Cement Sector Update October 2011

B R O K E R A G E I S M O R E T H A N C O M M I S S I O N

Cement SectorUpdate

October 2011

Weak 9 months: Dampening domestic infrastructures demand, high operating leverage due to excess capacity, clinker and crude oil price hike and currency depreciation hurt the earnings growth of cementcompanies. We are bearish for cement scrip in 2011.

Analyst ContactAshaduzaman RiadhSenior Research Analyst & In-Charge [email protected]

Exhibit 1: Bangladesh far behind the major economies on cement consumption

Industry Highlights

With growing infrastructure need of the country, cement demand growth surpassed economic growth rate of Bangladesh over the years.

The Industry is highly concentrated. Out of 34 cement

companies, large 10 companies control more than 70 percent of the total cement production in Bangladesh.

Though the industry has supply overhang, which is more than

12 mn mt and mostly belong to tiny players, Incumbent players are investing heavily in capacity additions to meet the expected

P

akista

n

V

ietna

m

China

World

S

rilank

a

India

Bangladesh

131 kg

178 kg

170 kg

84 kg

408 kg

430 kg

850 kg

demand from some mega projects. But the bubbles in the real estate sectors, inefficient ADP (Annual Development Program) implementation and mega projects uncertainty hurt the top line growth of the companies.

Contractionary monetary policy discouraging credit flow to the unproductive sectors like real estate will make the housing loan more costly. However, the government investment on transportation and housing infrastructure development is expected to keep the demand growth intact for that sector.

Being highly energy-intensive, with energy constituting ~40

0 200 400 600 800 1000

Source: CMAI, BCMA, PCMA, VCMA, Vharatbook.com. International cement review and meeting with Lafarge Surma

Exhibit 2: Cement demand growth v/s GDP growth (discuss with me), demand will remain flat in coming years

percent of total cost, cement industry is highly disrupted by the erratic power supply.

Power disruption and energy price hike have been taking a toll on capacity utilization and operational cost in this sector.

Key input costs hike like the prices of

clinker & freight and currency depreciation have already hurt the 9 months bottom line in 2011.

We remain optimistic about the demand of cement given

Bangladesh infrastructure and real estate development needs. But the demand growth is expected to be slower in 2012 .

8.00%7.50%

7.00%6.50%6.00%5.50%5.00%

25.00%

20.00%

15.00%

10.00%

5.00%

0.00%

Cement demand growth (RHS) GDP Growth (LHS)

Source: LBSL research, Companies' annual reports, ManagementMeeting

A N L B S L R E S E A R C H P U B L I C A T I O N

Page 1


Exhibit 3: The industry has supply overhang

Cement SectorUpdate

October 2011

Installed Cap (mt/d) Actual Production (mt/d) Capacity Utilization (%)Company 200

82009 2010 2008 2009 201

02008

2009 2010

Confidence 1600

1600 1600 695

744 998

43.44% 46.50% 62.38%

Heidelberg 7000

7000 7000 3527 3879 4449

50.39% 55.41% 63.56%

Meghna 3333

3333 3333 1862 2762 3360

55.87% 82.87% 100.81%

MI Cement 2800

2800 2800 1500 1500 1905

53.57% 53.57% 68.04%

Lafarge Surma 4000

4000 4000 2493 3223 3083

62.33% 80.58% 77.08%

Aramit Cement 700 700 700 456

541 570.7 65.14% 77.29% 81.53%

Source: Company annual reports, Management meetings

Exhibit 4: Domestic Cement Consumption; Individuals dominate

Individual20%

Demand, supply and competitive factors of cement industryDue to large efficient scale of production and high operating leverage, cementindustry across the world is highly concentrated. Nevertheless, the different scenarios

15%

Source: Meeting with Lafarge

65%

Pvt Org & RealEstate

Govt.

can be observed in Bangladesh where 34 out of 54 cement companies are in operation with combined annual production capacity of nearly 22 million metric tons. Annual Per Capita cement consumption is 78 kgs and annual cement demand was nearly 12 mn metric tons in 2010 in Bangladesh, which is significantly lower than that of other developing countries and world average.

Price and non-price competition are quite high due to segmented market. According to the source, the minimum efficient size for a cement plant is around 1 mn metric tons of production a year.

Exhibit 5: Companies adding capacity to meet growing demand; but reduced demand and high operating leverage weigh on profit

As only seven firms out of 34 are maintaining minimum efficient size, market has gone through the consolidation and it will continue in future. Reputed multinational companies supported by the parents with strong technological expertise and local

Current

Capacit

y (mt/d)

Expecte

d A

dditions

(mt/d)

Total

Expecte

d C

apacity

(mt/d)

manufacturers with strong production capacity and distribution channel are the top performers.

Company FY 10 FY 12E

FY12E Confidence 1600

400 2000

Heidelberg 7000 25009500

Meghna 3333 03333

MI Cement 2800 3000

5800

Lafarge Surma 4000 0 4000

Aramit Cement 700 0 700Source: Company annual reports, Management meeting

Top manufacturers are expanding their production capacity signaling theircommitment to retain and increase market share. Excess capacity will bar the new entry and put the headache to small players. Confidence cement, Heidelberg cement and MI cement are expected to add 400, 2500 and 3000 mt per day cement capacity respectively in 2012. Heidelberg will be the largest in term of production capacity in2012 among the listed companies followed by MI cement and Lafarge Surma.Multinational brand enjoys premium price for

high quality and brand reputation.

The dominant type of cement used in the country is Ordinary Portland Cement (OPC), with a 95% to 5% mix of clinker and gypsum. Clinker, is primarily imported from countries like India, Thailand, Malaysia, Philippines, Indonesia and China and is therefore very susceptible to rising global raw material costs. Stock of already extracted clinkers in those countries has substantially depleted due to high internaldemand and suppliers are expected to enjoy high bargain power in the 2012.


Page 2


Exhibit 6: Porter’s Five Forces Competitive Model

Cement SectorUpdate

October 2011

•• Long time is required for land side acquisition andinfrastructure build up.

•• Many incumbents have captive power generation where new entrants would find it difficult to get power connection.

•• Strong demand and supply side economics ofscale of existing players.

•• Restrictive government policy for finished cementimport.

•• High capital requirement to avail economies ofscale.

•• Incumbents possess substantial resources to fight back. Average capacity utilizations are below 60%.

••Existing cement companies enjoy high demand side benefits of scale and distribution channel.

Barrier to entry

High

Bargaining power of buyers

HIgh

•• Large number of segmented buyers••Goverment, more than 20 percnet consumer of cement ; enjoys monopoly power to select the cement companies.

••Buyers are price sensitive as cement accounts forlarge portion of infrastructure cost.

••As cement industry is likely to be conconcentrated in the future, oligopoly structure would curtail the buyers’ power.

•• Though Competitors are numerous but unequal in size and power. In Bangladesh where 34 out of54 cement companies are in operationwith combined annual production capacity of 21.4 million metric tons. As the industry is growing at a pace of more than 20%, all players have the scope for higher capacity utilization. But smaller local companies are prone to consolidation with large company to attain production efficiency. In an oligopoly structure, rivalry would get intensified in near future.

•• Though many small companies positioned regionally rather than nationally but the big players are revamping the distribution capacity to reach everywhere.

Rivalry among

incumbents

Medium

Bargaining power of suppliers

High

•••Clinker, is primarily imported from countrieslikeIndia, Thailand, Malaysia, Philippines, Indonesiaand China and is therefore susceptible to rising globalraw material costs and beyond the control ofmanufacturers.

•• Raw material suppliers are experiencing heavy infrastructure growth in their own country and will not be affected if they do not supply raw materials to Bangladeshi companies.

•• There is no substitute for what the supplier groupprovides

Threat of

Substitution

Low

---Cement is an integral raw material for Construction and there is no substitution threat.

Decreasing Constant Improving


Page 3

Company 2009 2010 HY 2010 HY 2011Confidence 18.83% 13.77% 18.90% 18.50%Heidelberg 24.87% 23.71% 26.02% 18.36%Meghna 9.70% 8.05% 9.11% 9.51%MI Cement 17.34% 22.43% 17.54% 23.05%Lafarge Surma 38.25% 10.21% 28.31% -13.37%Aramit Cement 23.08% 22.80% 19.60% 21.38%

Confidence 27% 39% -56% 2%

110%Heidelberg 2% 37% 366% 3

%27%

Meghna 15% -4% 44% 15% -109%MI Cement 23% 184% 222% -2% -12%

Lafarge Surma -245% -53% 23% 97% -122%Aramit Cement -989% -90% 68% -16% 68%


Exhibit 7: Key Financials

Cement SectorUpdate

October 2011

Sales Growth EBITDA Margin Net Profit Margin EBITDA/mt (BDT)

Company 2009 2010H Y

HY 2011 2009 2010 2009 2010 H Y 2010 HY 201 20092010

C

onfidenc

e

H

eidelber

g

-1.26% 41.55% 24.41% 35.07%

13.15% 15.46% 9.33% 3.69%

44.02% 21.47% 28.75% 5.82%

18.84% 36.54% 33.42% 36.63%

21.44% -24.90% -8.66% -32.17%

10.65% 8.75% 17.79% -0.87%

19.22%

13.41%

23.19%

21.08%

7.76%

11.81% 14.02% 14.89%11.93%

11.81% 12.00% 13.41%10.33%

2.91% 0.88% 3.57% 3.11%

8.20% 10.62% 8.20%11.06%

486.31

480.11

795.91

835.16

365.04

Source: LBSL research, Companies' annual reports

The country lacks cement plants that are integrated with clinker production and as a result is forced to import clinker for its entire

cement production.

Exhibit 8: Gross-Profit Margin under pressure for rising materials and freight costs

Source: Company annual reports, LBSL Research

Exhibit 9: Capex as percentage of OCF (Capex through internal financing)

Company 2006 2007 2008 20092010

Source: LBSL research, Companies' Annual Reports

Lafarge Cement is currently the only integrated cement producer in Bangladesh with a clinker production capacity of 2 mn mt per year that is sourced via a cross border conveyer belt originating from the Indian State Meghalaya. The company can extract the limestone at the said quantity for more than 60 years from the mine.

Financial Strengths and Performance

Confidence cement and MI cement substantially revamped their production capacity and maintained 41.55 percent and 36.54 percent top line growth respectively in 2010.

Gross profit margin of cement companies has been under constant pressure due to rising cost of clinker in the international market, local currency depreciation and higher freight cost due to record fuel price hike in 2011. Volatile crude oil price also affected the shipping cost of clinkers in local market. The cost of consumed raw material price rose to peek in half year 2011 damping the gross profit margin. Industry gross profit margin was 20.28 percent in 2009 and it reduced to 15.47 percent in 2010. Lafarge Surma managed highest gross profit margin in2009 as the company sourced limestone; main component of clinker from its own quarry. Earlier Suspension of limestone extraction by Indian court almost halted the production facility. Recently Lafarge has received the clearance from Indian court for sourcing limestone, which will help the company bypass the volatility in raw material prices and keep a leash on its key inputs price.

Lafarge enjoys more than 60 percent cost advantage in clinker use for having own limestone mine

Meghna cement consistently underperformed the industry gross profit margin due to high raw material cost disadvantages. Where industry per metric ton clinker

cost was taka 4600 in 2010, Meghna cement consumed the clinker at 32 percent higher cost. Higher raw material cost has always put a drag on the operating efficiency of Meghnacement.


Page 4


Cement SectorUpdate

October 2011

Exhibit 10: Extended DuPont Decomposition of Return on Equity

CompanyTax

burden(NI/ PBT)%

Interest burden(PBT/ EBIT) %

EBIT margin(EBIT/

Sales)%

Asset turnover(Sales/ Avg TA)

Leverag

e(Avg

TA/Avg TE)

ROE (NI/Avg. TE)%

Confidence 81.42 90.48 10.18 0.62 1.24 10.75Heidelberg 63.19 100.00 18.99 2.32 1.51 41.96Meghna 74.90 25.64 4.57 1.66 5.30 7.73MI Cement 62.50 91.64 18.54 1.64 1.83 31.99Aramit 71.97 65.21 18.43 1.08 8.54 79.74

Source: LBSL research, Companies’ annual reports

MI Cement’s EBIDTA/Mt ton stood at taka 999.22 Mt ton, while that of Heidelberg, Aramit cement, Confidence cement, Meghna cement and Lafarge cement stood at BDT 835.16/Mt ton , BDT 875.84 /Mt ton, BDT 480.11/Mt ton, BDT 345/Mt ton and BDT 376/Mt ton respectively (as per FY 2010 capacities of respective players). Improved demands of cement, captive power to meet the partial demand and convenient raw material transportation facility have helped MI and Heidelberg stand out from its comparable peers. Among the listed peers, Heidelberg, Confidence and Lafarge have 4 MW, 3.3 MW, and 30 MW power generation facilities respectively. As Lafarge is the only company having alternative raw material source, the company is expected to maintain higher EBIDTA margin and EBITDA/Mt in the coming years.

ROE of the cement sector impacted by the high leverage, low asset turnover. However, Heidelberg and MI cement maintained high est ROE in the listed companies mainly driven by very low interest burden, low tax burden, higher operating profitability and healthy asset turnover. Very l ow debt gave those companies sufficient breathing space through lower financial charges. Moreover, increased cash and equivalents of Heidelberg BDT 2496 mn are expected to drive additional other income in the year 2011. Lafarge has highest BDT 10394.32 mn debt in its balance sheet followed by Meghna and Aramit cement having BDT 2045.54 mn and461.52 mn respectively. High financial leverage dampened the ROE of Meghna and Aramit cement. Highest ROE of Aramit cement w as mainly driven by the lowest numerator effect for reserve loss and not reflective of the return measure. Negative reserve and surplus of Aramit cement from accumulated loss put a drag on thecompany’s net asset value available for per shares and made the ROE artificially high

Exhibit 11: Debt Position and Cash

Component Confidence Heidelberg M MI Cement Lafarge ADebt (BDT mn) 376.62 71.49 204

5.54191.07 10394.32 46

1.52Cash & Equivalent (BDT mn) 40.56 2496.33 62.53 60.18 87.29 23.84Net Interest Income (Expense )

(BDT mn)(1.52) 171.63 (

80.88)(45.99) (773.48) (

53.26)Source: LBSL research, Companies' annual reports

Exhibit 12: Most of the cement company saw the quarterly earning decline

Earnings plunged for most of the cement companies in third quarter (July-Sep) 2011. Earning of the Aramit, Confidence,

2010BDT mn 2011 Growth

(%)

46 percent, 112.85 percent and 52.85 percent respectively. Industry earning growth excluding MI and Lafarze followed the

Aramit 14.53 8.07 - 44.46% Confidence 46.66 19.85 -57.46% Meghna

11.28 -1.45 -112.85% Heidelberg232.32 109.53 -

52.85% Lafarge -299.31 -741.86 -

147.86% MI 91.68 200.54118.74% Industry 396.47 336.54 -

15.12%Source: LBSL research, Companies reports**Lafarge was excluded while calculating Industry growth. MI cement Year ends in June .

same trend and it was 15.12 percent lower than that of sameperiod of previous year. MI cement registered envious 118.74 percent earning growth. However, the main driver of this earning growth was not the core business rather it came from other non- operating income component which is transitory in nature. Other non-operating income of the MI cement spiked to BDT

the same period of previous year. Most of the non-operating income came from the interest income as the cash and bank balance of MI Cement Company increased substantially forrecent IPO proceeds.


Page 5

Net Profit Change

Highest gainersamong cementShare Price

sector

As of 3As of 6

As of 9

CY 2010months (Jan-

months (Jan-Confidence -59.98% Heidelberg -25.99% Meghna-60.59% Lafarge Surma

-

100.00% 61.85% 8.21% -9.29%

17.00% -6.00% -20.11% -29.23%

-63.00% 98.00% 8.00% -17.72%DGEN -

36.18%


Cement SectorUpdate

October 2011

Exhibit 13: Most of the cement stocks are still expensive in DSE

Company Price* Audited PE

Adjust

Audited

Audited P/BV

Adjusted Audited

P/BV

EV/EBITDA

Sales/MT

Confidence 97.3 15.13 28.12 1.2 1.25 42.86 3581.09

Heidelberg 2605 14.71 14.71 3.08 3.08 11.07 3962.75

Meghna 103.6 46.46 16.63 3.41 3.41 25.83 5715.75

MI Cement 137.4 41.39 41.39 7.17 7.17 20.49 3723.04

Lafarge Surma 274.5 NM NM 5.69 5.69 81.47 4712.81

Aramit Cement 867.75 16.84 16.84 9.05 9.05 226.29 4369.68*As of October 31, 2011, *for MI, EV is calculated based on 2009 yearly data, 22 May'11 Market Cap has been used. 2- Jan2011 Market Capitalization has been usedfor the rest.NM=Not MeaningfulSource: DSE, Company Report, LBSL Research

Exhibit 14: Bearish market took the toll on most cement shares

*November 2010 average prices compared with average price of October 2011Source: LBSL research, DSE, Companies' annual reports.

Heidelberg cement showed consistent earnings growth and the company stock was trading at trailing P/E ratio of14.71x, EV/EBITDA of 11.07x and Price to book value of3.08x. Heidelberg’s earnings quality was also persistent. Compared to the peers, Heidelberg stock price lost 25.99 percent YOY basis reflecting investors' bearish sentiment for this stock. Lafarge registered negative earnings in the latest two quarters due to suspension of limestone mining operations by Indian Court. Recently Indian court cleared the dispute, which would help revamp the company's production and reinforce its competitiveness. The company is expected to be profitable from the year 2012.

Comparing average price and index of month November

2010 and October 2011, stock of Heidelberg Cement and Aramit Cement were found to outperform the Benchmark index DGEN that lost 36.18 percent in the same time horizon. Confidence cement made 100 percent net profit growth in the CY 2010 but large portion, approximately BDT131 mn or 55 percent out of BDT 240 mn net profit camefrom investment in listed shares rather than from core business operation. This earning growth is not expected to be sustainable in the year 2011. However, BMRE of existing facility, venturing into

textile and electronic equipments’ manufacturing would help to smoothen the topline from the

volatility of cyclical cement business.

Revaluation loss of BDT 124.263 mn badly affected the profitability of Meghna Cement in 2010 but the company subsequently showed 8 percent earnings growth in HY2011. Again, ironically, all the firms in the industry booked negative earnings growths as of the latest 9 months ended on Septembe r 2011 except MI Cement (not shown on Exhibit 14) that filed a 118.74 percent growth after its first quarter ended on September that is mainly attributable to its export-earnings growth and the gains from currency fluctuations.

Cement industry faced higher prices for raw materials due to higher freight cost caused by the fuel price hike in the international market in last one year. Apart from fuel price, international price hike of main raw materials like clinker, Gypsum all of this significantly affected the operat ing environment of cement manufacturers with the high cost adversely affecting the construction sector. In addition, many companies have already expanded capacity an ticipating high cement demand in2011 and are suffering from capacity overhang and operating leverage for slow local demand in real estate sectors. Stock market bearishness, high inflationary pressure, declining remittance flow and no gas and electricity connection for new apartments have highly affected the demand of real estate in urban and rural real areas. Subsequently negative effects have been observed in local cement demand. Cement consumption in government sectors are growing less than expected pace for the dilly-dally in ADP implementation. Expected sales growth of cement sector largely depends on the macroeconomic performance and systematic risk like political instability, mounting inflationary regime and subsequently tight monetary policy and natural adversity that may jeopardize construction sector reducing thegrowth of overall demand. Finally negative wealth effect due to recent nosedive in the stock market may not keep the real estate investors in comfortable situation.


Page 6

Analyst Industry Designation E-mail


Cement SectorUpdate

October 2011

LBSL’s research reports are also available on Bloomberg LANB <GO>

Disclaime

rThis document (“the Report”) is published by LankaBangla Securities Ltd (“LBSL”) for information only of its clients. All inf ormation and analysis in this Report have been compiled from and analyzed on the basis of LBSL’s own research of publicly available docume ntation and information. LBSL has prepared the Report solely for informational purposes and consistent with Rules and regulations of SEC. The information provided in the Report is not intended to, and does not encompass all the factors to be considered in a best exec ution analysis and related order routing determinations. LBSL does not represent, warrant, or guarantee that the Report is accurate. LBSL disclaims liability for any direct, indirect, punitive, special, consequential, or incidental damages related to the Reports or the use of the Report. The information and analysis provided in the Report may be impacted by market data system outages or errors, both internal and external, and affected by frequent movement of market and events. Certain assumptions have been made in preparing the Report, and changes t o the assumptions may have a material impact on results. The Report does not endorse or recommend any particular security or market participant. LBSL, its analysts and officers confirm that they have not received and will not receive any direct or indirect compensation in exchange for expressing any specific recommendation, opinion or views in its Report. The information and data provided herein is the exclusive property of LBSL and cannot be redistributed in any form or manner without the prior written consent of LBSL. This disclaimerapplies to the Report in their entirety, irrespective of whether the Report is used or viewed in whole or in part.

LBSL Research Team

Md. Ashaduduzaman Riadh Senior Research Analyst & In-Charge Research & Analysis Dept

Md. Ashaduzaman Riadh Md. Tareq Ibrahim Mahfuzur

Market/Cement/Tannery/Textile/Ins Bank/NBFI

Senior RA Research Analyst Research

[email protected]

Rajib Kumar DasIstiak AhmedMaksudul Haque ChowdhuryMs. Tanzina Ahmed

Power/Ins Market/Research Support Ceramic/Services-

Research Analyst Research Analyst Research

[email protected] [email protected] [email protected]

LankaBangla Securities Limited Research & Analysis Department Corporate OfficeA.A. Bhaban (Level-5)23 Motijheel C/ADhaka-1000, BangladeshPhone: +880-2-9513794 (Ext-118) Fax: +880-2-9563902

Website: www.lbsbd.com


Page 7

Cement Sector Update October 2011

Documents

Transcript of Cement Sector Update October 2011