tpl_040813_115456

Fauji Cement Initiation Report

KATS Code FCCL

Bloomberg Code FCCL PA

Reuters Code FCCL.KA

Market Price Rs8.60

Market Cap Rs11.4bn /US$116mn

Free float Market Cap Rs6.3bn /US$64mn 1-Yr Avg. Daily Volume 11.34mn

1-Yr High/ Low Rs8.81/5.48

Estimated free float 55%

Share outstanding (mn) 1,331

Index weight 0.25%

FCCL: Key numbers

FY11A FY12A FY13E FY14F FY15F

EPS 0.3 0.3 1.7 2.1 2.3

Earnings Grow th 66% 5% NM 29% 9%

PE 26.9 30.4 5.2 4.0 3.7

Div Yeild 0% 0% 6% 9% 12%

ROE 3% 3% 15% 17% 17%

P/Bv 0.6 0.9 0.8 0.7 0.6

Source: Topline Research

PAKISTAN INSIGHT

Fauji Cement (FCCL)

April 08, 2013

Initiation Report

This report has been prepared for information purpose by the Research Department of Topline Securities. The information on which this report is based is obtained from sources which Topline Research believes to be reliable but we do not guarantee that it is accurate or complete. In particular, the report takes no account of the investment objectives, financial situation and particular needs of investors who should seek further professional advice or rely upon their own judgment and acumen before making any investment. This report should also not be considered as a reflection on the concerned company’s management and its performances or ability, or appreciation or criticism, as to the affairs or operations of such company or institution. Warning: This report may not be reproduced, distributed or published by any person for any purpose whatsoever. Action will be taken for unauthorized reproduction, distribution or publication.

Report completed on April 08, 2013.

Prices as of April 05, 2013.

Topline Research is also available on

Bloomberg, Thomson Reuters & Capital IQ

Topline Securities (Private) Limited

306, Continental Trade Centre, 3 Floor Block 8 Clifton, Karachi

Pakistan Tel: +9221-5303330-32

Fax: +92215303349

Asad I. Siddiqui [email protected]

Tel: +9221-35303331 Ext: 140

Expansion at the right time

Pakistan’s 4th largest cement producer, Fauji Cement (FCCL), will be one of the major beneficiaries of operating and financial leverage as its new line became operational when Pakistan cement industry dynamics have started to improve. FCCL with higher market share, improved production efficiency and strong cash flows has the potential to considerably reduce its debt obligations and post better than average earnings growth. We Initiate coverage on FCCL with ‘Buy’ rating and target price of Rs11. The stock is currently trading at FY13 and FY14 PE of 5.2x and 4.0x versus sector PE of 5.5x and 5.5x, respectively.

Expansion led above average growth After 2.3mn tons (7200tpd) expansion, FCCL has become Pakistan’s 4

th largest

cement manufacturer with 8.0% market share now compared to an average 6.6% in FY12. Further, the European made US$335mn new line has brought efficiencies as FCCL’s EBITDA margins has improved by 14pps in 1HFY13 vs average rise of 9pps of the industry. Resultantly, FCCL’s sales are likely to grow by 41% and 6% in FY13 and FY14 respectively with EBITDA margin improving from 34% in FY12 to 38% in FY13 and onwards.

Gains from declining debt and financial charges Due to improved efficiency and higher financial leverage, FCCL will be the major winner of turnaround in cement sector that stems from better margin scenario and sharp fall in interest rates. The company generated EBITDA of Rs2.8bn in 1HFY13 against Rs934mn in 1HFY12, which will help in early repayment of loan. We expect debt to decline to Rs11.4bn by end of FY13 from Rs13.5bn at end FY12. Moreover 425bps decline in KIBOR since July 2011 will also positively affect its profits. We expect financial charges to decline by 15% in FY13 and 36% in FY14.

Dividend likely thanks to healthy cash flows In 1HFY13, FCCL posted earnings of Rs938mn (EPS Rs0.7), against loss of Rs102mn. However, it reported taxation of Rs398mn (incl. deferred tax) while actual outflow was only Rs37mn. This suggests that FCCL’s actual earning is understated and this will continue in the presence of deferred tax liability. This non-cash tax expense along with high depreciation (Rs1.1bn a year) due to its expansion will generate enough cash for early debt retirement. Considering better cash position, FCCL may surprise investors by dividend of Rs0.5 in FY13 after a gap of 7-years.

BUY


Expansion online at the right time

At the time when FCCL was in the process of expansion, Pakistan’s cement industry was in tatters. Average capacity utilization dipped to 79% in FY07 from 92%in FY05.

To recall, foreseeing the growth momentum of FY01-06 to continue, when average GDP grew by 5.3% per annum and domestic cement dispatches grew by an average 10%, major Pakistan players ventured in capacity enhancement. Industry capacity increased by 46% to 30.6mn tons in FY07 from 20.9mn tons in FY06 which eventually rose to 42.5mn tons in FY11. However, with overall growth diminishing as structural issues restricted economic growth to 3.7% a year during FY07-11 and domestic dispatches grew by a mere 6% annually. Supply glut emerged on the domestic front (contributing 77% to total sales), adversely affected sector’s profitability.

Despite all this negativity, FCCL went ahead with its planned expansion of 2.3mn tons, and ever since its new capacity came online (May 2012) fate of the sector has taken a U-turn. Better margin scenario (favorable price movement in cement and coal prices), gradual rise in domestic demand and reduction in interest rate, all positively affected sector’s profitability.

In FY12, cement dispatches improved to 32.5mn tons, up 4% from previous year and we expect industry sales to grow by another 4% in FY13 to 33.8mn tons (local dispatches up 5%). In recent years (FY08-12), dispatches growth stood at an average 2% while growth in domestic dispatches stood at 3% per year.

Where improved dispatches have positive impact on the entire sector, FCCL will also benefit from its enhanced capacity. Against the industry growth of 4%, company’s volumetric sales has increased by 33% to 1.2mn tons in 1HFY13, thereby increasing its market share from 6% in 1HFY12 to 8% in 1HFY13. Company’s capacity utilization from 63% in FY12 has also caught-up with industry average capacity utilization of 72%. We estimate company’s volumetric sales to grow by an average 3-5% in next 5-years.

New capacity brings efficiencies

The new plant of European technology has also raised efficiency levels of FCCL. Though, operating margins of the entire sector grew, but growth in FCCL’s margin surpassed the industry. Peer analysis of 9 companies (with cumulatively market share of appox. 75%) reveals that sector’s operating margins improved by 9pps to 30% in 1HFY13 as against 21% in 1HFY12. FCCL’s margins improved from one of the lowest in the industry (15%) to one of the highest at 30%, up 15pps.

Similarly, company’s EBITDA margins, another gauge of efficiency, improved by 14pps to 37% in 1HFY13, while that of the industry grew by 9pps to 36%. In terms of EBITDA per ton, Industry’s ratio improved by 55% to Rs2,192 in 1HFY13 as against Rs1,415 in the same period last year. FCCL’s EBITDA per ton improved to one of the highest in the industry, a significant growth of 137% to Rs2,298 as against Rs971 in the same period last year.

Therefore, in addition to capacity enhancement, better efficiency is another key factor that would allow FCCL to record growth above the industry.

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Sector: EBITDA per ton Comparison

1HFY13 1HFY12 Growth DGKC 2,479 1,700 46%BWCL 2,448 1,622 51%KOHC 2,343 1,566 50%FCCL 2,298 971 137%LUCK 2,126 1,599 33%CHCC 1,947 873 123%MLCF 1,915 1,006 90%POIC 1,876 1,357 38%APCL 1,707 1,087 57%


Sector: Market share comparison

1HFY13 1HFY12 Growth LUCK 18% 19% -0.3%DGKC 12% 13% -0.4%BWCL 10% 10% 0.0%FCCL 8% 7% 1.2%MLCF 8% 8% -0.1%KOHC 5% 5% 0.4%ACPL 5% 6% -0.5%PIOC 4% 3% 0.4%CHCC 3% 3% 0.0%


Industry Capacity Utilization

Source: APCMA, Topline Research

50%

75%

100%

0

20

40

60

FY

02

FY

03

FY

04

FY

05

FY

06

FY

07

FY

08

FY

09

FY

10

FY

11

FY

12

Dispatches

Installed Capacity

Capacity Utilization (RHS)

(


Strong cash generation to reduce debt

Pakistan cement sector recent recovery comes from i) sector’s consensus on pricing, ii) reduced coal prices and iii) substantial reduction in interest rates. Cement prices, which slumped to around Rs265 per bag in mid FY10, averaged around Rs452 per bag in FY13YTD (up 9% YoY). On the cost front, average coal prices during FY13YTD stood at US$89.7 per ton, down 23% from US$116.7 in the same period last year. Adjusting for PKR depreciation coal prices are down 16% in PKR terms. The factors bode well for sectors profitability and ensuing improved cash position.

Thanks to better sector dynamics, FCCL in 1HFY13 generated EBITDA of Rs2.8bn against Rs936mn in the same period last year, up nearly 2-times. This compares favorably with growth of 63% by its peer. Going forward, we believe FCCL will generate EBITDA of Rs6.3bn in FY13, which will be 63% higher than Rs3.9bn generated in FY12. Company’s interest coverage ratio is expected to improve to 3.2x in FY13 as against 1.5x FY12.

This strong cash generation ability will enable FCCL to pay off its debt ahead of schedule. As per December 2012 accounts, FCCL’s debt stood at Rs11.9bn, of which appox. Rs5bn is local (weighted average rate of KIBOR + 200bps) and residual is foreign (6-month LIBOR+80bps). We think that company with no major capex planned in the near term will take advantage of its healthy cash position by swiftly deleveraging its balance sheet. Thus, we expect company’s debt to equity ratio that stood at 58:42 and 49:51 by the end of FY11 & FY12 to improve to 45:55 at end of FY13.

In addition to improve margin scenario, 450bps cut in the policy rate from July 2011 has also positively affected its profitability. As per our calculations, 1pps decline in interest rate improves company’s earnings by 2%. We expect financial charges to decline by 15% in FY13 and 36% in FY14.

Reported profits substantially lower than cash profit

Benefit of deferred tax is another area that will positively impact the cash flows of the company. Accelerated depreciation for tax purposes on capex of Rs21.6bn for the new plant will lower tax income as against accounting income, providing it tax shield (deferred tax advantage). The same is evident from 1HFY13 result, when company paid cash of Rs37mn as against the reported tax of Rs445mn. Though, temporary in nature, the reported earning understates the cash generation of the company due to this phenomenon. Furthermore, higher depreciation due to commissioning of new facility is another factor that understates the cash generation ability of the company.

Dividend surprise cannot be ruled out

Cement companies are best known as misers when it comes to dividend payout. While FCCL on the other hand, belongs to a group (Fauji Foundation) whose companies are renowned for paying exceptional dividends to their respective shareholders. FCCL last time paid Rs373mn (Rs0.30 per share) in dividends to its shareholders in FY06. Post FY06 the company has been holding its payout back as it had incurred heavy investment on its new cement line.

Though the company is likely to focus on debt retirement but our calculation suggest that it has the potential to surprise investors with dividend announcement. We estimate Rs0.5 cash dividend in FY13, however substantial improvement is expect in FY16 and onwards once it retires majority of its debt.

FCCL: EBITDA and margins


0%

15%

30%

45%

0

3

6

9

FY

11A

FY

12A

FY

13E

FY

14F

FY

15F

EBITDA (LHS) EBITDA margin

(Rs bn)

FCCL: Interest coverage ratio


5.7

1.5

3.2

5.6

7.7

0

2

4

6

8

10

FY

11A

FY

12A

FY

13E

FY

14F

FY

15F

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Major Risks

Cement price consensus

Price sustainability has always proven to be Achilles’ heel for Pakistan Cement Sector. Margins of the sector are much dependent on price sustainability, with FCCL no exemption. Thus, fear of a price war is the major concern in the eyes of investors. Furthermore, given FCCL high operating and financial leverage, the company is highly susceptible to fall in price.

We downplay any immediate threat to decline in cement price with our conviction coming from higher capacity utilization. Sector’s capacity utilization stood at 73% in FY12 and is likely to improve to 76% in FY13. Assuming 4% growth in sales, industry capacity utilization is expected to reach 85% by FY16 which is equivalent to the level seen in boom period. It is pertinent to note, effective capacity utilization of the sector (excluding non-operational old plants) was realized at 77% in FY12, and is going to reach 80% in FY13 we believe.

The accompanied table shows sensitivity of FCCL’s earning with reduction in retention prices.

Rupee Devaluation to add additional financial burden

Over the last 5-years, PKR has shed 7% a year of its worth against the greenback. With heavy chunk (55%) of its total debt US$ denominated, PKR depreciation and its implication is another area of concerns. We have assumed 7% in FY13 and 5% in FY14 in our earnings projections.

Furthermore, 1% PKR deprecation against the greenback erodes Rs0.02-0.03 per share from our earning projections.

Large float

During the 2QFY13, the parent company Fauji Foundation offloaded nearly 330mn shares (25% of capital) in the market. Resultantly, size of FCCL’s free float has now increased to 732mn shares (55% of capital), and consequently has become a hindrance to FCCL’s swift upward share price movement. Though, this share supply is a risk in any major price rally however it has increased turnover in the local bourse, which bodes well investors seeking actively traded shares.

FCCL: Earning sensitivity to cement price

FY13 FY14

Base Case 1.7 2.1

5% reduction 1.3 1.7

7.5% reduction 1.2 1.5

10% reduction 1.1 1.3


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FCCL: Financial Snapshot

Fauji Cement Company Limited: Income Statement

(Rs bn) FY11A FY12A FY13E FY14F FY15F

Net Sales 4.7 11.5 16.2 17.1 18.2

Gross Profit 0.8 3.1 5.5 6.0 6.3

Selling & Admin Exp. 0.1 0.1 0.1 0.2 0.2

EBITDA 1.0 3.9 6.1 6.6 6.8

Finance Cost 0.1 1.8 1.5 1.0 0.7

PBT 0.5 1.0 3.5 4.5 4.9

PAT 0.4 0.4 2.2 2.9 3.1

EPS (Rs) 0.3 0.3 1.7 2.1 2.3


Fauji Cement Company Limited: Balance Sheet


Non-current Assets 27.4 26.5 26.1 25.6 25.1

Current Assets 4.8 4.2 6.1 5.9 5.6

Total Assets 32.2 30.7 32.2 31.5 30.7

Equity 11.0 13.9 15.4 17.3 19.1

Non-current Liabilities 15.8 11.3 10.2 7.4 4.6

Current Liabilities 5.4 5.5 6.6 6.8 7.0

Total Equity and Liabilities 32.2 30.7 32.2 31.5 30.7


Fauji Cement Company Limited: Key Ratios


EPS (Rs) 0.3 0.3 1.7 2.1 2.3

Earnings Growth (%) 66% -11% NM 29% 10%

Revenue Growth (%) 25% 143% 41% 6% 6%

Gross margins (%) 17% 27% 34% 35% 35%

EBITDA margins (%) 21% 34% 38% 39% 37%

Net margins (%) 8% 3% 14% 17% 17%

EBITDA/Ton (Rs) 907 1,811 2,342 2,427 2,402

EV/Ton (US$) 86 73 65 58 52

EV/EBITDA (x) 23.5 6.0 3.8 3.5 3.4

Interest Coverage (x) 5.7 1.5 3.4 5.4 7.4

ROE (%) 3% 3% 14% 17% 16%

ROA (%) 1% 1% 7% 9% 10%

Debt to Equity 1.4 1.0 0.8 0.6 0.4


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Mr. Mohammed Sohail CEO Dir: +92 (21) 35303333-4 [email protected]

Research Team:

Mr. Nauman Khan Head of Research Dir: +92 (21) 353033346 [email protected]

Mr. Asad I. Siddiqui Research Analyst +92 (21) 35303330-2 Ext: 140 [email protected]

Mr. Zeeshan Afzal Research Analyst +92 (21) 35303330-2 Ext: 125 [email protected]

Mr. Uzair Ahmed Research Officer +92 (21) 35303330-2 [email protected]

Mr. Fahad Qasim Database Manager +92 (21) 35303330-2 Ext: 112 [email protected]

Equity Sales Team:

Mr. M. Rizwan Manager Equity Sales Dir: +92 (21) 35303337 [email protected]

Ms. Samar Iqbal Manager Equity Sales Dir: +92 (21) 35370799 [email protected]

Corporate Office:

306, Continental Trade Center,

Block 8, Main Clifton, Karachi,

Pakistan.

Phone +9221-35303330-2

Fax +9221-35303349

Analyst Certification

I, Asad I. Siddiqui, for the views expressed in this report certify that all the views about the subject matter are accurate

depiction of my personal view and no part of my compensation or any other benefits, was in/will be, directly or in

indirectly, related to the specific recommendation expressed in this report. Furthermore, I do not hold any beneficial

holding in the scrip.

CONTACT US

This report has been prepared for information purposes by the Research Department of Topline Securities. The information on which this report is based are obtained from sources which Topline Research believe to be reliable but we do not guarantee that it is accurate or complete. In particular, the report takes no account of the investment objectives, financial situation and particular needs of investors who should seek further professional advice or rely upon their own judgment and acumen before making any investment. This report should also not be considered as a reflection on the concerned company’s management and its performances or ability, or appreciation or criticism, as to the affairs or operations of such company or institution. Warning: This report may not be reproduced, distributed or published by any person for any purpose whatsoever. Action will be taken for unauthorized reproduction, distribution or publication.

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