How long can the cement sector’s winning streak last?

Over the past 12 months, Pakistani cement sector stocks have shot up by an astonishing 84%, a rally that has significantly outpaced the impressive bull run on the broader Karachi Stock Exchange. This begs the usual question: how much further does the cement sector have to go? Analysts appear convinced that while the past year’s breakneck speeds may no longer be the norm, there is still life left in this rally.

First, take a look at historic numbers: profits in the 20 listed cement companies (out of the 21 that exist in the country) reached nearly Rs28 billion for the first nine months of the financial year ending June 30, 2013 – up an astounding 182% compared to the same period last year. By comparison, profits for the entire fiscal year 2012 were just under Rs20 billion, a record that looks to be smashed to smithereens by fiscal 2013’s final results, expected to start rolling in around late July.

The run up in stock prices, then, is based on fundamentals. Astonishingly, however, despite having outperformed the KSE-100 index by 21% according to data compiled by BMA Capital, cement stocks still appear to be undervalued compared to the broader market. Furqan Ayub, an analyst at JS Global Capital, notes that even blue-chip cement stocks like Lucky Cement and DG Khan Cement are trading at discounts of 20% and 31% compared to the overall market, which is currently trading at 7.7 times earnings.

Other analysts concur: “Despite a 47% rally since January 1, given strong expectations from the new government to improve the investment climate, the law and order situation, and resolve energy crises and announce major large-scale infrastructure projects, we believe there is still room for upside in [cement] stock prices,” said Shagufta Irshad Khurram, a research analyst at KASB Securities, the Pakistani research affiliate of Bank of America Merrill Lynch.

The key factor that most analysts expect is that the infrastructure-friendly Pakistan Muslim League Nawaz will initiate a lot of government-funded construction projects that will drive up the domestic demand for cement. KASB’s Khurram, for instance, notes that the Pakistan Peoples Party-led government oversaw domestic cement demand expand by a meagre 3% per year during its five years in office. By contrast, the preceding Musharraf administration saw demand rise by a staggering 16% per year during its last five years in office, albeit from a very low base.

Nonetheless, there are substantial risks to the sector, not least of which is the government’s need to raise revenue by levying taxes on a sector that has hitherto been relatively lightly taxed. Among the proposals under consideration is the imposition of 1% import duties on the industry’s raw materials such as coal, a possible increase in sales tax from 16% to 17%, and calculation of sales tax on the basis of retail prices.

However, Farid Aliani, an analyst at BMA Capital, believes that while such measures will raise prices, they will not be enough to dampen demand by too much. “While the combined impact of all the proposed taxation measures implies an impact of Rs40 to Rs50 per bag on a retail price of around Rs455 per bag currently, the companies would likely be able to forward the additional cost to consumers,” Aliani wrote in a research note issued to clients on Friday.

The convergence of the election with the wheat harvest season appears to have caused a dip in cement sales during the month of May, which were down 1% compared to the same month last year. Analysts, however, predict that this dip is likely temporary and that sales are likely to bounce back over the summer.

Published in The Express Tribune, June 8th, 2013

Farooq Tirmizi

CEO, Elphinstone

Farooq Tirmizi is the founder and CEO of Elphinstone, the financial services firm that operates SmartRupee.

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