KARACHI, Nov 8: Cement sector has turned the underdog of the stock market. The fact that only a couple of months ago for the financial year ended June 30, 2006 cement sales had touched 18.4 million tons - the highest dispatches made by the cement industry in its history — seems almost a distant dream.

Hefty demand, sky-high prices and low capacity (utilisation) enabled cement companies to roll in gold. And expectations remained high. The industry drummed up no end to the party, on the back of great expectations of reconstruction of earthquake-hit areas, imminent construction of big dams and the hefty allocation of Rs415 billion under PSDP by the government for the current year.

For the first quarter of the current year (July-Sept 2006), profitability of cement companies nose-dived by 34 per cent and stood at Rs1.89 billion, compared to Rs2.67 billion in the corresponding period of the previous year. There could be several reasons for the turn of fortune of the cement industry, but on top of it all stands perhaps the break-up of the ‘cartel.’

The capacity utilisation quota for each cement company and consensus over what should be the minimum sale price per bag, produced fabulous profits for the cement companies for several years.

The government may espouse the main reason for the sharp decline in cement sales prices to its opening up of imports and allocation of Rs720 million in the budget for FY07 for providing freight subsidy at Rs60 per bag. But that did the industry little damage.

Earlier for the FY06, the cement sector’s profitability had grown by a whopping 51 per cent compared to the previous year. Total profit stood at Rs11.9bn compared to a year ago earnings at Rs7.9bn.

Analysts thought that the reasons for the remarkable growth were twofold: volumetric growth in sales with higher ex-factory and thus improved retention prices, which led to unprecedented increase in gross margins from 30 per cent in FY05 to 38 per cent in FY06.

Khurram Shehzad, cement sector analyst at InvestCap, stated that profitability of cement companies in 1QFY07 had dipped due to two major reasons. Firstly, despite remarkable growth in volumes, the ex-factory and retention prices had slipped badly.

Secondly, higher cost of sales and financial charges also led to decline in earnings. The break-up of cartel, resulted in free-for-all, both in respect of capacity utilisation and offered prices. The price war amongst producers resulted in decrease in average retention price per ton from Rs3,580 to Rs3,036 year-on-year.

Financial charges for the sector skyrocketed by 79 per cent in 1QFY07 due to high financial leverage as well as higher interest rates.

Atif Malik, analyst at JS Capital Markets, observed that cumulative profitability of sample companies in 1QFY07 stood at Rs1.94bn ($32m), depicting a decline of 32 per cent over 1QFY06 combined profits of Rs2.86bn ($47m). Net sales grew by 16pc mainly due to rise in cement sales volume, whereas, gross profits depicted a decline of 10pc on the back of lower retention prices by the manufacturers.

In 1QFY07, with new capacities piling up, price war situation prevailed in the market which led to the lower retention prices by the manufacturers. Gross margins also plunged as they stood at 30pc, down by 900bps over 1QFY06 gross margins of 39pc.

On per ton basis, net retention price of sample companies in 1QFY07 worked out at Rs3,565 per ton, 1pc lower than that of previous fiscal. On the other hand, cost of sales rose by 13pc to Rs2,500 per ton from Rs2,217 per ton. Thus, with falling retention prices and increased cost of manufacturing, gross profits depicted a healthy decline of 24pc to stand at Rs1,064 per ton versus Rs1,398 per ton last year.

Navin Ali, analyst at BMA Capital, stated that going forward he expected total installed production capacity to rise to 33m tons by the end of FY07 against expected total demand of 21.5m tons in 1QFY07.

That was believed to be primarily due to weakening cement prices which had gone down as low as Rs150 per bag at retail level in some parts of the country. Consequently gross profit margins for industry giants fell by an average of 400bps.

Zuhair Abbasi and Umer Bin Ayaz analysts at Capital One Equities held a bleak prognosis for the industry. They stated that no improvement could be expected in the short run. Export potential was going to be the chief contributor to companies’ sales performances as the higher export margins would play a vital role in offsetting the negative impact on gross margins.