AFTER a gap of two years, mergers and acquisition activity looks likely to kick off in the cement sector. Anhui Conch Cement Company Limited—the largest cement manufacturer in China, searching for a business opportunity in the high-growth sector, appears to have set its eyes upon Dewan Cement Limited.

There is as yet no official word on the matter but the the stock market is rife with rumours, and a sudden jump in trading volume of second-tier Dewan Cement Limited (DCL) stock suggests that some people know what others don’t. A source close to the company declined to confirm or deny the possibility of a takeover bid.

Stock brokerage firm, Insight Securities, in an Aug 10 report mentioned the rumours surrounding DCL’s acquisition and arrived at the DCL stock’s per share value at Rs22.3, based on the previous acquisition of Lafarge Cement by Bestway Cement in July 2014.

A cement sector analyst said that DCL production facilities operate at a capacity utilisation of 64pc, which was why DCL’s gross margins were just 14pc, dropping way below the industry average of 40pc

The closing price of DCL stock on Wednesday last was Rs16.50; the stock having already appreciated by 27.5pc in 2016. To-date, analysts reckoned that further performance was subject to material progress on the company’s debts restructuring deal.

DCL, a Yousuf Dewan company, has fallen upon bad times. Analysts point out: “Following liquidity problems, DCL has defaulted on its loan obligations and suits have been filed for the recovery of Rs7.2bn. Eight out of 32 lenders have also filed winding up petitions against the company. DCL is contending the litigations and is also in talks to restructure the debt. There is a glimmer of hope, however, as DCL has already restructured 30pc of its debts amounting to Rs2.05bn”.

Dewan Cement itself emerged on the scene through the acquisition of Pakland Cement Limited and Saadi Cement Limited, which have a combined capacity of more than 2.9m tonnes per annum. The plant of what was formerly Pakland, is located in district Malir, Karachi, while the Saadi Cement plant is in Kamilpur, near Hattar in Khyber Pakhtunkhwa.

A cement sector analyst said that the DCL production facilities operate at a capacity utilisation of 64pc, which was why DCL’s gross margins were just 14pc, dropping way below the industry average of 40pc. Lower margins of DCL were attributed to above average fuel and power costs, mainly due to the non-availability of Waste Heat Recovery Plant (WHRO) and Captive Power Plant (CPP).

“For improvement, an approximate investment of Rs3 to Rs4bn in WHRP and CPP is required”, says a sector analyst. But another market watcher thought that the company’s 5MW WHRP, which was planned to go online in FY17, could face delays as the company was starved of cash.

Total assets of DCL on Mar 31, this year amounted to Rs25bn. Paid-up capital stood at Rs4.84bn in shares of Rs10 each. Market capitalisation worked out at Rs8bn.

According to the last available numbers, chairman of the board, Dewan Muhammad Yousuf Farooqui, held 140m shares of DCL which accounted for 32.3pc of the total 434.1m paid-up shares. Another 132m shares or 30.3pc were vested in five associated companies, while 140.6m, or 32.4pc, of the total outstanding shares were dispersed among 7,296 investing public.

The chairman stated in his third quarter directors’ report for March 31, 2016: “The economy of the country is improving on constructive macroeconomic indicators, improved law and order situation, lower inflation and interest rates which would increase the local demand of cement. Domestic sales will continue to increase due to public and private sector projects as well as the mega project CPEC.”

Analyst Faizan Ahmed at JS Global said that the company’s margins were disappointing. The improvement in performance was thought to be linked to material progress on the company’s debt restructuring deal. “Back of the envelope calculations suggest that the company will need approximately Rs9bn (and as per discussions with DCL management) to get back into the business where the company will have to make debt payments (principal + interest) of Rs1.6bn per annum”, he said.

Profit after tax (PAT) of DCL for 9MFY2016 amounted to Rs386m, up 19pc over PAT at Rs324m in 9MFY2015. As the gross margins crumbled to 13pc from 15pc, operating profit fell 3pc to Rs555m, from Rs574m. The situation was salvaged by a reduction in financial charges by 23pc and lower tax effect by 36pc.

According to the numbers released last week by the All Pakistan Cement Manufacturers’ Association (Apcma), cement dispatches for the month of July 16 continued to grow defying street expectation of a major fall.

Overall, the cement industry was all set to expand over the next few years due to the pricing power of cement producers. Capacity utilisation was likely to reach 96pc in FY2018. A major capacity addition of 19m tonne (42pc of current capacity), worth around Rs192bn, was in the pipeline during FY2017-FY2020.

“Despite these additions, we see no price war risk (among cement producers) as additional capacity will easily be absorbed due to buoyant cement demand”, said analyst Nabeel Khursheed at brokerage Topline Securities.

But he underlined key risks as massive imported cement, increase in government levies, rising political noise, higher than anticipated rise in gas tariff, volatility in coal prices and delay in construction projects.

Published in Dawn, Business & Finance weekly, August 15th, 2016