AFGHANISTAN: Existing units' expansion plans pose risk of price war

Injection of additional capacity by way of expansion plans of existing units pose a risk of a price war within the industry. As per analysis of Yawar-uz-Zaman, head of Capital Market in Aba Ali Habib Securities, country already holds surplus capacity of 10 million tons that is 23 percent of its total capacity which could increase to 46.5 million tons. 

Untapped capacity couple with additional capacity arising from upcoming expansion plans would be a threat for industry price arrangement. As a result, profitability of small cement makers is expected to shrink after initiation of price war in the industry. As local demand in the country increased by a meagre CAGR of two percent in the last 5 years, cement price in the domestic market swelled up by 150 percent during the period under review. Consequently, sector gross profit margins have also improved to 33 percent from 19 percent in the same period. Going ahead, if distortion occurs in the industry's price arrangement, we foresee key players like (LPCL, LUCK, MLCF, FECTC, and FCCL) will have to face the margins contraction as their respective DOL are higher than other players. Hence, downgrade our outlook on sector from Positive to Neutral. 

Moreover, he said that DG Khan is one of the largest and leading cement producers, plan to increase its capacity to meet increased demand in the country through either expansion plans or acquisitions. As being intended to increase its capacity, DGKC sets eye on Lafarge buyout. However after takeover by Bestway, DGKC likely to pursue expansion plans in Hub, Balochistan. In the last 5 years DGKC plant has been utilising 96 percent of its capacity, with healthy cash flow and expected rise in cement demand in the country, company likely to continue its expansion plan of 2.6 million tons which is expected to be online in FY17. Currently, southern region of the country is equipped with 7-8 million tons of capacity where plants utilisation level is also higher than the other region. Moreover with export potential through sea, the regions also have strong demand potentials. 

Likewise DGKC, Cherat Cement also publicised to enhance its capacity to 2 to 2.5x million from 1.1 million tons (up 100 percent) last year. However, company's largest export market, ie Afghanistan discerns excess supply from the neighbouring Iranian cement market with comparative low price. Therefore, export to Afghanistan has declined 16 percent YoY in FY14, which pose less attraction for the company to go with its expansion plan. Currently, CHCC is exploiting 92 percent of its capacity with sales mix of local and export stand at 65:35 respectively. 

Zaman concluded that if DGKC go with its expansion in the southern region, it would take 1.5 to 2 years to bring its capacity online. Whereas, other strong players in the south market (LUCK and ACPL) might not seen the event positively. Therefore, industry price arrangement would be in doldrums in the upcoming years. Meanwhile, DGKC might issue right shares in the outgoing years to fund its expansion plan, which could restrict healthy dividend payout in FY15. Hence, downgrade our outlook on sector from Positive to Neutral.