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The current profitability of the cement industry is certainly not a fluke (read: “Cement: Troubles ahead!”, Mar 22, 2022). It is a direct outcome of prudent and swift raw material procurement decisions, slow and steady price hikes, and a general preparedness across industry participants in terms of energy and cost efficiency, one that began long before any crisis would hit.

And crises have hit the industry, and the economy more times than was thought possible with the country sinking into a recurrent balance of payment deficit, followed by a global pandemic sending shockwaves across the world, followed by covid-related supply shocks in international markets which then was followed by the ongoing Russia-Ukraine war. The world has not caught a break. Pakistan’s cement industry, however, demonstrates tactical planning, strategic management and timely investments (in waste heat recovery unit, multiple fuel usage, alternative fuel usage etc.) which have shielded the industry’s profitability from plummeting at times when it easily could.

A lot of this foresightedness can be associated to how “organized” the industry is where market information is close to uniform across players and price competition only occurs when demand in the market is slow (read: “Cement cartel: no cloak and dagger”, Dec 17, 2020).

For instance, almost all the cement manufacturers began to switch coal contracts from South Africa to Afghanistan, procuring the coal from the neighbour at a much-discounted price (on average 25-30%). Commodity prices, particularly coal, were sky-rocketing in the post-covid scenario when restrictions on mobility began to lift. Demand surge from coal-guzzling countries like China sent prices hurtling forward where much of the supply was restricted. When that price rally began to ease, the world was hit with the Russian-Ukraine war which has sent coal prices in a frenzy once again (“Coal: Brrrr!”, Mar 10, 22).

Raw material switching has thus far worked and margins for the industry particularly those in the north and close to the border improved from 1HFY21. Southern players like Attock, Thatta and Lucky had it more difficult as they had to weigh the cost of coal against freight and transport rates. They procured coal from markets which were the most feasible.

The margin improvement came amidst a lazy growth in the domestic market and export orders drying up, cross border and overseas. Exports declined to Afghanistan as the country undergoes a political transition with very little development happening, while surging freight rates (upwards of 200%) made it infeasible to continue exporting. In 1HFY22, exports share fell from 18 percent to 12 percent and is continuing to fall since.

Domestic demand was supposed to pick up on the back of PM’s construction package, hydro power projects, higher PSDP spending and Naya Pakistan Housing Program where demand was supposed to be fuelled by the mark-up subsidy offered to new home buyers. A lot of this demand has remained stuck. Domestic dispatches only grew 2 percent in 1HFY22 versus growth expectations of 8-12 percent.

But despite demand slowdown, cement manufacturers slowly but surely raised prices. This coupled with rising inflation in other building material costs such as steel may have led to a further demand slowdown too, particularly for new projects and new home owners. In the end however, cement manufacturers were able to increase revenue per ton sold by much more than the costs incurred to sell these dispatches (38% vs 33%) that led to margin improvement.

In the coming second half of the fiscal year, cuts in PSDP, falling construction demand due to higher construction costs and higher interest rates will thwart profitability significantly. While Afghan coal has thus far served as a shield, there are supply restrictions. Coal buying will continue to incorporate coal from traditional overseas markets such as South Africa and Indonesia where prices are up and supply is constricted. Cement makers will have to weigh out their options in planning to raise prices knowing it would affect demand. However, it also depends where other building materials are priced. Cement without steel cannot feed construction demand. If steel prices keep going up, it would not benefit cement manufacturers to keep prices at current levels while also losing demand because of steel (or other building materials inflation).

Meanwhile, debt servicing will give pause to earnings. Cement manufacturers, in unison, have increased debt in their plans to raise production capacity while SBP has hiked up interest rates several times. This would be a big dent on the income statement of those signing new financing terms with banks, not under long-term financing facilities or are offered prevailing interest rates for their debt.

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