Lucky Cement is likely to be the biggest beneficiary of the ongoing regional cement supply shortfall in the Middle East and India as it is the only cement producer located near the Karachi port. As a leader in terms of capacity, Lucky Cement is to divert a major portion of its production towards cement exports over the next two-and-a-half years in relation with the export window which would allow Lucky Cement to record a two-year (2008-2009) export growth CAGR of 48 per cent.
However, by end-2009, its regional capacities are to come on stream, which may hurt Lucky Cements exports. Hence, post-2009, it is assumed that the companys sales mix to once again be focused towards domestic demand, this was disclosed in JP Morgan research report on Lucky Cement.
It is important to note here that Lucky is the first Pakistani company to acquire certification for exports from the Bureau of Indian Standards. The company has already started exporting to India in small quantities. A pick-up in the pace of exports to India should be a near-to-medium-term catalyst and drive further stock price performance in spite of the recent run-up.
Even though, more expansions and surplus capacity could put pressure on domestic cement prices and result in margin contraction but the smaller players are more vulnerable to decline in cement prices due to capacity expansions and a slowdown in domestic demand.
The ongoing short-supply in the region is not likely to last forever and in line with this the possible slowdown in Pakistans cement exports post- 2009 due to upcoming regional capacities, particularly in India, Iran, the UAE, Egypt, and Saudi Arabia.
Report further said, in the medium term, India and sustained demand from the Middle East would drive Lucky Cements bottom-line growth. However, over the long term, after a likely moderation in export demand (by 2010), the domestic demand due to infrastructure development would keep earnings growth stable with a five-year (2008-2012E) revenue and EBIDTA CAGR of 11 per cent and 13 per cent, respectively.
Report revealed, domestic demand has been growing at a three-year historical CAGR of 19 per cent and shares a strong 0.9 correlation with the countrys real GDP growth. During FY07 at 24 per cent Y/Y, the domestic cement demand grew at 3.5x the real GDP growth.
With the demand from housing and infrastructure development picking up, we estimate the countrys domestic demand to remain robust, diligently tracking the growth in real GDP. Having the highest share in capacity and plants in the north and south, Lucky Cement should not find it difficult to divert dispatches sale for domestic consumption in case of a slowdown in exports due to the availability of surplus capacity in the region.
In its financial model, report assumes Lucky Cement is to maintain the clinker capacity at 6.5 million tons, where the planned GDR and capacity expansion is not part of our base case valuations. However, based on DCF sensitivity analysis, a clinker capacity expansion of 2.5 million tons could result in a DCF upside of 18 per cent-23 per cent from the base case, assuming 35 per cent of this expansion comes on line in 2010 and the companys total capacity reaches 9m tons by FY11. If regional supply shortages continue due to delays in capacity expansion, and Pakistan continues to provide regional importers a freight advantage, continued growth in exports beyond 2010 will be seen, which assumes an expected moderation post-2009.
A higher-than-forecasted increase in industry capacity could put pressure on local cement prices as has been seen historically. In our financial model, report projects 8 per cent increase in prices in FY08 and a 3 per cent increase in FY09-FY012.
With the sky-high cement prices back in 2006, FY06 was the best fiscal year for cement makers in a long time with the EBITDA margin in excess of 45 per cent for some manufacturers. However, with new capacities coming on line and the governments pressure to reduce prices, the sector saw a significant drop in cement prices, contraction in margins and hence poor profitability in FY07. Lucky Cement has been no exception, although the only difference now is that over the last two years with the expansion in the north and a new project in the south, the company has made itself more resilient to sectoral issues related to other cement companies in the country.
Hence, as a market leader, it is likely to see less volatility in Lucky Cements scrip compared to other sector players.
In FY07, local cement consumption reported a 24 per cent Y/Y growth, taking total dispatches to 21Mt, up from 16.9Mt in the corresponding period last year. The strong growth in local cement demand is backed by improving macro fundamentals, increased government spending in infrastructure development; the private housing construction boom given the growing purchasing power, and mega housing and commercial projects by large local and multinational real estate developers.
Cement exports have been equally strong, particularly in the current fiscal year on account of the increasing demand from Afghanistan, Iraq, Middle East and now even India.
Cement demand shares a strong 0.9 correlation with Pakistans GDP growth, where in the last four years (FY04-FY07), the local cement demand has grown at a CAGR of 18 per cent.