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Despite a 35 percent increase in its topline, Cherat Cement (PSX: CHCC) incurred a loss of Rs560 million after-tax in the first half of the fiscal year. This was to be expected. Whereas growth in capacity has allowed the company to increase volumes and grab a higher market share, cement prices are not cooperating as much. Higher capacity will certainly help - but not right now.

In the first quarter, the company saw a 53 percent growth in total cement dispatches year on year (local: 48 percent, exports particularly Afghanistan: 78 percent). But prices have remained shaky. With increased supply in the market, and a visible reduction in demand, prices have been under pressure, particularly in the north zone where the supply is substantially higher and new capacities have been added.

Unconsolidated Cherat Cement
Rs (mn) 1HFY20 1HFY19 YoY
Sales 9,512 7,033 35.2%
Cost of Sales 8,854 5,766 53.6%
Gross Profit 657 1,267 -48.1%
Distribution costs 182 191 -4.9%
Administrative 146 147 -1.0%
Other operating expenses 9 44 -78.5%
Other income 49 71 -31.5%
Operating profit 369 956 -61.4%
Finance costs 1,252 228 449.4%
Profit (loss) before tax (882) 728
Taxation (Credit) 322 300 7.6%
Profit (loss) for the period (560) 1,027
Earnings per share (Rs) (2.88) 5.29
GP margin 7% 18%
EBIT margin 4% 14%
NP margin -6% 15%
Indirect expenses % of revenue 4% 5%
Finance costs % of revenue 13% 3%
 Source: Calculations based on PSX notice

Gross margin falling from 18 percent to 7 percent are testament to higher cost of production. Costs were 82 percent of revenue and are now 93 percent which can be attributed to higher electricity and fuel costs. The company has signed Wheeling Regime Energy Purchase Agreement with Pakhtunkhwa Energy Development Organization (PEDO) for the supply of up to 3.8 GWH of electricity each year at a cheaper tariff. Furthermore, Cherat plans to install solar panels of 12.6 MW to further cut down on electricity costs. Fuel costs including coal will always remain subject to global price movements but better negotiated coal contracts and inventory management can help in mitigating price hike risks.

Other risks such as finance cost are more critical at this point. As a share of revenue, finance cost was 13 percent in1HFY20 compared to the corresponding period last year. The company’s new line comes on a long-term loan which is to paid back at a much higher discount rate. Moreover, short term borrowing also carries a higher mark-up.

Evidently, the company has a lot more capacity than it did last year. Cherat has an advantage of growing exports to Afghanistan, while demand in the north zone has recently improved. However, prices will remain under stress which will ultimately come down to reduced margins; and the losses will continue to the end of fiscal year.