Elixir Securities Limited – Elixir Insight

Karachi, December 05, 2018 (PPI-OT): Lucky Cement Limited – Consolidating the Conglomerate

With its ongoing expansions, contribution from local cement operations to LUCK’s Consolidated Earnings is projected to come down from 80% in FY18 to 58% by FY22. We are thus switching to publishing consolidated financials from now on; our Jun-19 PT however remains unchanged at PKR625/share, as our valuations had already been reflecting LUCK’s ventures in other businesses.

With a 5 year CAGR of 18%, LUCK offers an enticing growth story mainly driven by its power venture i.e. LEPCL which will contribute around 25% to LUCK’s consolidated earnings from FY22.

In addition, LUCK also offers exceptional diversification as it also operates in consumer markets through ICI and thus safeguards itself against weak cement dynamics which dominates its profitability.

We continue to flag our liking for LUCK that stands out from its peers due to 1) leverage free domestic cement operations and 2) lowest cost cement production. Beyond domestic Cements, other ventures account for almost 40% of the Valuation where we particularly like the investment in Lucky Electric Power – an area that we feel the market has not completely appreciated so far.

Consolidating the Financials: With its ongoing expansions in Automobiles, Power, Chemicals, Pharmaceuticals, Nutraceuticals and overseas Cement Operations, Lucky Cement Limited (LUCK) is all set to become one of the leading Conglomerate in Pakistan. In fact, contribution of local cement operations to the Company’s Consolidated Earnings is projected to come down from 80% in FY18 to 58% by FY22. Similarly, local cement operations which contributed 45% to the total revenue in FY18 will only be accounting for 27% of the pie by FY22.

We have thus consolidated the financials of all the businesses and will be laying out the projections on Consolidated Statements from now on. Note that our Jun-19 Target Price for the stock remains unchanged at PKR625/share, as our valuations had already been reflecting LUCK’s ventures in other businesses. We maintain our BUY call on the stock and re-emphasize that the Company should not be viewed as a pure cement play as the profitability contribution (EPS impact: PKR24 in FY22) from Lucky Electric Power will alone allow the group to post 5 year CAGR of 18% (FY18-23) – a feat unmatched by other Cement Players due to weak sector dynamics.

Domestic Cement Operations to Remain Depressed During FY19: We expect local cement operations of the company to remain depressed on the back of 1) slowdown in economy, 2) high cost of imported coal, 3) interest rate lift off making house financing more expensive, 4) further anticipated PKR/USD depreciation and 5) pressure on cement prices on the back of upcoming competition in North. We maintain our local industry demand forecast at 0% for FY19E (compared with 16%YoY in FY18). Our average long term domestic demand growth forecast stands at 5% over FY20-24. On export front, our growth forecasts from North and South regions stand at 0% and 40% for FY19E, respectively. The reason for expected surge in exports from South can be attributed to LUCK’s (and other players’) recent expansions as they channel the surplus to low-priced export markets.

While LUCK’s FY19 standalone EPS is expected to shrink by 8%YoY to PKR34.7 (vs. PKR37.7 in FY18), we anticipate FY20 and onwards earnings to improve on the back of 1) positive growth in domestic demand and 2) impact of LUCK’s upcoming 2.6 mtpa Brownfield expansion in KPK (expected COD: Dec-19). Our calculation suggests the project to contribute ~PKR14/sh to LUCK’s annualized standalone earnings.

ICI’s Acquisition Providing a Flavor of Multiple Industries: LUCK owns a controlling stake of 56% in ICI Pakistan Limited (ICI) via its subsidiary Lucky Holdings Limited (LHL). ICI mainly caters to four businesses i.e. Polyester Staple Fiber (PSF), Soda Ash, Life Sciences and Chemicals and Agri Sciences. The company manufactures and sells a wide range of industrial and consumer products. These include;

At present, ICI enjoys its highest revenue from PSF and Soda Ash (40% and 29%, respectively). The company is also setting up an infant milk manufacturing plant with the help of Morinaga and Unibrands (expected COD: Jun-19) and has acquired 100% stake in Cirin Pharmaceuticals.

During FY18, ICI contributed 13% to LUCK’s consolidated earnings (~PKR6.0/share). Going forward, we expect ICI to contribute on average 8% to consolidated earnings (PKR3.5, PKR4.6 and PKR6.3 in FY19, FY20 and FY21, respectively) where we believe the real growth would be coming from Nutrico Morinaga. Furthermore, expected dividends from NutriCo Pakistan and improvement in turnover of Cirin Pharmaceutical are expected to give earnings a further push. On valuations front, using a 25% portfolio discount, ICI contributes PKR73 to our LUCK’s Jun-19 PT.

Polyester Staple Fiber (PSF): ICI earns 40% of its revenue from its PSF business, which is projected to stabilize at 33% from FY22 (after the lapse of anti-dumping duty). Keeping the PSF core delta constant at USD300/ton (based on historic average), we expect the operating margins of the business segment to turn into negative in FY21 due to 1) expected PKR depreciation thus making raw material expensive and 2) slowdown in sales on the back of expected Chinese imports (after lapse of anti-dumping duty).

Hence we believe that the PSF segment, despite its highest contribution to ICI’s revenue, will once again become a profit dampener in the long run.

Soda Ash: Soda Ash contributes 29% to ICI’s top line and has been showing improvement on the back of 1) enhanced capacity (by 75k TPA) during FY18 to stand at 425k TPA and 2) growing demand fueling from silicate, paper and detergents markets. Going forward, the rise in feedstock prices would increase cost of production for the business; however the recent lapse of anti-dumping duty (ADD) levied on Soda Ash imports in India is expected to provide much needed breather for the segment.

Finally, according to media reports, China has started a new round of environmental checks, which is likely to impact Global Soda Ash prices. The environmental checks are expected to lead to supply curtailment in China, which in turn will favorably affect the prevalent export prices.

Life Sciences: Life Sciences contributes 18% to ICI’s top line. The major sub segments of the business are Animal Health division and Pharmaceuticals while the company also acquired certain assets of Pfizer and Wyeth during FY18. The segment registered a net turnover of PKR2.4bn during 1QFY19 (down 12%YoY) due to the ban on import and marketing of Recombinant Bovine Somatotropin (rbST) injections and slowdown in the economy. Medium term outlook remains less than exciting due to 1) continuation of ban on rbST injections and 2) expected margin attrition in Pharma business due to PKR devaluation. More than expected boost from Pfizer/Wyeth segments remains major upside risk for the division.

Chemicals and Agri Business: The Chemical business contributes 13% to ICI’s top line. During 1QFY19, the business recorded net turnover of PKR1.7bn (down 3%YoY) due to slow credit recovery. Going forward, the outlook on the segment remains modest due to curtailment of credit sales and slowdown in agriculture activity (as per revised GDP forecast).

NutriCo Morinaga: ICI Pakistan has entered into a Joint Venture (JV) with Morinaga International and Uni Brands to establish a 12kTPA infant milk production plant. The project has an estimated cost of PKR4.8bn and is expected to come online by Dec-19. At present, the average selling price of 1kg infant milk pack is PKR 1,870 (average of Nestle’s Lactose, Abott’s Similac and Searle’s Nurture Intelligence). We expect the company to launch its product at a 20% discount against competition at PKR1,500. The project is expected to contribute PKR1.2, PKR2.6 and PKR3.3 to ICI’s EPS for FY20, FY21 and FY22, respectively.

Lucky Al-Shumookh – Rehabilitation of Infrastructure to Drive Earnings: LUCK commands a 50% ownership stake in Lucky Al-Shumookh Holdings Limited (LASHL) which operates a cement grinding unit in the Republic of Iraq under an entity named Al Mabrooka Cement Manufacturing Company Limited (AMCMC). During FY18, the company completed brownfield expansion of 0.87 MTPA, doubling the capacity to 1.7 MTPA.

Going forward, we expect enhancement in economic activity and rehabilitation of infrastructure, translating into pickup in cement offtakes in Iraq. Resultantly, we expect the project to contribute PKR3.9, PKR4.2 and PKR4.4 to LUCK’s EPS for FY19, FY20 and FY21, respectively. Using Free Cash Valuation and a 25% portfolio discount, the project contributes PKR42/sh (7%) to LUCK’s Jun-19 PT. Note that, our earnings projections does not incorporate 1.2MTPA Greenfield clinker production facility in Samawah (Iraq)

LuckyRawji Holdings – Modest but Consistent Contribution to Earnings: Based in Democratic Republic of Congo (DRC), Nyumba Ya Akiba S.A. (NYA) is 50% owned by LUCK via Lucky Rawji Holdings. NYA has a fully integrated cement plant in the Kongo Central Province of DRC with a production capacity of 1.2 MTPA. We expect the project to contribute PKR1.9, PKR2.1 and PKR2.2 to LUCK’s EPS for FY19, FY20 and FY21, respectively. The project’s contribution to LUCK’s Jun-19 PT stands at PKR34 (5%) using Free Cash Valuation and a 25% portfolio discount.

Lucky Electric Power – “The Jewel in The Crown”: Lucky Electric Power Company Limited (LEPCL) is engaged in setting up a 660MW supercritical power project using Thar Lignite Coal. The company is wholly owned by LCL Holdings Limited (LCLHL) which in turn is a wholly owned subsidiary of Lucky Cement.

Required Commercial Operation Date (COD) for the project is March 1, 2021 while the estimated project cost is USD 885mn (vs. USD1.08bn earlier). As per our discussions with the management, the project cost has been scaled down due to changes in project design to use local coal (from an earlier plan of using imported coal). The changes in coal procurement has also revised up ROE component in Tariff to 29.5% (from an earlier of 27.2%).

We expect LEPCL to contribute PKR24.3, PKR25.8 to LUCK’s respective FY22 and FY23 Consolidated EPS i.e. a 26% and 25% of the company’s total earnings. With a 5 year (FY22-27) profitability CAGR of 9%, we believe LEPCL will more than hedge profitability of the company against weak fundamentals in cement operations in upcoming years. Using Dividend Discount Model (DDM), the project contributes PKR64 (10%) to our Jun-19 PT of PKR625/share for LUCK.

KIA Lucky Motors – An Adventurous Ride: Kia Lucky Motors (KLM) is a Joint-Venture between LUCK and KIA Motors Corporation where LUCK holds 70% stake in the project (i.e. PKR14bn out of total PKR20bn). The principal line of business of KLM is to carry out the assembling, distribution, marketing, sale, after-sale-service, import and export of all types of KIA motor vehicles, parts and accessories under license from KIA Motors Corporation. With an expected capacity to produce up to 30k units in the first phase, The Project aims to start its commercial production by Jun-19. Taking cues from the changing macros, we expect the company to operate at an average utilization rate of 40% during FY20-24. Lower offtakes and higher distribution costs are however expected to translate into losses in initial years (FY19-20), after which we expect the project to contribute PKR0.6, PKR0.6 and PKR2.1 to LUCK’s EPS during FY21, FY22 and FY23, respectively. The project contributes PKR32 (5%) to LUCK’s Jun-19 PT.

Valuations Offer a 35% Upside from Last Closing: Using a risk free rate of 11% and incorporating a 17.6% cost of equity, our Jun-19 PT for LUCK stands at PKR625/ share (unchanged). We have used a blend of FCFF and Relative valuations to arrive at this Sum of the Parts (SoTP) valuation, as illustrated in the enclosed below. The stock has lost 11% during 2018TD, underperforming the Benchmark KSE100 Index by 8%, largely due to foreign selling post downgrade from MSCI Emerging Markets and weakness in Cement sector dynamics (expected slowdown in offtakes, PKR devaluation etc.). However we emphasize that LUCK clearly stands out from its peers – firstly its domestic cement operations are leverage free (especially important amidst ongoing monetary tightening). Moreover the company boasts of an optimal energy mix and is the lowest cost cement producer in the country. Beyond domestic Cements, other ventures account for almost 40% of the Valuation. We particularly like the investment in Lucky Electric Power – an area that we feel the market has not completely appreciated so far.

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