JS Securities Limited – Morning Briefing

Karachi, June 25, 2018 (PPI-OT): Macro headwinds to further dilute sector profitability

Thermal coal prices have nearly doubled from its lows of ~US$54/ton in FY16 to currently hover in the range of US$102-104/ton.

Our sensitivity suggests that every US$5/ton increase in coal prices will erode Cement sector EPS by 2.8% to 7.7% from our base case.

Recent devaluation of 15% has compounded the already augmented energy costs; however, average exchange rate currently hovers near US$125.

Any further 5% depreciation will erode JS Cement Universe profitability in the range of 1.7-3.8% in FY19. We highlight that companies with higher export ratios such as Attock Cement (ACPL), Lucky Cement (LUCK), and Maple Leaf Limited (MLCF) will depict lower erosion in the bottom-line.

Given prevailing export prices of US$46/ton and exchange rate of Rs125, discount to domestic prices have almost contracted to Rs25-50/bag (KPK-Punjab region).

Current coal prices to soften gradually…

The recent rally in seaborne thermal coal prices has further raised the risk of margin contraction for cement manufacturers, where international prices have nearly doubled from lows of ~US$54/ton in FY16 to currently hover in the range of US$102-104/ton. The augmentation in prices was mainly led by (1) strong demand from China and India, (2) decline in inventory levels, and (3) supply tightness at various coal producing countries in the wake of environmental and safety concerns. However, this surge in coal prices remains unsustainable, where according to Fitch report, rising supply from China and Indonesia in the medium term will keep international prices at bay. To note, the Chinese government has guided local producers to increase domestic coal production to 3.7bn tons to support their power producers, while Indonesian exports are also likely to grow, owing to availability of higher margins on the commodity. Additionally, World Bank and Citi project coal prices to gradually cool off and settle in the range of US$85-90/ton and US$75-80/ton in FY19 and FY20, respectively which is in line with our estimates of US$85/ton and US$80/ton.

… While Long-Term Dynamics Remain intact

Coal prices may likely cool off over the long run (WB estimate for 2025F: US$57/ton), primarily on the back of (1) global shift to green and renewable energy, (2) implementation of massive gasification plan in China (shifting millions of household and industry to gas from coal), and (3) lower reliance on imported coal by India as Coal India (which fulfills 84% of total country requirement) is targeting to produce 1bn tons by end of this decade. However, more than expected surge in oil prices and/ or negative implications from US-China trade wars may create an artificial price hike in the medium term. In that case we highlight that every increase in US$5/ton of coal prices (assuming no price pass-on) will erode Cement sector EPS by 2.8% to 7.7% from our base case (see table).

Exchange rate parity to take its toll…

Amid deteriorating C/A deficit situation of the country, Pak Rupee has lost approximately ~15% of its value against the Greenback which has further aggravated energy costs of the manufacturers. While average exchange rate currently hovers near US$125, we provide a sensitivity of further 5% currency depreciation (assuming no price increase) will erode JS Cement Universe profitability in the range of 1.7-3.8% in FY19, respectively (see table). We do highlight that companies with higher export ratios such as Attock Cement (ACPL), Lucky cement (LUCK), and Maple Leaf Limited (MLCF) will depict lower erosion in the bottom-line. To note, we have not assumed any export sales from DGKC south plant in FY19 as it will dilute the benefit of initial year depreciation allowance. On the positive side, we highlight that industry exports since last 5 months have jacked up by 32% YoY, especially in South region (up by 92% YoY), indicating increasing competitiveness in international markets. Furthermore it is pertinent to mention that on export prices of US$46/ton (US$44-48/ton in different regions) and exchange rate of Rs125, exports price discount to domestic prices shrinks to Rs25-50/bag (KPK-Punjab region). While increase in export prices by US$4/ton or exchange rate depreciation to US$140 will narrow the discount to Rs0-22/bag, hence limiting risks of domestic prices attrition.

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JS Securities Limited – Morning Briefing

Karachi, June 25, 2018 (PPI-OT): Macro headwinds to further dilute sector profitability

Thermal coal prices have nearly doubled from its lows of ~US$54/ton in FY16 to currently hover in the range of US$102-104/ton.

Our sensitivity suggests that every US$5/ton increase in coal prices will erode Cement sector EPS by 2.8% to 7.7% from our base case.

Recent devaluation of 15% has compounded the already augmented energy costs; however, average exchange rate currently hovers near US$125.

Any further 5% depreciation will erode JS Cement Universe profitability in the range of 1.7-3.8% in FY19. We highlight that companies with higher export ratios such as Attock Cement (ACPL), Lucky Cement (LUCK), and Maple Leaf Limited (MLCF) will depict lower erosion in the bottom-line.

Given prevailing export prices of US$46/ton and exchange rate of Rs125, discount to domestic prices have almost contracted to Rs25-50/bag (KPK-Punjab region).

Current coal prices to soften gradually…

The recent rally in seaborne thermal coal prices has further raised the risk of margin contraction for cement manufacturers, where international prices have nearly doubled from lows of ~US$54/ton in FY16 to currently hover in the range of US$102-104/ton. The augmentation in prices was mainly led by (1) strong demand from China and India, (2) decline in inventory levels, and (3) supply tightness at various coal producing countries in the wake of environmental and safety concerns. However, this surge in coal prices remains unsustainable, where according to Fitch report, rising supply from China and Indonesia in the medium term will keep international prices at bay. To note, the Chinese government has guided local producers to increase domestic coal production to 3.7bn tons to support their power producers, while Indonesian exports are also likely to grow, owing to availability of higher margins on the commodity. Additionally, World Bank and Citi project coal prices to gradually cool off and settle in the range of US$85-90/ton and US$75-80/ton in FY19 and FY20, respectively which is in line with our estimates of US$85/ton and US$80/ton.

… While Long-Term Dynamics Remain intact

Coal prices may likely cool off over the long run (WB estimate for 2025F: US$57/ton), primarily on the back of (1) global shift to green and renewable energy, (2) implementation of massive gasification plan in China (shifting millions of household and industry to gas from coal), and (3) lower reliance on imported coal by India as Coal India (which fulfills 84% of total country requirement) is targeting to produce 1bn tons by end of this decade. However, more than expected surge in oil prices and/ or negative implications from US-China trade wars may create an artificial price hike in the medium term. In that case we highlight that every increase in US$5/ton of coal prices (assuming no price pass-on) will erode Cement sector EPS by 2.8% to 7.7% from our base case (see table).

Exchange rate parity to take its toll…

Amid deteriorating C/A deficit situation of the country, Pak Rupee has lost approximately ~15% of its value against the Greenback which has further aggravated energy costs of the manufacturers. While average exchange rate currently hovers near US$125, we provide a sensitivity of further 5% currency depreciation (assuming no price increase) will erode JS Cement Universe profitability in the range of 1.7-3.8% in FY19, respectively (see table). We do highlight that companies with higher export ratios such as Attock Cement (ACPL), Lucky cement (LUCK), and Maple Leaf Limited (MLCF) will depict lower erosion in the bottom-line. To note, we have not assumed any export sales from DGKC south plant in FY19 as it will dilute the benefit of initial year depreciation allowance. On the positive side, we highlight that industry exports since last 5 months have jacked up by 32% YoY, especially in South region (up by 92% YoY), indicating increasing competitiveness in international markets. Furthermore it is pertinent to mention that on export prices of US$46/ton (US$44-48/ton in different regions) and exchange rate of Rs125, exports price discount to domestic prices shrinks to Rs25-50/bag (KPK-Punjab region). While increase in export prices by US$4/ton or exchange rate depreciation to US$140 will narrow the discount to Rs0-22/bag, hence limiting risks of domestic prices attrition.

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