Sector analysis

Its problems galore as multiple events take a turn for the worse for cement manufacturers. The latest news compounding cement manufacturers’ misery is the imposition of about PkR6.35bn aggregate fine by the Competition Commission of Pakistan (CCP) for fixing of cement prices. This adds to already two previous negative developments with respect to the break-up of the so-called ‘pricing agreement’ or cartel as well as the SBP’s LoI with the IMF wherein the SBP has agreed to do away with the subsidised financing rates under the export refinance scheme. Within our coverage universe, fines imposed by the CCP for Lucky and DGKC stand at PkR1.27bn and PkR933.4mn, respectively. Factoring in the negatives, we downgrade the Cement Sector to ‘Marketweight’ with a Neutral call on both Lucky and DGKC.

We believe FY10E earnings uncertainty for cement manufacturers should increase after imposition of hefty fines (PRs6.35bn for the industry) imposed by the Competition Commission on grounds of alleged cartelisation.

While one-time impact of fines is high (PRs3.93/sh for Lucky as against FY10E earnings of PRs9.73/sh and PRs3.07/sh for DGKC as against FY10E earnings of PRs0.53/sh), we expect cement manufacturers to appeal the penalty and final liability could differ, be delayed or waived.

To us, the path of future cement prices is a greater concern where manufacturers may have a tougher time raising prices (and reclaiming FY09 peak margins) under the regulators increasingly watchful eye.

Profitability outlook for FY10 is largely contingent on quarterly price recovery from current levels where we factor in ~15% higher-than-current prices by end FY10. We eye high EPS uncertainty ahead and maintain underperform on DGKC & Lucky Cement.

D. G. Khan Cement (DGKC) announced its full year FY09 result on 17^th September 2009, where the company posted earnings of PkR525.6mn (fully diluted EPS-PkR1.72) compared to a loss of PkR53.2mn (fully diluted LPS-PkR0.17) in full year FY08. Though a significant improvement, the results were significantly lower than consensus estimates mainly due to higher tax expensed in FY09. That said, positive earnings momentum was achieved on the back of a 114%YoY increase in export dispatches as well as considerably higher retention prices. During 4QFY09, the company recorded an additional impairment of PkR102.7mn, taking total impairment recorded in FY09 to PkR257.4mn. As expected, the company did not announce any dividend along with the result. At current levels DGKC offers an upside of 37.6% to our target value of PkR47.3 per share, however, we will be updating our models and will communicate our revised target price post release of detailed accounts by the company – Buy!