DGKC: Work in progress

With a loss of Rs2.2 billion, DG Khan Cement (PSX: DGKC) join the ranks of its peers in the industry that were in dire straits during FY20. That is not to say, it was unexpected. In fact, earnings are in line with market expectations as the year revealed its many complications month after month. By 9M (Jul-Mar), the company’s volumes had grown by 7 percent but it still incurred a loss of Rs1.9 billion. The third quarter followed the running trajectory, only exacerbated by the outbreak of the coronavirus.

Pre-lockdowns, a few factors coming into play pushed the company to a corner. With economy in doldrums and the government trying to stabilize it through austerity measures resulted in reduced development expenditure and tightening monetary policy.

For DGKC, volumes grew but less desirably. However, local sales were marred by competitive retention prices that resulted in lower revenues fetched. In addition, the company has its plants in the north, where exporting markets such as India (with a levy of 200% on imports from Pakistan) and Afghanistan were less receptive. In 9M, the company’s exports had declined by 50 percent from last year. With the company’s new plant in the south, it was able to export some clinker but which typically carries less price per ton sold. Overall revenues during the year declined as a result. For the sake of comparison, revenue per ton sold (estimated) for 9MFY20 declined 6 percent against the corresponding period last year denoting a reduction in prices fetched across sales.

Though coal prices have been at their five-year lows, depreciation of rupee and inflationary pressures caused costs per unit sold (estimated) for 9MFY20 to rise 9 percent. Though volumes for full-year are not available, the gross margin coming down during the year to less than 5 percent against 13 percent in FY19 is a clear indicator of the price-cost dynamics. Covid realities did not bring about too much change since margins stood at 4 percent during 9M period as well (9MFY19: 16%).

The second major factory for DGKC is its leveraged balance sheet. High interest rates caused financial costs to inflate so much that they stood at 12 percent of revenues in FY20, up 50 percent from last year’s already high 8 percent. That’s a pretty big dent. Comparatively, overheads were 8 percent of the company’s annual revenue against 6 percent last year. This is higher than other cement companies and resulted in DGKC’s eventual loss.

Though covid-19 is not entirely behind us—and there is good reason to believe the country may be hit with a second wave—the construction industry is undergoing a transformation bolstered by government keen interest in the sector.

The government’s construction amnesty package should spur new private sector investment in brick and mortar developments across the country while its push for Naya Pakistan Housing may add to the construction of at least 100,000 more houses over the next few years. Moreover, dam constructions have begun. All these will result in positive business for DGKC which is a prominent player, now operating in both the north and south zones.

This together with improved price retention will help one end of the balance sheet while reduced interest rates will taper financial costs down. Known risks for now can be kept at bay which means FY21, optimistically will be a better year, by far, for DGKC and other cement players.