LUCKY CEMENT LIMITED – Analysis of Financial Statements Financial Year 2003-3Q Financial Year 2011

Lucky Cement Limited is currently one of the largest manufacturers of cement in Pakistan. During FY10, in order to decrease cost of production, Lucky Cement signed an MoU with Oracle Coal Fields for coal supply and also implemented the Waste Heat Recovery Project in Karachi that uses wasted heat from the production system to run turbine engines.

It also led to signing of MoU to sell 50 MW to Karachi Electric Supply Company. In FY09, the plant’s production capacity was increased to 7.75mtpa. During FY10, the company’s production of clinker and cement increased by 7.92% and 13.05% respectively. Lucky Cement produced 6.054 million tons of clinker and 6.461 million tons of cement during FY10. As a result of massive capacity expansion over the past years, Lucky Cement has been able to consolidate its position as the largest cement exporter.

During 1H11, the company’s production of clinker and cement decreased by 3.7% and 9.1% respectively. Lucky Cement produced 2.908 million tons of clinker and 2.785 million tons of cement during 1H11. As a result of massive capacity expansion over the past years, Lucky Cement has been able to consolidate its position as the largest cement exporter.

Overview

The three quarters ended March 31, 2011 have marked a period of grave turmoil and adversity for the cement industry. Overall, the industry suffered from a 10% negative growth over the nine-month period, covering both domestic and export sales. For the company in particular, local sales increased by 12.43% while the export sales declined by 32%. This turn came as a result of the sharp decline in clinker and loose cement sales in the Middle East, the slack in construction activities and cement over-supply. However, bagged export sales of cements increased by 5.5% for the firm over the tenor. The firm’s market share in the local segment increased from 12.79% to 15.61% while that in the export segment declined from 33% to 26.51%.

Financial performance (3Q11)

Lucky Cement experienced a revenue growth of 2.8% in the nine months despite the declining wave being experienced by the industry. Clinker production decreased by 6.5% while cement production fell by an astounding 9.93% as compared to the similar tenor last year; the dispatches of clinker and cement were adversely affected as well, declining to 4.277 million as compared to 4.865 million last year, representing a decline of over 12%.

Coal and electricity form a major component of the cost structure of the company totalling to a massive 63% of the cost of sales; over the nine-month period under review, coal prices increased by 37.5% internationally translating into a 21.11% rise in the cost of production for the company. The impact was neutralized to some extent by the Waste Heat Recovery system that helped to pacify the increase in costs due to rising electricity tariffs.

As the graph above depicts, GP margin fell by -4.05% over the nine-month period whereas operating profit margin declined by -5.84% in the same period due to the reasons disclosed above. The inability of the firm to absorb the high power and fuel costs was also reflected in the consequent fall in the return on assets and common equity ratios.

As far as the efficiency of the firm’s operations is concerned, the graph above depicts the story clearly; the performance of Lucky Cement worsened on all counts whether it be the rate of use of total assets or the ability to manage debtors via an effective credit policy. The total asset turnover took a dip from a well-balanced 47% to 45%, while the inventory turnover ratio declined from 19.28 times to 12 times. The fears that this imposed regarding the lengthening of the cash/operating cycle were proved correct by the corresponding increase observed in inventory days from 18.9 days to 29 days; the marginal decrease in the debtor days perhaps resulting from the implementation of a stringent credit policy could not help offset the negative impact this caused on the bottom line operating cycle length. Surprisingly enough the liquidity position of the firm strengthened as the current ratio increased from 0.7 to 0.81 over the nine-month period.

It is crucial to consider the debt profile of Lucky Cement over the tenor and not quite astounding to find that the debt position worsened during these months of adversity. The debt to asset ratio increased from 34% to 36% as did the debt to equity ratio from 53% to 55%. For the stockholders such high debt on takes present a grave question mark regarding the leverage advantages available for grabs and the firm undoubtedly forms a very risky investment. When we stratify the debt of the firm according to their relevant time horizons, it is interesting to find that the majority of the debt taken has been on a short-term basis. This implies from the decline in long-term debt to equity proportion from 14% to 10% over the period. Also that the debt servicing ability of the firm has suffered marginally, with the Times Interest Earned shrinking from 8.4 times to 8 times over the period. Lastly the EPS shrunk from 7.92 rupees to 7.65 rupees this march yet again presenting bad news for the investors.

Cement sector during FY10

The cement sector posted a reasonable growth of 9.4% as the total sales volume increased by 2.94 million tons to reach 34.22 million tons by June 2010 from 31.28 million tons. Local cement demand increased by 14.6% to 23.53 million tons in FY10 against 19.4 million tons in FY09 mainly due to increased spending in the private sector and higher agricultural support prices provided by the government to the rural sector.

Northern region cement market recorded a growth of 18% in export volume while the southern region market posted a decline of 2% during FY10. However the export sales were at 10.7 million tons compared to 11.4 million tons i.e. a drop of 6.1% from the previous year mainly due to a drop in exports to India by 52%. However in the Middle East, Iraq and Afghanistan export demand was relatively similar.

The overall capacity utilization of cement plants increased to 76% in FY10 from 74% in FY09 due to increased domestic demand with capacity expansions in the sector. According to recent statistics released by APCMA, 3 million tons of capacity expansion took place in FY10 (as compared to 5 million tons in FY09). The total cement production capacity of the industry stands at 45 million tons by end of FY10 as against 42 million tons in last fiscal year.

Comparison with industry

Lucky Cement has a gross margin of 32.56% compared to the industry average of 15.15% due to cost deductions due to local coal supplies and new electricity generation plants. Being one of the largest cement manufacturers, Lucky Cement has a profit margin of 12.84% compared to the industry average of 1.4%, depicting its profitability owing to a large proportion of export sales.

The company is also not highly leveraged with a Debt to Asset ratio of 34.5% compared to the industry average of 50%. This can be owed to its reduced financing costs and its financial stability. The Return on Assets is also much above the industry i.e. 8.19% as compared to 1% indicating a well above proportionate increase in the net profit as compared to the assets acquired.

Owing to such factors, its earning per share is also Rs. 9.7 as compared to an average of Rs 2 showing high investor confidence and growth potential.

Profitability (FY10)

Lucky Cement Limited posted a profit after tax of Rs. 3.137 million in FY10. The profit for FY10 was 32% lower as compared to the profit earned in FY09 (PAT FY08: Rs. 4.597 million). The gross sales of the company decreased by 6% to Rs. 29.052 million in FY10 from Rs. 30.915 million in FY09. The decrease in gross sales was largely due to lower cement prices, locally and internationally. The local sales volume of the company increased by 26.32% and the exports increased by 2.21%, hence doing better than the sector trend.

The net sales of the company decreased by 6.92%; from Rs. 26.330 million in FY09 to Rs. 24.509 million in FY10. The increase in sales revenue was thus mainly due to lesser prices as although sales volume had increased, sales price remained constant. Lucky Cement decreased exports, which had increasing distribution cost.

Cost of sales of the company increased by 0.07% during FY10. The cost per ton of cement decreased by 11% due to the implementation of Waste Heat Recovery Project and using lesser expensive coal from a local supplier. The fuel and coal costs are 62% of the total costs, which went down by 16.2%. In the previous years, the profitability of the cement sector was greatly affected as cost of sales had increased by 31% in FY09.

Thus, a decrease in sales revenue as compared to costs resulted in a decrease of 18.68% in the gross profit for FY10. The operating expenses increased by 44.05% mainly due to distribution costs of exports, however, it was the drastic decrease in the finance costs (from Rs. 1237 million in FY09 to Rs. 569 million in FY10) that increased the profitability of the company. The finance cost was mainly reduced due to early repayment of high mark-up carrying long-term loans and resorting to export refinance and Foreign Currency Import Finance (FCIF), hence the company recovered via the hedge of exports.

Profitability (FY03-10)

The profits of Lucky Cement has been increasing since FY03, however, at varying rates. The growth in profits had been declining from FY06 to FY08 due to rising costs but surged during FY09. During FY08, the growth of the company’s profits slowed down to 5%.

FY08 was marked by the cement sector as not only the year which saw growth in cement prices, both locally and internationally, helping the companies to secure more profits; but also the year in which they faced massive growth in operation costs, primarily fuel and electricity costs. This led the cement companies of the country to face massive problems in continuing productions and even to obtain profits from sales after the deduction of operation costs. Many cement companies were faced losses due to these costs.

Lucky Cement managed to obtain profits during FY08 when other companies posted losses. Lucky Cement anticipated these events and quickly employed counter strategies, like shifting to exports and reducing finance costs, resulting in high profits for the company. Also the energy and fuel crisis has also been spotted by the company in due time and preventive measures are employed with the hope that they will reduce operations and fuel costs in the future.

Lucky Cement had showed a growth of 35.4% in sales, from 12.25bn in FY07 to 16.95bn in FY08. This growth was achieved through increase in exports, along with the rise in cement retention prices over the year. Local retention prices showed an increase of Rs 133.7 per bag in FY08 from Rs 129.7 per bag last year, having a growth of 3.1%. Export retention prices, on the other hand, showed an increase of US$55.7 per ton (Rs 152.6 per bag) in FY08 as against US$47.2 per ton (Rs 133.2 per bag) in FY07.

Although sales volume of the company grew by 19.7% to 5.56m tons as compared to 4.64m tons last year, yet domestic sales for the same period declined by 9.2% to 2.89m tons as against 3.18m tons last year. This occurred due to more focus toward high yield exports, which showed a growth of 83.0% to 2.67m tons in FY08 from 1.46m tons last year. During FY08, ratio of local sales to export was 52:48 against 69:31 in FY07.

Profitability ratios

The gross profit margin of the company fell to 32.56% during FY09 from 37.26% in FY08. Likewise, the profitability margin of the company also fell from 17.46% in FY09 to 12.8% in FY10. This shows that the profitability of the company has deteriorated during FY10 after improving in FY09.

The gross margin showed a rising trend in FY09, primarily due to the increasing export demands. Net margin showed a slight increase as finance charges drastically increased to Rs 1237 million from Rs 127 million representing a rise of 881%, as the company was wound up in cross currency swap transactions which were providing interest rates hedging and SBP had also increased its markup rate- hence a higher financing cost.

Return on assets (ROA) and Return on Equity (ROE) also decreased during FY10 due to a lesser proportionate increase in profits as compared to the increase in asset and equity base of the company. The assets of the company decreased by 0.2% and equity increased by 7.93% but the profit after taxation fell by 51.75%.

Asset quality

The company’s performance in terms of asset management remained more or less the same during FY10 as compared to in FY09. The operating cycle of Lucky Cement became 79 days in FY10 as opposed to 80 days during FY09. However during FY10, it took Lucky Cement 68 days to sell its inventory as compared to 63 days during FY09. This is because the stock of the company increased while the sales reduced. Also, the day sales outstanding went from 15 days to 11 days during FY10, depicting that it took the company greater period of time to recover credit payments.

The Total Asset Turnover ratio of the company had a declining trend till FY05, after which it started improving. The ratio continued to improve during FY09 but again declined marginally in FY10. The total asset turnover ratio had been increasing due to higher growth in sales revenue as compared to the growth in assets over the years till FY09 but then it slightly decreased due to lesser selling price despite high sale volume.

The rising trend of sales/equity was disrupted during FY08 when the ratio declined from 1.34 times in FY07 to 0.91. However, the Sales/equity ratio improved to 1.13 times in FY09 due to higher sales revenue and again declined to 0.98 due to lower sales revenue.

Liquidity

The liquidity position of the company became lesser favourable during FY10 as the current ratio fell from 0.86 in FY09 to 0.71 in FY10. This was due to 12.55% decrease in current assets and 6% increase in current liabilities. The stores, spares and inventory of the company declined by 2% and the net taxation income fell by 17%. However, the major reason behind decline in current assets was a 68.2% decrease in cash and bank balance of Lucky Cement. Cash is the most liquid asset and such a substantial decline could make it difficult for the company to meet its obligations.

Lucky Cement had shown a positive trend in FY09. The current assets were raised by cash in hand due to a smaller Days Sale Outstanding time period and also sales tax refundable by the company. On the other hand, current liabilities had increased, there were quite a few short-term borrowings done by the company as financing facilities, along with many bills payable. Liquidity position may remain weak until the company reduces its bills payable and short-term borrowings.

Debt management

Lucky Cement has a strong position when it comes to debt management. Since the end of FY06, the company has employed strict measures to keep its debts under control. This futuristic preventive measure has helped the company a lot in these times when interest rates are continuously on the rise. The action to reduce loans and to depend on equity for expansionary purpose finances has been critical in saving the company valuable profits that would have been otherwise lost in the name of finance costs. The swap agreements are another preventive measure the company is employing to save itself further from interest rates.

The results of the preventive measures are visible in the debt to asset ratio and the long-term debt to equity ratio, which show a downward trend since FY06. Total debt to equity has also been on a declining rate. In FY08 although the total debt increased significantly due to the rise in current liabilities, the overall effect has been declining owing to the rise in equity by the issuance of GDRs. Recently cost reduction measures like the Waste Heat Energy Project and using local coal has also helped in reducing debt. Hence the debt to asset ratio signifies that the company succeeded in lowering its overall debts and strengthening its financial position.

The TIE ratio had been declining from FY04 to FY07 but in FY08 the TIE raised significantly, i.e. from 4.28 to 24.48 times. It again declined in FY09 to 5.85 and then marginal increase in FY10 to 7.46. Although the EBIT for the year was less than that of FY07 (3,077,660 as compared to 3,695,402), but in FY08 the finance costs were reduced drastically through swap agreements, causing the rise in TIE. Still, for future times, the company would have to reduce its operating costs along with its finance costs to maintain the positive stream of TIE.

The earning per share of the company had a general positive trend that has been established since FY05. The Earning per share of Lucky Cement decreased to Rs. 9.7 in FY10 from Rs 14.21 in FY09, due to a lesser PAT. However, the price to earning ratio rose during FY10, depicting high investor confidence in the company. The average market price of the company’s shares in FY09 was Rs. 54, which rose to Rs. 71 during FY10. The company announced a dividend of Rs. 4 per share for FY10.

Future outlook

Although currently the price of cement has fallen worldwide, major construction projects due to the rising income per capita of countries leading to more residential and commercial construction projects worldwide will boost its sales and within the next 3-4 years, the price of cement is expected to increase.

Local cement sales can be expected to show positive growth during FY11 due to the construction of 8 dams in each province, rehabilitation of flood victims in Pakistan and increased spending by the private sector will give a boost to local cement sales.

Export sales growth may slow down as it has slightly reduced already due to Gulf region capacities. Also, political tension with India has already closed a window of opportunity that had appeared in FY09. India constitutes 8.5 percent of total Pakistan’s cement exports. However, local cement manufacturers are exploring markets like Central Asia and other new markets to enhance cement exports.

As for Lucky Cement, the working capital ratio can easily improve if they manage and reduce their Days Sales Outstanding. Also a likelihood of increasing in world cement prices plus increase in local demand may lead to higher selling prices which can in turn increase its sales revenue leading to higher gross margin. As investor confidence is already there, company’s share prices are expected to increase too.

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