FEBRUARY 2014

The Pakistan Credit Rating Agency Limited






CEMENT – AN OVERVIEW









The Pakistan Credit Rating Agency Limited
CEMENT



February 2014
www.pacra.com










STUDY CONTENTS PAGE

Summary

1
Sector Study:
Global Cement Industry 2
Pakistan Industry 2
Business Risk 4
Financial Risk 6
Outlook 7
CEMENT – AN OVERVIEW


SECTOR STUDY


The Pakistan Credit Rating Agency Limited
SECTOR STUDY

PACRA has used duecarein preparation of this document. Our information has been obtained fromsources weconsider to bereliablebut its accuracy or completeness is not guaranteed. PACRA shall oweno
liability whatsoever to any loss or damagecaused by or resultingfromany error in such information. Noneof theinformation in this document may becopied or otherwisereproduced, stored or disseminated
in wholeor inpart inany formor by any means whatsoever by any personwithout PACRA’s written consent. Our reports and ratings constituteopinions, not recommendations to buy or to sell.
Tel: 92 (42) 35869504 Fax: 92 (042) 35830425 www.pacra.com
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Pakistan Cement - Production and Capacity Utilization
Cement Capacity (Mln Tons) Total Production (Mln Tons)
Export (Mln Tons) Capacity Utilization (%)

CEMENT – AN OVERVIEW
(FEBRUARY 2014)


SECTOR DYNAMICS
Business Risk Medium
Outlook Stable to Positive
HIGHLIGHTS
* Listed companies only

FY13
Total Companies 18
No. of listed Companies 17
Share of listed
Companies (based on
capacity) 94%
Cement Production 33mln Tons
Capacity Utilization 74.6%
Market Capitalization PKR 248bln
Revenue* PKR 193bln
Net Income* PKR 38bln
Cement Sector Loans PKR 54bln
Share in Banking Loans 1.3%
Cement NPLs PKR 16bln
Share in Total NPLs 2.6%
Cement Infection Ratio 29.6%




ANALYSTS

Aisha Khalid
+92 42 35869504
aisha@pacra.com

Rana M. Nadeem
+92 42 35869504
nadeem@pacra.com
OVERVIEW
Pakistan’s cement industry has an oligopolistic structure – top five players
(out of a total of 18) controls above 55% share. Geographically production
facilities are concentrated in north (83%) of the country, while south has around
17%. During the last decade, the Pakistani cement industry has expanded its
production capacity significantly; while gradually making inroads into the
exports markets. The cement production capacity of Pakistan stood 44.8mln tons
in FY13. Demand dynamics, playing key role in cement manufacturing, kept
capacity utilization at ~75%, a behavior observed in past few years. Currently,
Pakistan is ranked among the world's top 10 cement exporting countries.

PERFORMANCE
During FY13, total cement production stood at 33mln tons (~3% YoY rise).
Local sales of cement reflecting an increase of ~5% were 25mln tons, whereas,
cement export (8mln tons) registered a meager decline of 2% mainly due to entry
of Iranian cement in Afghanistan – Pakistan’s biggest export market (53% share
in total exports during FY13). Owing to relatively stagnant domestic demand as
against the supply, the industry faced intense competition in the past few years.
Lately, the industry players, after experiencing sizeable business losses, have
started focusing on improving their margins. This coupled with gradual increase
in cement demand, particularly in the local market, has resulted in higher prices
and thus improved profitability for the sector. Moreover, lower coal prices
combined with alternative energy measures helped in rationalizing production
costs. Benefiting from strong cashflows, cement players repaid debts. This along
with lower interest rates resulted in reduced finance cost. Thus the sector posted
record profits in FY13. During 6MFY14, the industry sustained its performance.
OUTLOOK
Going forward, the government has allocated PKR 1,150bln towards PSDP
in FY14 for the Federal and Provincial Annual Infrastructure Development
Programme. More than half of this allocated amount is expected to be utilized
for infrastructure development. Although cement exports are under pressure,
ongoing infrastructure development programmes and uptick in economic
sentiments are likely to keep domestic cement demand strong. Strong
profitability of recent years has helped the sector in building financial strength.
With continued performance trend, the financial profile of the players is
expected to improve due to further reduction in leveraging.

WHAT COULD CHANGE THE OUTLOOK;
Initiation of Price War | would negatively impact sector dynamics.
Rise in Energy Cost | owing to higher contribution of energy cost, significant
rise in coal prices and/or upward movement in gas/electricity tariff would
hurt margins.
Instability in the Export Markets | with the availability of low-cost Iranian
cement in Pakistan’s biggest export market – Afghanistan – sustainability in
the price and demand for Pakistani cement would be challenging.
Next Wave of Expansion | early expansion may bring pressure on the
financial profile of the sector owing to lower capacity utilization in
comparison to historical pattern.

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CEMENT


SECTOR STUDY Page 2 of 7
February 2014
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2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
Capacity 1,995 2,058 2,205 2,310 2,520 2,835 2,520 3,045 3,255 3,465 3,570
Production 1,800 1,950 2,130 2,310 2,550 2,770 2,840 3,060 3,310 3,600 3,700
Capacity Utilization (%) 90.2% 94.8% 96.6% 100.0% 101.2% 97.7% 112.7% 100.5% 101.7% 103.9% 103.6%
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Capacity and Production
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Pakistan Cement - Production and Capacity Utilization
Cement Capacity (Mln Tons) Total Production (Mln Tons)
Export (Mln Tons) Capacity Utilization (%)
1. Global Cement
Industry
 Positive relationship
with economic
development of the
global economy
 Produced in almost
every country
 China – the largest
producer in the
world
1.1 Historically, the world cement market has been highly fragmented. Due to
high transportation cost and nature of the commodity, international trade is limited
when compared to other construction commodities like steel, lumber and fixtures. As
a result of rapid industrialization during the 20
th
century coupled with population
growth and development of high-durability infrastructure, the cement demand
increased significantly
across the world. Most
countries started off by
setting up cement
manufacturing companies to
fulfill local demand, which
was fueled by urbanization,
development of high-density
cities, dams, industries and
road networks. However,
1970s witnessed
considerable global
consolidation, starting in
Europe, followed by
America in 1980s and lately in Asia (excluding China). Thus, the trade in cement/
clinker increased over the years as various leading multinational companies took-
over / merged with local firms.
1.2 Major Players: In 2012, the largest three international cement
manufacturing countries included China (60%), India (7%) and the USA (2%).
Meanwhile, these three players also continued to consume a significant share of the
worlds’ production – 67%.
1.3 Global Producers: Global production of cement in 2012 stood at 3,700mln
tons with China leading the other locations by a far margin. In line with demand
trends, the global capacity is concentrated in developing and emerging markets
experiencing high growth rates. Pakistan stood at 15
th
position with production of
32mln tons.


2. Pakistan Industry
 Listed
companies
 Protection of
players’ interests
and rights by
APCMA
 Oligopolistic
structure
 Current Capacity
~45mln tons
2.1 History: The history of cement manufacturing in Pakistan dates back to
1921 when the first plant was established at Wah. The country inherited four cement
plants in 1947 with total
installed capacity of just
0.5mln tons. After 1947, two
new plants were setup by the
public sector in 1956 to cater
to the growing demand of
cement emanating from
economic growth. The Sindh
Government established
Zeal-Pak in Hyderabad
while, the Punjab
Government established
Maple Leaf cement in
Daudkel. The number
increased to six over the next
ten years (1956-66).
Continuing with its growth trajectory, the private sector also took initiative
established another three new plants (Javedan, Gharibwal and Mustehkam). During

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CEMENT


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February 2014
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the nationalization era (1971-77), most of the established industries in the country
were nationalized. The cement industry faced a lean period and consequently, no
new cement plants were set up during this time. As a result of nationalization, the
State Cement Corporation of Pakistan (SCCP) was established in 1972 and all the
cement companies were transferred to SCCP. During its tenor, the SCCP established
five new plants to reduce the demand-supply gap with a stated capacity of 1.8mln
tons. During the period of 1977-88, denationalization of industrial units encouraged
and boosted investments activities in the country. Moreover, housing and
infrastructural development activities gained pace and magnified cement demand.
Consequently, the number of cement plants increased from 9 to 24 and seven new
cement manufacturing plants were established by the private sector with installed
capacity of 2.54mln tons, Meanwhile, SCCP continued on as a state-owned entity
and established four new plants with an installed capacity of 1.6mln tons. The
cement industry witnessed another major change in the 1990s as the industry was
privatized, leading to privatization of eight units. Moreover, the government also
announced tax exemption of all industrial units (including cement) in Khyber-
Pakhtoonkhwa (KP) and Baluchistan. Consequently, the private sector also
established new plants while tempting existing units to embark on capacity
expansion to reap benefits of growing cement demand. Towards the end of 1990s,
the industry's installed capacity exceeded local demand, while the industry geared up
to start exporting the surplus production. During the latest decade, the Pakistani
cement industry has expanded its production capacity significantly; while gradually
making inroads into the exports markets mainly to India and Afghanistan. Apart from
these two countries, Pakistan cement is also being exported to South Africa, Iraq, Sri
Lanka, Tanzania, Djibouti, Mozambique, Sudan and Kenya. The cement production
capacity of Pakistan stood 44.8mln tons in FY13 while capacity utilization of the
industry was at 75% owing to its excess supply. Currently, Pakistan is ranked among
the top 10 in the world's cement export.
2.2 Listed Sector: As of now, there are 18 cement manufacturing companies
operating with 24 plants in the industry. Except Askari Cement, all other companies
operating in the sector are listed and consequently, comply with the rules and
regulations set by the Karachi Stock Exchange (KSE). The market capitalization and
the paid-up capital of the listed players were PKR 248bln and PKR 75bln
respectively at end-FY13 (PKR 118bln at end-FY12). Meanwhile, market
capitalization of top 5 companies stands at 69% and Lucky cement is the market
leader with 27% of the market share. With improved demand fundamentals and
better retention prices, most of the industry players are enjoying historic profits
resulting in significant YoY enhancement in market capitalization.
2.3 Geographical Distribution: Cement is a specialized product requiring
specific raw material sources. Most of the cement manufacturers in Pakistan are
located near mountainous regions or plateaus that are rich in clay, iron and mineral
capacity. The concentration of the production facilities are divided in two zones-
North and South. The Northern region consists of Punjab, KP, and some parts of
Baluchistan have 19 plants and accounts for majority (~83%) of the total installed
capacity due to the close proximity to raw materials. Meanwhile, Southern region
consisting of mainly Sindh and remaining parts of Baluchistan have only 5 plants and
account for remaining 17% of the capacity. Moreover, the barriers of entry of a new
participant are high as there is an overcapacity hang in the sector and substantial
initial investment is required to set up the plant.
2.3.1 The cement industry is experiencing over-supply situation, the profitability
becomes a function of volume and economies of scale, location advantage and
proximity to major market becomes very important factor. Due to the high freights
charges (20% of the retail price), plants located near the raw materials and major

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February 2014
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consumption centers enjoy a distinct advantage from the rest. The north region
enjoys closer proximity to Indian Punjab province and the Afghanistan market,
whereas, the south region has access to sea-port for shipping to other export
destinations. Meanwhile, the terrain is such that large scale dams, which may provide
a huge impetus to demand in their proximity, are more likely to be constructed in the
north region.
2.4 Oligopolistic Market Structure: Pakistani cement industry has an
oligopolistic structure with cement being homogeneous product and there is large
number of sellers. The top 5 companies’ (Lucky, Bestway, DG Khan, Fauji and
Maple Leaf) concentration ratio (~55%) for industry shows that market power is
limited to a few leading companies. Lucky Cement is the leading player in the
market with 16% share. Moreover, 80% capacity is controlled by the top 10
producers.
2.4.1 The cement industry operates under the rules and regulation set out by
Ministry of Industries and Production (MOIP), which oversees the sector
performance and provides requisite support to increase its international
competitiveness while maximizing job creations. The industry is completely
deregulated and the companies are free to decide the operational details of how they
run their plants, what fuel they use and where they sell their final product. Notably,
there are three foreign (Lafarge, Bestway, and Attock) companies and couple of
armed forces entities (Askari and Fauji) operating in Pakistan, while rest of the
companies are majority owned by various renowned business groups and
industrialists.
2.5 All Pakistan Cement Manufacturers Association (APCMA): In order to
protect the interests of the cement manufacturers, they have formed a trade
association, called the All Pakistan Cement Manufacturers Association (APCMA). It
was established in September 1992 under the section 32 of the companies Ordinance
Act 1984 and is a registered body under section 3 of the Trade Organization
Ordinance 2007 in April 2008 by the Ministry of Commence. Most of the leading
cement manufactures are members of this organization, while some manufacturers
opted to stay out of this club.
2.5.1 The purpose of the body is to collect and distribute industry data, represent
the industry participants to government, advice the government on policy
development and to effectively protect its members’ interests and rights. The body is
structured as an Executive Committee, which meets frequently to discuss current
issues and future policies. The Executive Committee of APCMA has significant
influence on industry dynamics as it has the representation of owners and top
management of major cement manufacturers.
2.6 Sales pattern: The Pakistan’s cement industry is regional, seasonal and
cyclical. The cost of shipping cement quickly overtakes its value, thus, the customers
traditionally purchase cement from local sources. The demand for cement is affected
by the monsoon period and the winters due to unfavorable working conditions, with
the highest offtake recorded in the summer months before monsoon rains begin.
Closely tied in with GDP growth, the demand patterns are also highly influenced by
the economic cycle in the local market.


3. Business Risk
 Strong correlation
with Development
Programmes
 Growth in local
3.1 Demand driver: In India and China, the major demand driver for the
industry is the private housing sector followed by Government infrastructure
projects. This is in sharp contrast to Pakistan where private sector demand lags the
consumption in infrastructure. The main growth engine for the sector is the allocation
made towards Public Social Development Programme (PSDP) funds by the

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CEMENT


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February 2014
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0
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375
450
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FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13
M
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P
K
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B
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Pakistan Cement Sector - Demand Driver
Federal Public Sector Infrastructure Development Programme Spending (PKR Bln)
Provincial Annual Infrastructure Development Programme Spending (PKR Bln) *
Local Cement Consumption (Mln Tons) * Estimated as per infrastructure share in Federal PSDP
-5%
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(50)
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P
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B
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Pakistan Cement Sector - Revenue and Income
Revenue (PKR Bln) Net Income (PKR Bln) Net Margin (%)
* Listed Companies only
cement demand
 Recovery in local
prices
 Record profitability
in recent year

Government of Pakistan in its annual budget. The funds are primarily used towards
the development of
infrastructure projects – a
main driver of cement
demand. However, the trend
in previous years has been to
allocate a substantial amount
towards PSDP at the time of
budget announcement which
is not consumed fully as the
year progresses to absorb the
growing government
expenditures in other areas.
With increased infrastructure
spending in the last two years, local cement production have also witnessed an
improvement. The adjacent graph explains this positive correlation. With the
ongoing infrastructure development programmes, the domestic demand is expected
to remain strong in the near term.
3.2 Cost component: The industry’s energy factor constitutes for majority
(around 50-60% of COGS) of the production cost. However, the percentage varies
among manufacturers depending on the fuel mix and nature of the plant. This energy
requirement is of two types; i) fuel (used in the production process to heat up the
kiln) and ii) electricity (used for remaining production process and for other
electricity requirements at the plant). Most of the industry players use coal to meet
their fuel requirements, which is the major component of the energy cost. Recently
few players have also started using alternative fuel, a cheaper source, to meet this
requirement. The coal prices have significantly reduced in the last two years
resultantly helped the industry players in registering better margins. The electricity
requirement is being met through captive power plants (gas/coal/Waste Heat
Recovery plants) and WAPDA. Though a hike has been observed in power tariffs
recently, manufacturers have been able to pass on this increase on to the consumer
via higher price to protect their margins.
3.3 Performance: During FY13, total cement production stood at 33mln tons
(~3% YoY rise). Local sales of cement reflecting an increase of ~5% were 25mln
tons, whereas, cement export (8mln tons) registered a meager decline of 2% mainly
due to entry of Iranian cement in Afghanistan – Pakistan’s biggest export market
(53% share in total exports during FY13). Owing to relatively stagnant domestic
demand as against the
available capacity, the
industry faced intense
competition in the past few
years. Lately, the industry
players, after experiencing
sizeable business losses,
have started focusing on
improving their margins.
This coupled with gradual
increase in cement demand,
particularly in the local
market, has resulted in
higher prices and thus
improved profitability for the sector. Moreover, lower coal prices combined with
alternative energy measures helped in rationalizing production costs. Benefiting from

The Pakistan Credit Rating Agency Limited
CEMENT


SECTOR STUDY Page 6 of 7
February 2014
www.pacra.com

strong cashflows, cement players repaid debts. This along with lower interest rates
resulted in reduced finance cost. Thus the sector posted record profits in FY13.
During 6MFY14, the industry sustained its performance.
4.2 While the production side of the business is mostly under control, challenges
for the management emanate from three main sources:
i. Increasing the efficiency of the plants, for which waste heat-recovery systems
and more efficient production processes might be considered,
ii. Establishing efficient supply chain while minimizing distribution costs, and
iii. The development of export avenues and building relationships in export
markets.
These three concerns are expected to dominate the agendas of the management.
Companies that are successful in navigating these issues would increase
competitiveness while also lowering the long-term risk to their businesses.

4. Financial Risk
 Moderately capital
intensive
 Improved financial
profile

4.1 Cement is moderately capital incentive industry. However, it usually requires
considerable time to set up a unit (depending on the size of the plant) in comparison
to other industries (textile or pharmaceutical). The cost of establishing a cement
manufacturing unit varies as to the size of manufacturing capacity and also depends
on the type of machinery/ plant (Chinese, European and Hybrid) being installed and
requisite technological framework implemented to manage the plant. Nevertheless,
the cement manufacturers have had a highly geared capital structure due to
substantial set-up costs involved.
4.2 The manufacturing of cement requires huge liquidity/ finances to fulfill its
working capital requirements. The industry’s working capital requirements are
mainly a function of its inventory and receivables. Players utilize short-term lines for
working capital requirements while long term lines are used to conduct plant
maintenance and optimization. The industry's financing needs (both short-term and
long-term) are mostly being met by local banks. The cement industry is recipient of
the total banking advances amounting PKR 55bln (as of end-Sep13) out of the total
advances of the banking sector (PKR 4,210bln as of end-Sep13). The cement sector
is among the highest Non Performing Loans (NPLs) to the tune of PKR 15bln
depicting a NPL/Loan ratio of 28%.
4.3 Few years back, when local demand had eroded, the cement companies’
financial profile had come under pressure. However, there had been little support
from the owners of these units towards improving the financial position of these
entities. Except for DGKC, the owners had been reluctant to augment the equity-base
of the concerns or to bail-out the companies by providing funding on relatively easier
terms. This had led a couple of companies into default (Maple Leaf and Gharibwal)
while ZealPak closed down its unit. The reluctance of the owners to inject capital
during times of distress heightened credit-risk of the sector.

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CEMENT


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February 2014
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0%
7%
14%
21%
28%
35%
42%
49%
56%
63%
70%
0
20
40
60
80
100
120
140
160
180
200
FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12* FY13*
P
K
R
B
l
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Pakistan Cement Sector - Capital Structure
Debt (PKR Bln) Equity (PKR Bln) Debt / (Debt + Equity) (%)
* ListedCompaniesonly
4.4.1 On average the sector's average debt:equity ratio was high (56:44). However,
the industry operated at varying degree of leverages amongst producers. Most of the
new cement plants or expansions had been financed by debt rather than equity. Thus,
the industry had a highly
geared capital structure due
to substantial set-up costs
being involved.
Consequently, the Pakistani
cement industry was
plagued by high debt
structure. In addition, the
higher interest rate
environment in the country
further impacted industry
players' debt servicing
ability and thus, adversely
deteriorating the sector
coverages. The industry had also experienced low retention prices due to the price
wars, which had further compounded the profitability of the sector.
4.4.2 In the recent past, with better business margins, the industry’s cashflows
have improved significantly. Resultantly interest and debt service coverages depicted
significant recovery as average debt:equity ratio dropped to 27:73 at end-Jun13.
5. OUTLOOK
 Stable to Positive
5.1 Going forward, the government has allocated PKR 1,150bln towards PSDP
in FY14 for the Federal and Provincial Annual Infrastructure Development
Programme. More than half of this allocated amount is expected to be utilized for
infrastructure development. Although cement exports are under pressure, ongoing
infrastructure development programmes and uptick in economic sentiments are likely
to keep domestic cement demand strong. Strong profitability of recent years has
helped the sector in building financial strength. With continued performance trend,
the financial profile of the players is expected to improve due to further reduction in
leveraging.
5.2 What Could Change the Outlook;
 Initiation of Price War | would negatively impact sector dynamics.
 Rise in Energy Cost | owing to higher contribution of energy cost, significant
rise in coal prices and/or upward movement in gas/electricity tariff would hurt
margins.
 Instability in the Export Markets | with the availability of low-cost Iranian
cement in Pakistan’s biggest export market – Afghanistan – sustainability in the
price and demand for Pakistani cement would be challenging.
 Next Wave of Expansion | early expansion may bring pressure on the financial
profile of the sector owing to lower capacity utilization in comparison to
historical pattern.


Disclaimer:
PACRA has used due care in preparation of this document. Our information has been obtained from sources we consider to be reliable but its
accuracy or completeness is not guaranteed. PACRA shall owe no liability whatsoever to any loss or damage caused by or resulting from any
error in such information. None of the information in this document may be copied or otherwise reproduced, stored or disseminated in whole or
in part in any form or by any means whatsoever by any person without PACRA’s written consent. Our reports and ratings constitute opinions,
not recommendations to buy or to sell.