August 2010

Cement Sector

LUCKY CEMENT
LUCK: RIDING
ON

EXPORT

Company Update
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Company Update

Luck: Riding on Export

Continuation of coverage with BUY stance on LUCK with 16% upside potential We continue our detailed coverage on Lucky Cement Company (LUCK) with a DCF value of Rs 77.2/share. We like LUCK due to 1) timely expansion giving Company an edge 2) export market share of more than 30% 3) simultaneous Presence in both Northern and Southern region of the country 4) attractive price multiples (it is currently trading at FY11 PER and PBV of 5.98x & 0.72x). We recommend 'BUY' on LUCK. Coal encompass more than 60% of Total cost During the period FY11 cement sector of Pakistan to remain under pressure because of sharp surge in the international coal prices during 2HFY10. The coal price contributes more than 60% of total cost & such a high surge in coal prices is main concern for whole industry as well as for Lucky.

KEY DATA KATS code LUCK Reuters code LUCK.KA Current price (Rs) 66.79 Year high, low (Rs) 84.31, 58 Year ADV (mn) 2.1 Adjusted Beta 1.2 Market cap (RS'bn) 21.54 Market cap (US$ mn) 252 Shares outstanding (mn) 323 Free float (%) 40 Major shareholder Younus Brothers Fair value (Rs) 77.2 Upside potential (%) 16

Index

Price Relative to KSE 100 Index

PKR 100 80 60 40 20

10,500 9,000 7,500 6,000 4,500

Scenario Analysis (Coal vs. EPS) Optimistic-case Coal price per ton (Landed-Cost) $ 145 EPS-FY11 12.42 Source: WE Research Base -case 155 11.60 Pessimistic-case 165 10.78

Jan-09 Feb-09 Mar-09 Apr-09 May-09 Jun-09 Jul-09 Aug-09 Sep-09 Oct-09 Nov-09 Dec-09 Jan-10 Feb-10 Mar-10 Apr-10 May-10 Jun-10 Jul-10 Aug-10
KSE 100 INDEX LUCK

Market share to remain 20% during FY11 The market share of LUCK during the FY08 stands at 16% & 23% on the local & export front respectively, however its exports market has improved a lot to the level of 33% during FY10. Whereas we expect the company's market share will boost to the extent of 20% of total cement dispatches of the country by the end of FY11 (currently stands at 19% in FY10). Risk to our valuation Risk to our valuation include 1) expected price per bag to decrease due to Supply glut 2) increase in political wrangling in Pakistan to raise country risk 3) Delay in construction of water reservoirs by the new political democratic set-up. Scenario Analysis (10PIB vs. fair value) Optimistic-case 10 Yr PIB 12.5 Fair value (Rs per share) 82 Source: WE Research Base -case 13.00 77.2 Pessimistic-case 13.5 73.5

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Company Update

Valuation remain terrific LUCK with Fair value of PKR 77.2/ share offering an upside potential of 15.6% from current level. We have value LUCK on Discounted cash flow method (DCF). Trading at FY11E PER of 5.98x, with estimated ROE of 13.31 for the period FY11, we believe LUCK trades at a discount to its worth. FY09A FY10A EPS (Rs) 14.21 9.70 Book value (Rs/share) 71.90 77.60 DPS (%) 4.00 4.00 PE (X) 4.70 6.89 P/BV (X) 0.93 0.86 Dividend Yield (%) 6.0 6.0 Dividend Payout (%) 28.1 41.2 Source: Company reports & WE Research Sales revenue to remain lackluster going forward Net sales revenue of the company is expected to touch Rs. 28.6 billion during FY13 Net sales revenue of the company is expected to touch Rs. 28.6 billion during FY13 which will be the highest revenue stream in the form of net sales by LUCK. However net sales of the company have remained weak during the past couple of years owing to the domestic dreary cement prices. FY11F 11.60 88.80 3.50 5.76 0.75 5.2 30.2 FY12F 10.98 97.25 4.00 6.08 0.69 6.0 36.4

Cement dispatches of the company to remained dreary Going forward we expect cement dispatches of the company to remain dreary primarily due to the above mentioned reason of lower exports volumes due to the massive regional expansion. However cement dispatches on the local front is expected to remain balanced on the back of government continued focus on infrastructure development and work on the floods effected areas to boost local cement consumption. Vertical integration to bright the future Lucky has also made an arrangement with the European company to extract coal locally from the Thar coal field (the largest coal field in Asia). However we expect it to be positive for the company in the longer run as 5% lower coal cost boosts company's EPS by 9%. Moreover as per our estimation extraction cost should not be more than $10 per ton if extract in bulk, thus around 5% of cost saving in the present scenario and is expected to increase further, as extraction cost tend to decrease with the passage of time. Power sale agreement is also another diversification strategy Lucky Cement Company is the largest cement producer of the country, expanding its wings to the huge different contracts such as 10-year agreement of power sale with KESC having strapped facility. The company's power sale agreement with KESC is a take and pay agreement of 49.5MW power supply from its Karachi plant. Sale is expected to start from the start of FY11 with the link to Lucky's power generation unit to KESC's grid in Karachi. However we expect the company will be able to supply only 30MW of excess power utility to KESC out of its total power capacity of 95MW in the South.

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Company Update

Earnings are expected to grow at 3-year CAGR of 7% Recurring Earnings of the company will grow at a 3 year CAGR of 7% to Rs 3.5 billion as against Rs 3.1 billion in FY10 mainly due to lower base effect in FY10 earning Recurring Earnings of the company will grow at a 3 year CAGR of 7% to Rs 3.5 billion as against Rs 3.1 billion in FY10 mainly due to lower base effect in FY10 earning. We have positive stance on the company owing to its simultaneous presence in both the region of the country as well as proximity to sea is another major advantage for the LUCK.

Source: Company Reports & WE Research

Rs in million
4,500

Profit after Taxation

4,000

3,500

3,000 FY09A FY10A FY11F FY12F

Source: Company Reports & WE Research

Closure of PEZU plant operated on 9th August. As per news reports, production at Lucky Cement's Pezu plant has been halted for 5 days (23rd July to 28th July) after 50 unauthorized persons, who claim to be union leaders, have infiltrated the premises. However as per our discussion with management the plant is operational from Monday 9th August, 2010. As per discussion and analysis out of 15 days closure the working days was around 12 and as per 300 working days in a year the company has around 65 reserve day to adjust orders and incidental shifts. We expect it to be Neutral for company's profitability in FY11 except lower cement dispatches in the month of July only.

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Company Update

Sector update
Cement consumption strongly correlated with country's core fundamentals Cement consumption & GDP growth are strongly correlated variables all over the world. Pakistan has also emerged as one of the developing nations during FY00-07 attained sustainable growth rates in the range of 5% - 8.5%. After that global economic crisis has destroyed the country core fundamentals, however some recovery have witnessed during the past few months but the recent floods in the country have destroyed the hopes of 4.5% GDP growth. We have now revised our GDP growth assumption to 3% for FY11. Sector's eminence by the end of FY10 the recent floods in the country have destroyed the hopes of 4.5% GDP growth. We have now revised our GDP growth assumption to 3% for FY11 Pakistan's extensive cement sector consists of 25 cement companies. These companies are operating with a combined 29 cement plants. Out of these plants, 19 are located in the northern region of the country and remaining 10 are located in southern region. The total production capacity of the cement sector stands at 44.82 MTPA (million tonnes per annum) as per data issued by APCMA. Going forward, this capacity will increase during FY11, owing to expansions undertaken by Fauji cement and Gharibwal Cement (GWCL), all based in the northern part of the country. Taking cue from that, we estimate total capacity of the industry to touch 47.5 MTPA during the current year FY11-FY12.

In light of this, Pakistan's leading producers such as Lucky Cement (LUCK), DG Khan Cement (DGKC) and Attock Cement (ACPL) have taken a first mover advantage by undergoing expansions and they are in line with tapping local demand as well as export opportunities emanating from Afghanistan, UAE, far east and African countries.

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Company Update

Demand drivers 1) Local cement demand has grown by 1.6x the GDP growth over the last ten years. 2) Housing demand. 3) Government's spending on development-related projects. 4) Relatively price inelastic, so price not a major demand influencer. 5) Standardized product. Cement consumption strongly correlated with country's core fundamentals... Cement consumption & GDP growth are strongly correlated variables all over the world. Pakistan has also emerged as one of the developing nations attaining sustainable growth rates in the range of 5% - 8.5% since FY00. For FY11, we expect the country to attain GDP growth of 3.0%. Housing growth to spur consumption going forward According to public sector based House Building Finance Corporation (HBFC) figures, the average population per housing units in Pakistan is approximately 9 people per housing unit as compared to the global average of around 6 persons per housing unit. The units required for a population of 165 mn, Pakistani should have 27.5 mn housing units, an addition of 6.7 million to the current 20 mn units. We anticipate an increase in per capita income that will translate into construction of at least 6 - 7 mn homes. This aspect is facilitated by banking sector's renewed mortgage finance business. At present this business is merely less than 1% of GDP in Pakistan (total size of mortgage liabilities is nearly Rs 55bn) as against 3% - 4% in neighboring India. Banking industry is aiming for a target of at least Rs 300 bn till FY11-12 under the guidance of State Bank of Pakistan and International Finance Corporation (IFC). PSDP allocation & disbursement- key to cement consumption At present Pakistan's PSDP program accounts for nearly 45% of the total domestic cement consumption. Government's increased focus towards infrastructure development in the country over the last few years has also given impetus to our assertion. It has been a main driver of cement consumption in recent years. However PSDP cut and its disbursement remained a major cause of concern during FY10. We expect PSDP to remain driver again in FY11 due to the government focus on small Dams, infrastructural development and construction and rehabilitation work on floods affected areas. Pakistan per Capita Consumption There are 29 cement units working which are producing 44 million tonne per annum Pakistan currently has a per capita consumption of 135kg cement which is comparable to that of India's 150kg per capita. However it is just a third of China's but substantially below the world average of 300kg and the regional average of over 400kg for peers in Asia and over 600kg in the Middle East.

PSDP to remain driver again in FY11 due to the government focus on small Dams, infrastructural development and construction and rehabilitation work on floods affected areas.

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Company Update

Global Cement Production: Pakistan yet to make its mark Pakistani cement sector is still not in world ranking because of low per production capacity and its utilization. Currently there are 29 cement units working which are producing 44 million tonne per annum. But our neighboring countries China and India are on the 1st and 2nd rank in Asia with 900 million tonnes and 185 million tonnes per annum. If we go through world comparison USA, Japan and Russia ranked below India and China.

We expect cement dispatches of the county is expected to remain stagnant YoY in FY11 to 34mn tons (local sales of 25mn tons and export sales of 9mn tons). The primary reason behind stagnant sales is expected drop in cement exports due to massive regional expansions

Cement profitability to boost in FY11 We expect cement dispatches of the county is expected to remain stagnant YoY in FY11 to 34mn tons (local sales of 25mn tons and export sales of 9mn tons). The primary reason behind stagnant sales is expected drop in cement exports due to massive regional expansions. On local cement consumption we expect it to grow significantly on the back of improvement in private sector construction activities and construction and rehabilitation work on floods effected areas with construction work on small dams. Sales tax increase to pass through easily In the recent budget sales increase in the GST by 1% to 17% is expected to pass through to the end users easily (i.e. Rs 2.5/bag). On the other hand lower cement prices is an issue for the small and inefficient producer where they cannot compete with the giants Lucky and DGKC.

TDAP has announced 35% subsidy on inland freight subsidy on sea routed exports in April. However we do not expect it's to continue going forward owing to the government budgetary constraints on the revenue side

FED on gas is not a worry for cements Enhancement in the rate of FED from 5.09% to 10% (per MMBTu) on natural gas is neutral for the cement sector owing to no gas allocation to cement plants in the country and the sector is fulfilling its 90% percent of energy requirement form coal. Inland freight subsidy if continued may be a trigger In the budget FY11 the topic of inland freight subsidy totally eliminated. The TDAP has announced 35% subsidy on inland freight subsidy on sea routed exports in April. However we do not expect it's to continue going forward owing to the government budgetary constraints on the revenue side. On the other hand if TDAP continues with the current inland freight subsidy in FY11 it will boost the country's cement exports routed through sea.

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Company Update

FY10 Result Review

Lower domestic prices keep FY10 in dark Lucky Cement Company Limited (LUCK) announced its results for FY10. The company posted after tax earnings of Rs 3,137 million (EPS; 9.70 per share) as compared to Rs 4,596 million (EPS; 14.21 per share) in FY09. The company has also announced cash dividend of Rs 4.0/share i.e. (40%), is highest payout ratio in the company's history which is around 42%. The primary reason behind massive earnings decline is owing to dreary domestic prices during the 1HFY10 which resulted in a YoY lower retention prices for the company. The domestic prices during the 1HFY10 as remained as low as Rs 235/bag at the retail level in the North. Moreover the volumetric sales of the company grown significantly by 12.3% to 6.63 million tons for FY10 (26% increase in local sales and 2.2% increase in exports). Sales revenue remained stagnant Top line of the company has showed a decent performance over all with the sales revenue declined by nominal 6% during FY10 to Rs 24,508 million as against Rs 2,6330million during FY09 Top line of the company has showed a decent performance over all with the sales revenue declined by nominal 6% during FY10 to Rs 24,508 million as against Rs 2,6330million during FY09. The major cause behind this stagnant sales revenue despite 12% increase in volumetric sale is only because of lackluster cement prices on domestic level (Net retention prices for domestic sales remained around Rs 3,320 per ton on average for Lucky cement during the FY10). Production and other cost showed balance Cost of sales during the FY10 remained poise as during the same period last year to Rs 16,529 million as compared to Rs Rs 16,519 million during FY09. Such stable cost of sales is mainly because of lower coal prices YoY, while increase in volumetric sales to balance the cost of production to FY09 level. Moreover the distribution cost of the company boosted by massively due to increase in company's inland transportation cost and ocean freights. On the other hand delay in the disbursement of inland freight subsidy funds also resulted in a massive increase in distribution cost. In the end finance cost of the company showed decent improvement because of the company's switching to low cost export refinance. Rs in million Net Sales Cost of Sales Gross Profit Operating Profit Financial Charges Profit before Taxation Profit after Taxation EPS (Rs) Source: Company Report FY10A 24,508 16,529 7,978 4,242 569 3,417 3,137 9.70 FY09A 26,330 16,519 9,811 7,217 1,236 5,177 4,596 14.21 YoY -6.92% 0.6% -18.68% -41-22% -53.96% -33.99% -31.74% -31.74%

The primary reason behind massive earnings decline is owing to dreary domestic prices during the 1HFY10 which resulted in a YoY lower retention prices for the company

Outlook and Recommendation Lucky cement is one of the largest cement manufacturers in the country with the added advantage of simultaneous presence of both the regions of country. We expect the ongoing development of waste heat recovery in the company's plant and other business diversification to boost the company's margins in the sky during the years to come. We maintain our Buy rating on the Lucky cement with 1-year target price of Rs 77.2/share.

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Company Update

Assumption Summary
FY2009A FY2010 FY2011F Dispatches Forecast Local Dispatches (mn-tons) Exports Dispatches (mn-tons) Cement prices Assumptions Gross Local prices (M.tons) Exports Prices (US$/ton) Coal Prices Assumptions C&F Coal (US$/ton) Economic assumption Inflation (%) Exchange Rate average (US$) Source: WE Assumptions 2.46 3.4 6106 53.5 106 20.77 78.96 3.12 3.51 5050 51 88 11.73 84.55 2.76 2.95 5275 53 98 12.4 89.5 FY2012F 3.12 2.65 5578 55 110 11.2 93.5

Background
Lucky Cement Limited was incorporated in Pakistan on September 18, 1993 under the Companies Ordinance, 1984 (the Ordinance). The shares of the company are quoted on all the three stock exchanges in Pakistan. The Company has also issued GDRs which are listed and traded on the Professional Securities Market of the London Stock Exchange. The principal activity of the company is manufacturing and marketing of cement. The company has two production facilities one at Pezu, District Lakki Marwat in Khyber Pukhtunkhwa and the other at Main Super Highway in Karachi, Sindh.

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Company Update

Financials
Income Statement Rs in million Net Sales Cost of Sales Gross Profit Selling & Admin Expenses Other Income Other Charges Profit before Taxation Taxation Profit after Taxation Balance Sheet Rs in million Share Capital Total Equity Non-current Liabilities Current Liabilities Total Liabilities & Equity Non-current Assets Current Assets Total Assets Cash Flow Statement Rs in million Cash from operation Cash from Investing activities Cash from financing Net Change in cash Beginning Cash Balance Ending Cash Balance Key Ratios Analysis Key Ratios EPS DPS PER (x) PBV (x) EV/ton (USD) Gross Margin Operating Margin EBITDA Margin Pretax Margin Net Margin Return on Fixed Assets ROE ROA FY09A 14.21 4.00 4.70 0.93 55.3 37.8 28.0 28.7 19.5 17.3 16.2 19.8 12.0 FY10E 9.70 4.00 6.89 0.86 44.0 32.6 17.3 22 13.9 12.8 11.6 12.5 8.2 FY11F 11.60 4.00 5.76 0.75 36.7 34.0 23.0 26.5 19.0 15.3 12.7 13.1 10.1 FY12F 10.98 4.00 6.08 0.69 31.4 30.6 20.9 23.6 17.8 13.8 12.3 11.3 9.3 FY09A 8,422 -5,788 -1,855 779 270 1049 FY10A 4,247 -1,377 -2,241 629 1049 1679 FY11E 4,942 -510 -4,494 -62 1679 1617 FY12F 4,557 -541 -2,924 1,092 1617 2709 FY09A 3,234 23,252 6,042 9,043 38,337 30,479 7,858 38,337 FY10A 3,234 25,095 3,572 9,641 38,310 31,438 6,871 38,310 FY11E 3,234 28,719 3,337 5,117 37,173 29,774 7,398 37,173 FY12F 3,234 31,451 2,762 4,092 38,305 29,068 9,237 38,305 FY09A 26,547 16,519 10,027 2,594 23 827 5,177 580 4,597 FY10A 24,508 16,529 7,978 3,736 2 257 3,417 280 3,137 FY11E 24,583 16,233 8,349 2,704 118 520 4,676 924 3,752 FY12F 25,666 17,814 7,851 2,480 (47) 506 4,556 1,005 3,551

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