Managing expectations

While announcing its financial results for FY19 in its PSX notice, Maple Leaf Cement (PSX: MLCF) also announced that in order to improve the company’s debt/equity leverage, the Board of Directors have recommended issuing 85 percent rights share. Over the past 20 months, interest rate has been raised several times. Meanwhile, the profitability of Maple Leaf is down by 60 percent in FY19 which is preceded by a revenue growth of only 1 percent. Floating rights share is the right decision.

To put it in perspective, the company’s finance costs have grown from 3 percent of revenue, now to 5 percent of revenue in FY19. If the company is worried about rising debt levels, there is a strong reason for it and the rights share issuance could help relieve some of the company’s long term debts. But would that help profitability? By a little, maybe. By its own estimates, maybe not (more on that in a bit).

The company’s plant is located in the north zone where the domestic demand has hit some bumps in the road. Austerity and contractionary government policies have led to demand lethargy in the domestic markets that were earlier rife with construction and infrastructure activities. Though government projects continued, commercial projects declined considerably exacerbated by government policies at the time including restriction on property purchases by non-filers or ban on high rise construction by the highest court.

Though these two restrictions were eventually lifted, the domestic impetus was missing.

This led most cement players to start exporting more. Except, players in the north also faced hurdles there. Given political tensions with India and Afghanistan and Iranian cement seeping into the latter market, north players were left with a lot of overcapacity and no idea how to dispense it. Both domestic and export markets were shrinking.

Reduced demand also led to price volatility as players chased down the demand. Though it improved in the latter half of the year, in some domestic northern markets, the competition seemed intense. This all resulted in a 1 percent growth in revenues for Maple which is—granted the circumstances—is a decent enough top-line. Compare this to Thatta’s top-line growth of 22 percent.

The reason is simple. Located in the south, Thatta had the option to sell cement (more specifically clinker) overseas which is simply not cost effective for cement manufacturers in the north. Though as a result, the company faced ballooning distribution costs which put considerable pressure on the bottom-line.

Its distribution and other indirect expenses grew to 10 percent of revenues (FY18:9%). For Maple leaf, they stood stable at 8 percent of revenues as of last year. The cost scenario is also not difficult to ascertain that led to the falling margins—higher on average coal prices and rupee depreciation together adding to the cost burden. Thus bringing down the profitability, despite a lower tax incidence (12% in FY19, against 17% in FY18).

In its second notice to the PSX in just five days, Maple Leaf also published its 5-years financial projections to fulfill disclosure requirements for rights issuance. By its own estimate, the company’s revenues will grow by 40 percent in FY20; proceeding to incur a loss that year. The year next, the company expects to recover. The 40 percent growth component is likely expected due to Maple Leaf’s new capacity that it added in Apr-19, but the projection seems ambitious given demand trends.

However, if the construction under Naya Pakistan Housing Program starts in the next few months, it may not be too unrealistic an estimate after all. Having said that, other avenues of demand have few chances of recovery—especially the Indian market and government driven new projects. On the upside, monetary policy may find relieve in the coming months, while coal prices globally are headed south.

Both these factors will benefit all cement companies from the costs side.