Cement’s pecking order

BR Research 15 Nov 2021

The upcoming expansion cycle within the cement industry will bring capacity to nearly 100
million tons by FY25; up almost 30 million tons. The last expansion cycle added about 20
million tons of capacity which the industry is currently utilizing by 84 percent. Industry
players—particularly those located in the north zone of the country—are tying their
collective hopes to continually growing demand in construction and infrastructure. This
government’s amnesty package for the construction industry which would (potentially)
ramp up real estate activities, the ambitious target to generate supply of 5 million homes
together with hydro power and other infrastructure projected planned are supposed to be
the three main drivers of these massive investments.
Will the expected demand materialize? If the market grows by an annualized 10 percent, the
industry will be able to absorb 85 percent or more of its capacity. The industry’s historic growth
CAGR is around 6 percent, with annualized growth rate at 8 percent. The past six years—FY16
to FY21—the industry grew by 9 percent on average, 6 percent if FY21 is not included since the
growth that year was incredibly high. The 10 percent growth target is not unrealistic given past
records, but it is very optimistic. FY22 for instance is not going to deliver a 10 percent growth
given how bad exports are performing due to erratic supply-chain issues in the global markets
and how lazy domestic demand has been so far (4MFY22: 1% in domestic dispatches). Since
exports are not going to start turning around over the next few months (read: “Cement
prepping!”, Nov 9, 2021 and “Cement: Trouble brewing”, Oct 6, 2021), reliance on domestic
markets over the year will grow more.
The macroeconomic situation is changing from a few months ago. Interest rates will start going
up. Meanwhile, construction costs are moving up rapidly as cement, steel and other important
building materials become more expensive. If construction hits snags because of rising costs,
demand for these goods will suffer. Moreover, there is very little data to know, for instance, the
volume of new construction projects in the works (FBR is supposed to have a record of new
projects registrations but has thus far has shared very vague data to the public), or the volume of
homes that are incrementally added to existing supply (different sources quote different numbers
based on their motivations, rather than market research). One data point that could be considered
valuable information was SBP’s growing financing in housing and construction, specially under
the Mera Pakistan Mera Ghar. Alas, SBP has shared no data on the number of loans taken on and
average size of loans which would help analysts understand the potential impact of the scheme
and estimate the number of housing/number of projects in the works. The existing data is
virtually meaningless.
So, whether it is 10 percent growth expectation or 5 percent, it is mostly conjecture and based on
market sentiments than anything else. Nevertheless, in a worst-case scenario, the cement industry
would have idle capacity for a year or so, will give out more discounts and witness shrinking
margins. In 1QFY22, the industry’s gross margins have climbed to 25 percent (from 19% last
year) owing not to stupendous demand, but really high retention (read: “Cement: Camouflaging
risks”, Nov 3, 2021) and a careful control over costs despite coal prices giving the world a run
for its money (read: “Coal chills”, Oct 18, 2021).
The expansion cycle itself while not a new phenomenon in the industry does change the market
structure. For instance, Fauji cement considered to be one of the smaller cement players in the
north with one of the lowest earnings per share in 1Q is all set to climb up the ladder by a few
hoops. By FY25, after merging with Askari Cement (the plant is already a subsidiary of Fauji
Foundation), and undergoing expansions at both the Fauji and Askari plants, the cement player
will have knocked Lucky Cement off its 2nd position taking its place next to Bestway. As a
player that operates in both the north and the south zone, this is not a threat for Lucky Cement in
all honesty. But it does put Fauji miles ahead of its peers such as Cherat, Kohat and Mapleleaf in
terms of capacity.

Though, it would take a special cement plant to rival Kohat’s efficiency that boasted the highest
margins in the industry in 1Q and the second highest earnings per share despite the company
being a mid-sized player. The real rivalry for Fauji perhaps will come into play with DGKC that
is operating plants in the south and north zones, and will capture a similar market share by FY25
granted its expansion comes through. Having said that, merely expanding capacity does not
guarantee Fauji a leadership position, even if it stands tall in terms of capacity. What does then?
More on that later.