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.