of profits, while the others remained in red. While the sector's volumes and top line witnessed a moderate growth, the higher input costs owing to aforementioned factors more than offset the positive impact, thereby leading the depressed bottom line.

After a lackluster performance, domestic sales finally showed a bit higher growth in the recent quarter of ongoing fiscal year, which together with price hike augur well for the sector. While the surge in the cement prices was an outcome of cost push and offsets sky rocketing coal prices, it worked to achieve break-even level for the sector. Also, any incremental benefit (if any) of higher prices is likely to remain nominal in nature as well as limited to handful of companies who take advantage on account of lower conversion cost than peers. Nevertheless, volumes are expected to grow at higher pace as construction activity is in full swing and profitability is likely to turn better due to (i) better prices and (ii) robust export volumes.


Measures taken in the recently announced budget for FY09 bode well for the sector's growth. The PSDP (public sector development program) budget for FY09 has been set at Rs.550bln, which augurs well for the sector, as it may increase construction activity. The annual housing construction demand in the country is hovering at around 600k per year, which is expect to increase further with the government announcement of 1,000k housing units. Out of total PSDP, allocation for dams' and reservations' construction projects includes Rs. 75bln for FY09. This again goes in favor of the cement sector for FY09 and beyond. The major concern for manufacturers is 20% rise in the excise duty - the decision was made contrary to the demand for reduction in the duty. A 100 basis points increase in sales tax from 15% to 16% across the board except for exempted industries can be another negative factor for the industry. A positive for cement companies - especially loss making companies - was announced that the minimum tax payable at 0.5% of turnover would be withdrawn.


The industry is achieving milestones by recording highest ever volumes in exports, verifying the enormous potential the Pakistan cement industry possesses in the wake of timely expansions. Given the strong growth lying in the export market along with expectation of higher construction activity in the country, the cement demand is expected to maintain uptrend in years to come. According to reports, the sector's installed capacity will increase by around 10mln tones by FY10, registering a compounded annual growth rate of 26% for four years period (FY06-10). Compared to this cement demand is likely to increase by 8mln tones at CAGR of 20% by FY10. Meanwhile, capacity utilization is expected to remain somewhere around 75%-80%. Nevertheless, the demand and supply will be balanced and will remain favorable, going forward. This is expected to support the sector in maintaining profit margins, with stable to rising prices in the very existence of cartel. On the other front, downside risks stem from (a) continued rise in coal prices, (b) any slowdown in the government's infrastructure spend and (c) continued macro instability that could hurt consumer sentiment. Nevertheless, the overall outlook of the cement sector appears positive, in the absence of any unforeseen negative developments.