Cement: FED reduction likely in FY12 Budget

In the wake of rising energy cost and lower dispatches especially after floods, government is expected to bring some relief to the sector in the upcoming budget FY12. As per news reports, the steps include likely reduction in federal excise duty (FED) by Rs200 per ton or Rs10 per bag which would straightly improve retention prices. Furthermore, higher utilization of development expenditure would reflect positively on local dispatches. In this report we present the expected measures for cement sector along with its impact on Lucky Cement and DG Khan Cement. We expect the upcoming budget to be Neutral to Positive for the sector.

§ In the upcoming budget government is most likely to reduce federal excise duty (FED) to Rs500 per ton (25 per bag) compared to current Rs700 per ton (Rs35 per bag).

We expect PSDP (Public Sector Development Project) allocation to be at Rs610bn (federal and provinces) as against Rs663bn last year. However, the actual allocation is expected to remain higher on the back of better fiscal discipline.

We believe govt. most likely to continue with recently imposed 1.5% additional Special Excise Duty (SED) to 2.5% on cement in next fiscal year FY12.

The reduction in FED would improve the net retention prices by Rs10 per bag hence would provide cushion to the sector’s rising conversion and energy cost.

Despite reduction in PSDP target, actual utilization in FY12 is expected to remain better compared to FY11 due to better fiscal space. This would allow the government to spend on high cement usage areas like small reservoirs and dams (Daimer-Bhasha) thus bode positive for the entire cement sector.

SED is a pass though item and hence neutral for the sector.

The likely reduction in the FED in the upcoming budget is expected to augment sector’s profitability as companies would not pass on the cost reduction to the final consumer amid strict price discipline. We believe this would bode well for companies having larger local share in their sales mix like DGKC (local sales 68%). As per our estimates, the step would enhance DGKC FY12F earnings by Rs0.94/share, while LUCK earnings would augment by Rs1.55/share.

In addition to strict price discipline adopted by cement producers ( North Rs400 per bag and South 380 per bag), higher utilization of PSDP is expected to yield positively on sector’s volumetric sales.. However, on the export front oversupply scenario in Middle East would continue to restrict growth in export sales.

We remain ‘Over-weight’ on cement sector with DG Khan (DGKC) and Lucky Cement (LUCK) as our preferred play of the sector. DGKC is available at a massive 85% discount to replacement cost (US$120 per ton) with a strong portfolio value. While LUCK is available at attractive FY12F and FY13F PE multiple of 5.6x and 5.0x respectively. Thanks TLR