AKD Securities Limited Equity Research – Daily Report

Karachi, December 20, 2017 (PPI-OT): Pakistan Cements: Update on ongoing expansionary cycle

Being the second of the ongoing pandemic expansion cycle (first in the south region), LUCK has successfully commissioned its brownfield expansion of 1.30mtpa at Karachi plant. This should be followed by a 1.2mtpa brownfield expansion of ACPL (expected COD: Dec’17) and 2.80mtpa Greenfield expansion of DGKC (expected COD: 1QFY19) at Hub, Baluchistan. Post completion of the first expansionary phase (5.30mtpa) in South, capacity utilization in the region/total industry is expected to drop at 57%/82% by 1QFY19 from 93%/86% in FY17, assuming demand growth of 8%. Consequently, this is likely to create significant supply side pressures, therefore, exerting pricing pressure over the short term, where the prices have so far remained stable (contrary to North region where cement prices declined by 6.5% since Jun’17).

On the other hand, out of the ten announced expansions in North (totalling 19.6mtpa), only 5 have been able to achieve financial close so far (totalling 9.30mtpa). Accordingly, we see the pace of expansion to be gradual in North with additions coming online in a phased manner – the first expansion is expected to achieve its COD in 4QFY19. This should allow prices in the North region to stabilize at current levels as capacity utilization is anticipated to hover around 90% in the next 4yrs. In the context of the ongoing expansionary cycle, we prefer cement players with exposure in the Northern region including LUCK, MLCF, PIOC and CHCC.

South region- Risk of pricing indiscipline prevails: South region is currently undergoing a rampant expansionary cycle (four announced expansions: totalling 7.80mtpa or 91% of current capacity), where LUCK has successfully commissioned its brownfield expansion of 1.30mtpa at Karachi. This will be followed by 1.2mtpa brownfield expansion of ACPL (expected COD: Dec’17) and 2.80mtpa Greenfield expansion of DGKC (expected COD: 1QFY19) at Hub, Baluchistan.

Post completion of the first expansionary phase by 1QFY19 (5.30mtpa) in the south region, capacity utilization in the region is expected to drop to 57% by 1QFY19 from 93% in FY17 (assuming demand growth of 8%). Moreover, we foresee capacity utilization of South region to average at 70% over the next five years (assuming our 8% demand growth assumption). Consequently, this is likely to create significant supply side pressures, therefore, exerting pricing pressure over the short term, where the prices have so far remained stable (contrary to North region where cement prices declined by 6.5% since Jun’17).

North region- Prices to stabilize at current levels: In the North region, out of the 10 announced expansions (totalling 19.6mtpa) only 5 have been able to achieve their financial close so far (totalling 9.30mtpa). Accordingly, we see the pace of expansion to be gradual in North with additions coming online in a phased manner – the first expansion by MLCF (2.20mtpa) is expected to achieve its COD in 4QFY19, followed by 4 expansions of cumulative 7.10mtpa capacity (likely to achieve their COD by the end FY20).

Despite these supply additions (totalling 9.30mtpa), we see capacity utilization of North to settle around a comfortable level of 85% by the end of FY20 against 84% in FY17. In this backdrop, we expect prices in the North region to stabilize at current levels, expecting no downward revision in prices. Furthermore, the remaining additions also pose no significant threat in our view as they currently stand at very initial stages with completion likely to take time. Assuming they come online by FY22, capacity utilization of North region would still remain above 82% by the end of FY22.

Investment Perspective: Though risks in the form of pricing war (especially in South region) and rising coal prices (surged +32% since May’17) exist, but recent correction in our AKD cement universe (down 51%CYTD) offers attractive entry points especially when growth story remains intact. While maintaining our preference for the sector (particularly North players), our top picks include well diversified, energy efficient companies like LUCK (TP: PkR898/sh), MLCF (TP: PkR108/sh), PIOC (TP: PkR109/sh) and CHCC (TP: PkR140/sh) in our Cement Universe.

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