Maintaining cement sector strength has become necessary for sustaining the uptrend in the equity market, especially as low growth and erratic input costs cramp the real economy, according to analysts and investors associated with the industry. After oil and gas, cement is the second biggest trading cluster at the KSE, and its strong showing in the last fiscal was central to the Index’s strength in H2-FY12. Mounting political and security threats, coupled with chronically low GDP growth, has left the bourse as the only platform still attracting meaningful foreign investment, something Islamabad would naturally like to see continuing.
Yet lately the cement sector has come under increasing scrutiny, with technical traders warning of overbought levels, and producers pointing at election year expansionary compulsions and likelihood of greater export revenue as enough to sustain the uptrend. At stake is not just industry cash flow at a time of unprecedented infrastructural upgradation across leading plants, but also the KSE index itself, which is heavily reliant on just four or five sectors to drive its growth.
After months of slowdown, both local cement dispatches and exports picked up in September, by 19.8 and 3.6 per cent respectively, hinting at renewed election-year demand at home and improved export prospects in Afghan and Indian markets. Yet with capacity utilisation at 68.86 per cent (that too after a stellar ’12), exports still on a downward year-on-year trajectory, and the local macro environment not favouring growth, questions have arisen about the sector’s ability to sustain last year’s strength.
Input cost and bull-run
The last fiscal saw the industry’s main input cost cut dramatically due to a sharp drop in coal prices. The downtrend continued till the new year’s first fiscal, with prices dropping 20-25 per cent yoy for Q1-FY13.
“Both production and consumption are falling, while cement end-price increased 30 per cent last year,” says Sarfaraz Abbasi, senior analyst at Summit Capital, Karachi. “Excitement in company scrips owed to reduced input cost, mainly coal, whereas both local demand and export fundamentals remain weak”.
Producers, on the other hand, point at the government’s election year spending compulsions as providing sufficient bid in prices through FY-13. “Local demand increased nine per cent last year,” according to Waleed Saigol, who sits on Maple Leaf Cement’s board of directors. “Now, with the election element, we expect increased demand. However, there is always the risk of knock-on effects of unstable input cost, like fuel, etc”.
There is also the possibility of a reversal in international coal prices as Quantitative Easing III (QEIII) and subsequent dollar debasement to spur growth across the Atlantic is expected to raise commodity prices over coming quarters.
Overbought or more upside room?
“It’s difficult to accurately speculate on immediate price movement. There are a number of factors that must play out first”, says Faisal Merchant, chief investment officer at National Asset Management Company (namco), a mutual fund that manages approximately Rs900 million in investments. “FY-12 earnings were super solid, prompting producers to invest heavily in capacity utiliastion, further reducing fixed input expenditure. Personally I feel good about holding cement a little longer”.
Last year’s bull run led to heavy reinvestment by industry majors. DG Khan Cement (DGKC), Lucky Cement (LUCK) and Maple Leaf Cement (MLCF) have installed waste heat recovery plants and invested in capacity enhancement, making them more cost effective.
“Following adjustments we deem necessary to maintain the uptrend, Maple Leaf’s replacement value has increased to around $500-600 million,” according to Waleed Saigol.
Yet despite these measures, techincals remain unimpressed. “I’ll need to see more to give a convincing buy-and-hold call,” says Mohammad Tahir, technical analyst at First National Equities, a Karachi based brokerage with net capital value exceeding Rs1.3 billion.
“It’s tricky, but for the moment technicals hint at overbought levels just around the corner. Failing clear signs of increased local demand, and sorting out of export related issues, we might see a drop. But if the government and industry come through, there is definitely more upside.
Presently, he sees crucial support for DGKC at around 43 (currently around 50). Lucky has strong support at 115 (now at 130-131), but failure to rebound will expose it to 90-95 levels. However, Maple Leaf (9.25) has very strong support, and possibly a rebound, at 8.5.
“The reason is a clear turnaround in its EPS numbers (earnings per share), indicating a management overhaul, and outdoing its contemporaries where numbers matter,” says Hammad Malik, who currently heads First Pakistan Securities Ltd, a Lahore-based brokerage house.
“Whereas EPS trends for most majors have remained more or less the same, Maple Leaf seems midway in engineering a text-book turnaround story.”
SBP action, swing factors
Recent monetary easing came at a good time for the cement sector. The 200bp drop in interest rates over the last fiscal helped reduce the industry’s debt burden, one of the most leveraged. But with incessant government borrowing diluting the easy money, private sector offtake has been minimal because industry remained crowded out, cement being no exception.
Buoyed by the rate cut, cement industry profit grew 152 per cent yoy last year, its 114 per cent increase in stock prices outperforming KSE by 81 per cent. And there are concerns that the stock price is inflated, helped by exogenous influences as opposed to intrinsic demand. There are also concerns of cartel-like behavior, reflected in retail-level price anxiety. “We expected such large profit (brought about by coal price and SBP rate cuts) to lead to price rationalisation at the retail level. But we see no such signs yet,” says a cement contractor, worrying that high prices will eventually lead to demand contraction.
“I’m not surprised few people are able to sift through this mess clearly,” continues Hammad. “It’s not very complicated at all once you break it down to bare numbers”.
Simply put, the index is trading at record levels, a trend whose continuation is in everybody’s interest. And to sustain these levels, volumes need to pick up, which have been near dry for a good two months running.
At such times, favourable corporate results matter more for market pundits than the macro framework. In this regard, it seems cement majors are right up to mark. They undertook a dangerous gambit – heavy reinvestment and deleveraging at peak levels – but it seems it is just such measures that tilt the local bourse. It is these trends that technicals price in, rather than fundamental news. That means there might be some life in cement yet, and by proxy the market, perhaps till after the election.
The writer is a financial journalist covering MENA and Pakistan
Strong cement sector essential for stock market uptrend
