Financial results of cement companies for the first quarter of FY18 are starting to roll in and expectations are they will see a further pressure on margins despite increase in volumetric sales (15% in 1QFY18). The sector closed off FY17 with an across the board decline in gross margins-on average dropping to 38 percent from 42 percent in FY16-despite shifting much of the sales mix toward domestic markets against exports which are traditionally low margin. A combination of factors attributed to this, including a surge in energy and input costs and an increase in federal excise duty (FED).
The pressure is now building further as the sector moves into expansion mode and retail prices start to move south.
Energy costs, which include cost for electricity, gas, furnace oil (FO) and coal, play a pivotal role as they constitute bulk of the cost of production. As total cost of sales, the share typically lies between 45 percent to as high as 70 percent. As coal and oil are imported, movement in international prices for both impact margins heavily. During FY17, coal prices ballooned sharply-between July-16 and Jan-17, they surged by more than 62 percent resulting in greater costs for cement companies all around. If the first quarter of FY18 is considered, coal prices rose by 6 percent between July-17 and Sep-17.
Cement companies located in Punjab and KP areas are impacted more as they maintain higher overall costs because of extra transportation rates in moving up from the port. Much of the sector has attempted to diversify energy mix by making use of alternative fuels, setting up captive power plants to produce electricity in-house and buying less electricity from the grid. But these measures haven't been able to shield the sector from fluctuations in coal prices.
Meanwhile, during FY17, the FED was changed to Rs1,000 per ton from 5 percent of sale value in FY16 which came to decreased net sales price between 3-5 percent. The RLNG tariff imposed since Nov-16 also made gas expensive.
The kicker comes in now as prices in the north have shrunk by 10-15 percent since Jan-17 and are likely be rationalize further as the sector moves into its expansionary cycle over the next 2-5 years and capacity utilization comes down (read "The rise and fall of the cement titans", Oct 9, 2017). Per estimates made by Foundation Securities, a fall in prices of Rs25 per bag would see a 9-16 percent fall in earnings for most of cement players; and cement margins will likely recede to 35 percent in 1QFY18. Case in point is DGKC's margins announced yesterday landing at 35 percent from 44 percent this period last year. The sector must hunker down for the next 2-3 years and let this wave wash over it.
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