Distribution costs bust DGKCs profitability

The market had not anticipated DGKCs bottomline to decline very significantly. But the results of the company released yesterday showed that analysts had been rather optimistic.
Despite an improvement in gross margins of nearly 5 percentage points in 9MFY11 against the same period last year, net margins shed by roughly 2 percentage points in the same period.
One would have expected the cost of sales to have been the real culprit due to rising coal prices and power costs, but the improvement in gross margins in both 3QFY11 and 9MFY11 versus the same periods last year beg an insight into what actually went wrong.
While DGKCs revenues improved in both 3QFY11 and 9MFY11; mainly due to value-based growth in local dispatches and volume-based growth in export dispatches, distribution costs increased tremendously.
The increase of about 75 percent in exports in 9MFY11 - primarily volumetric growth - explains the surge in distribution costs. The increase is particularly high for 3QFY11 relative to the other quarters of the fiscal year because the increase in exports during the third quarter was considerably high; roughly thrice that in 3QFY10, and over 40 percent of total 9MFY11 exports.
In order to function at full capacity, the company covers any shortfall in local dispatches via export dispatches, and this is why exports increased in 9MFY11 when the volume of local sales declined.
Despite the surge in distribution costs, however, the operating margin in 3QFY11 improved year-on-year, although the operating margin for 9MFY11 declined slightly.
But high finance costs and taxes played their part eroding the operating gains, and, became a reason for net loss in 3QFY11 and a significant decline in profits in 9MFY11.
Rising interest rates on the companys short-term loans affected the finance costs while higher taxation expenses were reported due to significant deferred taxation.
Going forward, it is expected that the companys local dispatches will increase due to post-flood reconstruction activity and local prices are also expected to go up. On the exports-front, competitive pricing in international markets is likely to keep the companys export margins under pressure, though recent resumption of exports to India might offer some respite.
With one unit of the Waste Heat Recovery (WHR) project already in operation and the first phase of the Refused Derived Fuel in production stage, the company is likely to do even better on its gross margins in future.

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DG Khan Cement P&L

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(Rs in mn)             3QFY11   chg Y/Y   9MFY11   chg Y/Y

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Net sales              4,904        26%  13,078        10%

Cost of sales          3,643         5%  10,131         4%

Gross profit           1,261       209%   2,947        40%

Gross margin              26%      146%      23%        0%

Distribution costs       754       354%   1,523       121%

Operating profit         664        53%   1,979         6%

Operating margin          14%       21%      15%        0%

Finance costs            539        16%   1,555         9%

Taxation                 140       178%     246       344%

PAT                      (15)       82%     177

Net margin                 0%                1%

EPS (Rs)               (0.04)              0.49

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