Karachi, February 23, 2022 (PPI-OT): Cements: 2QFY22 earnings beat; coal overhang ahead

Earnings of cement companies outperformed expectations in 2QFY22 driven by a combination of one-offs and better than expected coal inventory management.

While most cement manufacturers have so far been able to pass on the cost pressures and preserve margins, the same has come at the cost of slower demand.

Looking ahead, coal prices remain a key variable. We expect coal prices to start easing off post June 2022 but we nonetheless run a sensitivity to determine the impact of coal prices clocking in higher than our base case, in case the current elevated levels last longer than expected.

2QFY22 results outperformed street estimates

The recent quarter results of JS Cement Universe outperformed industry estimates and were a surprise to many. While LUCK underperformed compared to expectations; MLCF, KOHC, CHCC, ACPL and DGKC posted better than expected results. MLCF posted the highest accretion in gross margins versus the rest of the industry owing to efficiencies on the energy front and usage of Afghan/local coal for fuel and power generation. KOHC stood second in the industry with gross margins of 30% primarily owing to higher usage of Afghan coal in the coal mix. However, some of the positive surprises were led by non- recurring entries as some companies had one-offs which are likely going to be absent in the coming quarters. CHCC had higher other income due to a component of exchange gain on derivatives whereas DGKC had a lower effective tax rate. ACPL had higher other income mainly due to dividend from its subsidiary.

Stable margins due to effective inventory management

Gross margins were broadly in-line with our estimates for most companies. Sector’s margins have remained stable despite rising input costs during the past few quarters owing to effective coal inventory management. The sector was able to maintain its gross margins at ~25% where MLCF, KOHC, FCCL and CHCC showed the highest gross level performance from our universe.

Keep an eye out for coal

With fuel cost comprising ~45% of the sector’s Cost of Sales, the recent spike in coal prices – triggered by a ban on coal exports by Indonesia – has led to the procurement of coal at higher rates by cement manufacturers, requiring them to raise cement prices. Most cement companies now have an average coal cost of ~US$155/ton for 3QFY22. Also, from the current Richard Bay coal price quote of ~US$199/ton (+45% CY22 YTD) we can deduce that effective coal prices for companies to remain high during 2HFY22. In the last 12 months, cement prices have hiked by a cumulative Rs120/bag (up 21%), which does not include any pass on of the recent coal price impact. During the same period, cement demand has been relatively dull where local cement sales during 7MFY22 have witnessed -1% YoY decline.

We highlight that companies like CHCC, KOHC, FCCL, FLYING, BWCL and MLCF which use the cheaper Afghan coal in their coal mix have increased the consumption of Afghan/local coal of late to save up on costs.

We see coal prices to eventually normalize going forward and cement companies to likely procure coal at lower rates post 4QFY22. However, it is too early to change our base case assumption of coal price at US$95/ton for FY23. A sensitivity analysis is being presented on FY23 earnings by change in coal prices where we have taken a demand growth of 0% YoY for FY22 and 6% YoY for FY23 with cement price assumption at Rs730/bag. Even with average coal prices at US$115 for FY23, the sector’s P/E is reflected at 6.4x, providing upside from current levels.