DGKC: Improving margins to further drive upside

Morning Shout Pakistan Daily Notes DGKC: Improving margins to further drive upside; Buy!
We reiterate Buy on DGKC with a 37% higher PO of PRs148 (34% upside), as we lift our earnings for FY15‐18E by 3‐19%. Key reasons for estimate changes are: (1) higher expected 4yr sales CAGR of 5%, (2) incorporating 30MW power plant, (3) lower risk‐free rate assumption, and (4) the valuation roll‐over.
We draw greater comfort for sustainability of GP margins (currently at 38%) from an easing energy cost scenario (net effect of lower power tariff and higher gas tariff is positive). Persistently declining coal prices, lower expected inflation and robust sales trend strengthens our view.
The 30MW coal power plant is expected to come online by FY17; we expect the project to augment earnings by PRs2.24/2.29 in FY17/18E.
We believe expansion by DGKC is inevitable with announcement of upto 2.5mn ton plan in 2H15, though we flag that a capital call is highly unlikely given growing free cash flows. Upgrading PO to PRs148/sh; reiterate Buy! We are upgrading our PO for DG Khan Cement (DGKC) by 37% from PRs108 to PRs148 (34% upside), on lifting our earnings for FY15‐18E by 3‐19%. Key reasons for our estimate changes include (1) upward revision of local cement off‐take, now expected to grow at a 4‐year CAGR of 5% over FY15‐18E compared to 3% previously; (2) incorporation of 30MW pulverized coal based power plant expected to come online in FY17; (3) downward revision of risk free rate assumption from 11% to 10%; and (4) the valuation roll‐over. Softer energy costs lead comfort on margins We have gained more comfort on the sustainability of DGKC’s gross margins (38% on cash‐basis in 1QFY15) going forward, mainly on the back of easing energy cost scenario industry wide. In our view – falling coal prices, lower expected inflation, lower transportation cost and robust local off‐take trend ‐ will keep margins strong despite another expected PRs5‐10/bag cut in cement prices. Coal prices have come off by 21%YoY in 1HFY15, followed by 8%QoQ decline in 2QFY15; we expect the trend to persist near term. The recent PRs2.97/KWh cut in electricity tariff could potentially augment earnings by 2%/4% in FY15/16E. However, this will likely be offset by the subsequent proposed gas tariff hike as DGKC is 40% reliant on gas for its energy needs. Incorporating a 15% gas price hike on the current gas price (base tariff and GIDC) and a PRs2.37/KWh effective cut in power tariff (including PRs0.60/KWh fuel surcharge); we estimate 1% higher earnings in FY15/16E. 30MW Coal power plant to provide significant upside 31 December 2014
Mohammad Ali Amin [email protected] KASB Securities Limited +92 21 111 222 000 D. G. Khan Cement Co. Current Price PRs110.65 Price Objective PRs148.00 Reuters DGKH.KA Bloomberg DGKC.PA Shares Outstanding 438.12mn Market Cap PRs48478mn (USD481.84mn) DGKC – Valuation Snapshot 2014A 2015E 2016E
13.62 14.38 14.90
8.4 5.6 3.6
8.1 7.7 7.4
0.8 0.7 0.7
3.5 3.5 3.5
3.2 3.2 3.2
11% 10% 9%
9% 8% 8%
2.91 2.38 2.38
EPS (PkR) Eps Growth (%) PE(X) PBV (X) DPS (PkR) DY (%) ROE (%) ROA (%) EV/Ebitda (X) Source: KASB Research DGKC – Portfolio Break‐down (%) DGKC is actively working towards setting up of 30MW coal‐power plant, expected to cater to about 45% of their power requirement. L/C for import of equipment from China has been established, and the plant is expected to come online in FY17. On incorporating the coal‐power plant in our estimates, and assuming a power mix of 45%/40%/15% from coal/gas/WHR respectively, we expect the project to augment earnings by PRs2.24/2.29 in FY17/18E. Given the successful completion of this project, the company is eyeing another similar project to (1) reduce its dependence on expensive grid energy, and (2) eliminate inefficiencies arising from poor gas supply in Punjab. NCL, 0.8%
NML, 10.2
%
AICL, 1.4%
MCB, 87.7
%
Expansion announcement expected in FY15; but capital call highly unlikely The company is expected this year to announce its 2.5mntpa cement expansion project in Hub region (South), with the L/C opening target delayed to Mar‐15 from Dec‐14 earlier. The company was initially negotiating an arrangement with K‐Electric Limited (KEL) to service their power requirement for this project. However, given the high cost of infrastructure for the above mentioned arrangement, DGKC is now exploring other options to furnish its power Refer to important disclosures on page 3 Source: KASB Research Page 1
morning shout requirement at the proposed plant site, which has resulted in a delay in the expansion announcement. Civil work at plant site has already begun, and the plant will be procured from a European supplier FLSmidth. We flag that a capital call by DGKC is highly unlikely given (1) the company’s strong cash balance (PRs1.3bn as of FY14), and (2) expected cumulative free cash flow of about PRs14bn over the next three years. KSE‐100 Intra‐day Movement 32,050
31,950
Diversification continues to strengthen DGKC has a portfolio value (based on market value) of PRs80.5/sh. The company holds 102mn shares of MCB, comprising 88% of its total portfolio, while other associat ed investments include NML/NCL/AICL contributing 10%/1%/1% to the total portfolio. The company has announced further investment of PRs450mn in AICL in FY15, translating into about 9mn shares of the AICL. The aforementioned investments have led DGKC to realize healthy dividend income of PRs2.7/sh/PRs3/sh in FY13/14. With further diversification planned in the form of about PRs3bn investment in paper, dairy and real‐estate businesses over FY15‐17, we expect healthy increase in DGKC’s non‐core income, going forward. Valuations are still attractive despite recent run‐up DGKC is currently trading at a 37% premium to the market value of its portfolio, as compared to a mere 3% discount as of year‐end FY14. Our DCF based valuation suggest DGKC’s core operations alone to have a value of PRs95/sh, which has partly started reflecting in the stock price now owing to (1) delay in expansion announcement, which had caused the market to overplay the risk to industry’s price mechanism, and (2) low likelihood of a rights issue. We are eyeing further upside in the stock, which currently trades at an FY16 P/E of 7.4, at a 14% discount to KASB Cement universe. 31,900
31,850
31,800
31,750
31,700
KSE30 KSE100 KSE All Share EFOODS ENGRO MLCF OGDC DGKC Close % Chg 20,708.13 ‐0.1% 31,953.90 0.1% Vol. US$ mn 74.72 102.99 23,224.43 110.15 219.57 44.02 205.00 110.65 116.32 10.07 9.46 8.90 4.93 4.65 0.3% 4.7% ‐0.1% 1.2% ‐2.2% 0.1% Source: KSE KSE‐100: Top Gainers & Losers MUREB
Technical View Ahmed Hanif [email protected] KSE‐100: Formation in both short & long term charts is bullish PAKT
NATF
PKGS
RMPL
The index witnessed another range bound session where it tested its 20DMA and closed above that level. GLAXO
The overall formation of the index in both short term and long term charts is looking bullish and the index could retest its all‐time high of 32,315 and then 33,500‐33,600 area ultimately. ABOT
POL
As mentioned in the earlier reports that as long as the index is trading above 30,640, it could trade in a bullish mode. However, an intraday breakage of 30,500 could break the bullish trend and the index could then undergo a corrective phase. ARPL
It is recommended to accumulate buy positions on weakness with risk defined below 30,500. SEARL
12:18 1:42 PM 3:05 PM
PM
Source: KSE Index Data & Volume Leaders
Sales tax on four POL items increased by 5% (BR) FBR) has increased sales tax by 5% from 17% to 22% on the import and local supply of four petroleum products, including motor gasoline including petrol and HOBC, kerosene oil, light diesel oil (LDO) and high speed diesel (HSD) from January 1, 2015. FBR has not increased sales tax from 17% to 22% on the import and supply of furnace oil and jet fuel. Low 31,765
9:29 AM 10:54
AM
Morning News `
Hi gh 31,989
32,000
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‐4%
‐2%
0%
2%
4%
6%
Source: KSE
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morning shout World Markets and Commodity Prices International Equity Markets Asian Markets (Closing Rates)
Price All Ordinaries Shanghai Composite Hang Seng BSE 30 Jakarta Composite KLSE Composite Nikkei 225 NZSE 50 Straits Times Seoul Composite Taiwan Weighted KSE‐100 Index European Markets (Last Trading Session’s Rates)
Price Abs. Chg.
% Chg.
Abs. Chg.
5,392.33 3,165.81 23,501.10 27,403.54 5,226.95 1,766.83 17,450.77 5,577.20 3,366.11 1,915.59 9,268.43 31,953.90 ‐54.6 ‐2.2 ‐272.1 7.8 48.6 ‐1.6 ‐279.1 ‐15.1 ‐1.6 ‐12.3 ‐17.9 47.2 ‐1.00 ‐0.07 ‐1.14 0.03 0.94 ‐0.09 ‐1.57 ‐0.27 ‐0.05 ‐0.64 ‐0.19 0.15 ATX BEL‐20 CAC 40 DAX AEX General Swiss Market FTSE 100 % Chg.
2,160.08 3,276.41 4,245.54 9,805.55 421.59 8,983.37 6,547.00 ‐14.6 ‐38.7 ‐72.4 ‐121.6 ‐5.3 ‐51.2 ‐86.5 ‐0.7 ‐1.2 ‐1.7 ‐1.2 ‐1.2 ‐0.6 ‐1.3 17,983.07 4,777.44 4,282.35 2,080.35 ‐55.2 ‐29.5 ‐30.3 ‐10.2 ‐0.3 ‐0.6 ‐0.7 ‐0.5 American Markets Dow Jones Ind. Average NASDAQ Composite NASDAQ ‐100 S&P 500 Index, RTH Source: Bloomberg Foreign Portfolio Investment in Equities Country Day (US$mn) Pakistan India Indonesia Japan Philippines South Korea Sri Lanka Taiwan Thailand Vietnam Abu Dhabi Qatar WTD (US$mn)
1.5 (34.3) 201.1 N.A (4.6) (80.3) 1.2 74.9 (4.5) 4.3 (7.0) (4.7) MTD (US$mn)
2.4 (34.3) 194.3 (3,240.2) (4.6) (174.9) 1.6 422.4 23.6 8.9 3.2 (20.9) YTD (US$mn) 12M (US$mn)
(45.8) (248.7) (634.3) 1,742.1 (128.3) (1,963.9) 12.2 (1,380.3) (842.9) (0.8) (100.4) (36.0) 386.2 16,030.0 3,766.1 22,519.1 1,256.1 5,683.8 158.6 13,115.8 (1,091.4) 131.0 979.2 120.1 382.3 16,074.3 3,766.1 27,193.4 1,256.1 5,683.8 158.6 13,115.8 (1,091.4) 131.0 979.2 2,452.2 Date
30‐12 29‐12 30‐12 19‐12 29‐12 30‐12 30‐12 30‐12 30‐12 30‐12 30‐12 30‐12 Source: Bloomberg, NCCPL Forex and Money Market snapshot 6‐Month KIBOR (Offer) 12‐M T‐Bill (Average) 10‐ year PIB (Average) PkR/ US$ Source: KASB Money Market Current Previous Chg. 9.64 9.38 10.93 100.94 9.63 9.38 10.93 101.03 0.01 0.00 0.00 ‐0.09 Commodity Prices Price WTI (Crude Oil) Gold CRB Index Source: Bloomberg 54.12 1,200.55 233.48 Abs. Chg. % Chg. 0.51 17.26 0.24 1.0 1.5 0.1 KASB Securities Limited, 5th Floor, Trade Centre, I.I. Chundrigar Road, Karachi This report has been prepared by KASB Securities Ltd. and is provided for information purposes only. Under no circumstances is to be used or considered as an offer to sell or solicitation of
any offer to buy. While all reasonable care has been taken to ensure that the information contained therein is not untrue or misleading at the time of publication, we make no representation as to its accuracy or completeness and it should not be relied upon as such. From time to time KASB Securities Ltd. and any of its officers or directors may, to the extent permitted by law, have a position, or otherwise be interested in any transaction, in any securities directly or indirectly subject of this report. This report is provided solely for the
information of professional advisers who are expected to make their own investment decisions without undue reliance on this report and the company accepts no responsibility whatsoever for any direct or indirect consequential loss arising from any use of this report or its contents. In particular, the report takes no accounts of the investment objectives, financial situation and particular need of individuals, who should seek further advice before making any investment. This report may not be reproduced, distributed or published by any recipient for any purpose. The views expressed in this document are those of the KASB Securities & Economic Research Department and do not necessarily reflect those of KASB or its directors. KASB, as a full‐service firm, has or may have business relationships, including investment‐banking relationships, with the companies in this report. Page 3

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