D.G. Khan Cement Company Limited (DGKCC), a unit of Nishat group is one of the largest cement manufacturing unit in Pakistan. It is listed on all the three stock exchanges of the country. Before it was the largest unit but now it came on the second position after the Lucky Cement.

RECENT RESULTS (1H'08):

Industry trends: During the half year under review, the cement industry in Pakistan achieved an overall growth of 24.35% compared to the same period last year with break up of domestic growth of 9.31% and export growth of 149.15%. The industry also witnessed a 100% growth in exports of clinker during the half year compared to the same period last year (SPLY).

Despite the double-digit growth in the cement dispatches, the earnings declined due to an average of 13.2% decline at retention level cement prices to an average Rs 127.4 per bag during the period under review as against Rs 146.8 per bag in the SPLY.

The financial charges along with the cost of production have also increased in H1'08 because of the rising interest rate scenario along with an increase in cost of furnace and coal that constitutes more than 50% to the cost of production.

Cement industry during the period operated at over 77% of its installed capacity against 74% for the SPLY. The slight improvement is even more impressive when compared with increase in installed capacity over the comparative periods.

Despite the increase in sales, the gross and net profits have declined by 36% and 61.5% respectively. The profit after tax declined to Rs 329.6 million with an EPS of Rs 1.30 compared to an EPS of Rs 3.40 in the SPLY. The contributing factors to this decline in profitability are more than 2.5 times increase in the raw material and packaging costs, nearly 3 times increase in the electricity and gas charges, a 100% increase in the furnace oil/coal costs, and an increased depreciation on property, plant and equipment. The financial costs have increased by more than 300% as compared to SPLY.

The Greenfield cement plant started by the company in Khairpur in FY04 has been completed and the clinker production was started on trial basis in May 2007. Commercial production also commenced on 27th June 2007. The plant has a capacity of 2.1m tpa. Hence the total capacity of the company has been enhanced to 4.21m tpa from 2.11m tpa. This plant achieved 99% capacity utilisation for the period H1'08.

The company is currently evaluating another expansion plan of 6700-1200 tpd clinker in Hub, near Karachi. The expansion is estimated to take 24 months for completion will raise its total capacity to 6.32-7.99m tpa from 4.21m tpa.

Currently the work is in progress in the new vertical cement grinding mill at the DG Khan site. The shipments from plant supplier have begun and cement grinding mill is expected to start its operation in the last quarter of FY08. After the completion of this project, the excess clinker produced at D.G. Khan site would be ground and sold, leading to greater efficiency. Also in order to reduce costs, the company is contemplating to formulate methods to use waste energy from the whole process in order to minimise energy cost escalation.

The FY07 was characterised by cascading profitability for the cement industry as the combined profits of the sector declined by 56% from Rs 12.3 billion in FY06 to Rs 5.3 billion in FY07. At the same, total cement dispatches grew by 31.8% compared to FY06 from 18.4m tons to 24.3m tons.

DGKC managed to obtain a 30.4% share in total industry profits, a position second only to Lucky Cement. The local sales volume rose by 22% during the year, but capacity constraints restricted the further growth, so that the sales growth of the company was lower than that of the industry growth of 24%. Export sales, however, declined by 7.4%. Moreover, the growth in sales volume was not accompanied by a growth in sales revenue, which suffered a decline of 19%.

The clinker and cement production of the company grew nominally during the year, at the rate of 4.2% and 12.3% respectively. The production from the four days of commercial production from the Khairpur site plant further augmented production. Capacity utilisation stood at 113% in FY07, only slightly higher than the 112% utilisation in FY06.

The gross profit margin of DGKC declined from 49.81% in FY06 to 31.65% in FY07 accompanied by a decline in net profit margin from 30.4% to 25.27% for the same period. The decline in profits of the company and the industry was caused by a number of factors.

Low retention price was one of the major reasons for the drop in profitability. Sales prices suffered a 37% decline in FY07 compared to the previous year. This situation arose as the expanded capacities of various companies came online, leading to a supply overhang. This resulted in downward pressure on the prices and the gross profit.

Secondly, steadily rising fuel price resulted in a 37% hike in cost of sales. Moreover, the hand rate of Kraft paper has also grown steadily, with a 16% rise in cost of paper bags on average. These factors severely hit the gross and net profits of the company. Subsequently, the profit margins also declined.

Other income showed a positive trend with a significant growth of 63%. This was mainly a result of higher dividend income. The growth in other income helped ease the pressure in profits, contributing positively to the bottom line.

The performance of DGKC in terms of asset management was weak during FY07. During the year, the inventory turnover (days) of the company more than doubled compared to the FY06 when the management of inventory seemed most efficient (evident from the lowest inventory turnover in days). This can be traced back to lower sales revenue for the period, coupled with a higher stock of inventory. At the same time, the average time taken by the company to recover cash from sales has also increased. The increase in inventory turnover in days and days sales outstanding (DSO) have prolonged the operating cycle of the company significantly.

Besides this the sales to equity and total asset turnover of the company have declined. An increase in the paid up capital was one factor behind this trend. The capacity utilization has, however, improved nominally over the previous year. Hence overall, the efficiency of DGKC in the field of asset management has deteriorated significantly. However, the company's performance in the area may improve in following periods as full-scale production from the newly inaugurated Khairpur plant augments sales.

The debt management ratios of DGKC have shown a positive trend during FY07. The debt to asset and equity ratios as well as the long term debt ratio has all receded during the period. This reflects a reduction in the company's dependence on debt financing. Hence the leverage of the company has declined. Despite this decline, the TIE has cascaded for the same period, against a previously positive trend. The financial charges of the company rose by 3.9%. This increase in financial charges, together with a 51% decline in EBIT has brought about the reduction in interest coverage.

DGKC's liquidity stance has been strengthening since the past few years and the FY07 saw a continuation of this trend. The increase in current assets that brought about this change comprised of a 98% increase in short term investments. Further, the cash and bank balances have also risen considerably. The liquidity position of the company therefore seems safe.

The low cement retention price and high cost of sales during the year have severely hit the EPS of DGKC, bringing it down to Rs 6.40 from as high as Rs 13.11 in FY06. But despite the decline in profits, the company has declared a dividend of Rs 1.5 per share.

FUTURE OUTLOOK: In light of the to rising coal rates in the international market and a hike in inland freight due to increase in petroleum prices, the DGKC has decided to use gas for heating the kiln. To start with gas firing equipment for plant 2 at D.G. Khan has been procured and about 60% of the coal has been replaced with gas. This change is expected to reduce energy cost during FY08.

The Federal Budget 2008 has announced a PSDP of Rs 520 billion, which is 20% higher than last year. Moreover, the PSDP is largely infrastructural centric, hence the cement industry is likely to attain a significant portion of this amount.

Moreover, the cement industry has been demanding a cut in Central Excise Duty (CED) which is one of the major reasons for high cement prices. Although the government has promised to reduce the duty gradually, but no such measures were announced in the budget 2008. On the contrary, an additional special excise duty at the rate of 1% has been imposed on manufacturing activity. In the presence of these duties and with the imposition of the additional duty, the profitability of the sector will be threatened.

With the industry wide expansions of capacity, the industry is now in a position to export a sizeable portion of its produce. However, the incentive announced in trade policy of FY 2006-07 for the construction of bulk handling and storage facilities of cement and clinker has not materialized, which is a serious impediment in smooth export activities.

In addition, the industry is also seeking approval for the export of cement to India. The permission of the export of cement by land route, if granted by the government, will benefit DGKC, as its Khairpur plant is located at a short distance from the Wagha border. Export of cement from the northern border has also started from Khairpur plant.