Lucky Cement is currently the biggest
cement manufacturer in Pakistan.
It is primarily involved in the production and distribution of cement and
clinker and sells its produce in domestic and in foreign markets as well. The
company has two production facilities at Pezu, District Lakki Marwat in Khyber
Pakhtunkhwa and at Main Highway
in Karachi. Recently,
Lucky increased its production capacity massively and as a result the company
increased its production of clinker and cement in 2009 by 8.7% and 8.9%
respectively. Due to this capacity expansion, the company achieved the position
of the largest cement exporter. The company has the highest export market share
of 30% and a 13% market share in the domestic market.
The cement industry profited immensely from
the construction boom that took place in Pakistan. However, in the past
couple of years due to the economic recession, the demand for cement has
plummeted in Pakistan
and abroad as well. This has led to fall in cement prices which had an adverse
impact on all the companies in the cement industry. Lucky, although not
unscathed by the recession, has performed considerably well compared with the
average firm in the industry.
Profitability
The profitability of the company fell
considerably during the past couple of years. The Net Profit Margin fell from
17.5% in 2009 to 13% in 2010 whereas the Return on Equity also fell from 19.8%
to 12.5%. However, this fall occurred due to fall in cement prices and increase
in input prices for example increase in the price of coal internationally. The
industry average for Net Profit Margin in 2010 was 1.4% which is considerably
lower than 13% of Lucky. One thing to be noted over here is that the sales
volume increased in 2010 but sales revenue fell because of lower selling
prices. This can be further proved by the fact that the Gross Profit Margin
fell from 37.3% to 32.6% in 2010. This fall in Gross Margin was the real reason
behind the decreased profitability of the company which as mentioned before was
brought about due to higher input costs and lower cement prices. This same
trend was observed with rest of the firms in the industry. Thus, this fall in
profitability is not unique to Lucky Cement.
Cost
Breakup
It is quite evident from the above
graph that in 2010, the bulk of the costs of the company are cost of sales and
distribution cost. Due to higher coal and petroleum prices, both of these costs
have gone up and have resulted in decreased profitability. Due to sensible debt
reduction policy, the finance costs have gone down. This cost breakup shows
that the company’s profitability and cost structure have been affected by
external factors and the firm is trying its best to operate efficiently in an
adverse economic environment.
Industry Comparison
RATIOS
|
LUCKY
|
INDUSTRY
|
Gross Profit Margin
|
32.60%
|
15.15%
|
Net Profit Margin
|
13%
|
1.40%
|
Return on Assets
|
8.19%
|
1%
|
Earnings per Share
|
Rs. 9.7
|
Rs. 2
|
Gearing Ratio
|
34.50%
|
50%
|
Current Ratio
|
0.713
|
0.67
|
Lucky’s comparison with the industry clearly shows that its profitability is far better compared to the average firm in the cement industry. This is clearly evident by the Gross and the Net Profit Margins. This improved profitability has also impacted the Earnings per share positively as well. Furthermore, we can also deduce from the gearing ratio that Lucky is far less leveraged compared to the other firms in the industry. This reduces the financial risk of Lucky as well which is certainly a desirable characteristic for any firm operating in a recessionary economic environment. As far as the liquidity is concerned, again the liquidity of Lucky is better than the industry average. Hence, this industry comparison clearly shows that Lucky is financially stronger than the average firm of the cement industry.
Liquidity
The liquidity position of the firm
deteriorated over the past several years. The quick ratio fell from 0.732 in
2009 to 0.65 in 2010. The current ratio of the company in 2010 was 0.713
whereas the industry average was 0.67 meaning that the firm’s liquidity
position was better than most of the other firms in the industry. A cause of
concern for the company was that the cash and bank balances fell by 68%.
However, this drop can be explained as the company repaid part of the long term
debt and paid cash dividends as well. A positive trend has taken place in 2010;
inventory turnover in days and average collection period both have decreased
whereas the payable days have increased. This may have a positive impact on the
company’s liquidity over time.
Debt
Management
The debt position of the firm has
improved dramatically. Lucky Cement repaid its part of its long term debt and
it reduced its long term debt by 61%. This can be proved by the Gearing and
Interest Coverage ratios as well. The Gearing ratio fell from 39.4% to 34.5%
whereas the Interest Coverage ratio improved from 5.83 to 7.45 times. Thus, the
firm’s debt servicing ability has improved. I believe that this debt reduction
is an extremely sensible step by the company. In today’s recessionary
environment, it is better to reduce one’s debt in order to prevent the profits
being eaten up by the fixed finance costs. Such a measure also reduces the
risks of bankruptcy.
Asset
Management
Lucky Cement’s inventory turnover in
days has decreased from 26 days in 2009 to 13 days in 2010 which is a positive
sign. However, as I mentioned before, Lucky Cement’s sales volume increased in
2010 but due to low cement prices, its total sales revenue fell compared to the
previous periods. So, higher inventory turnover did not lead to higher profits.
The average collection period fell from 18 days in 2009 to 12 days in 2010,
which will have a positive impact on the company’s cash flow. Total Asset
Turnover, on the other hand, fell from 0.6858 to 0.6397 in 2010. However, this
was expected because of lower cement prices. This does not mean that the firm
is not using its total assets efficiently.
Market
Value
The Earnings per Share of Lucky
decreased in 2010 because of reduced profits. Before 2010, the company’s EPS
was continuously increasing. This shows that the company has the potential to
increase its profits significantly given favorable economic conditions. The company paid a cash dividend of Rs.
1,294,000,000 in 2010 which is a massive dividend considering the economic
environment. Thus, the dividend payout ratio was about 41%. This shows the
level of confidence the company has in its future prospects. The company was
not only able to convey a sense of confidence to its shareholders by paying
such a big amount as dividend during a recession but was also able to cleverly
increase its return on equity as dividends are paid out of Retained Earnings
and they thus reduce the overall equity of a firm.
No doubt the market was also optimistic about
the company’s future as the market price of Lucky Cement’s share rose from Rs.
72.2 to around Rs. 74 just in the month of November 2010. Furthermore, the Book
value per share of the company rose from Rs. 71.9 to Rs. 77.6 in 2010. As the
book value per share is around the same value as that of the company’s share
price, it means that the existing shareholders may not incur huge losses in the
case of a bankruptcy which is highly unlikely in the first place.
Future
Expectations
The above analysis has proved that the
company’s financial performance has been adversely affected by external factors
such as lower cement prices and not by the company’s policies. On the contrary,
Lucky has tried its best to decrease its costs and increase its profits. The
retirement of debt in order to decrease finance costs was just such a strategy.
The company has been able to perform well above average compared to the other
firms in the industry which had to incur losses over the past several years. As
the company’s fundamentals are strong, I believe that the company will be able
to perform far better in the coming years. The recovery of the global economy
will boost the company’s exports and the reconstruction of houses of the flood
affected people of Pakistan
will lead to a surge in local demand as well. All these activities will augur
well for the cement industry and even more so for Lucky Cement as it is the
largest cement manufacturer in Pakistan.
Recommendation
In the end, the question comes down to
the fact that whether we should purchase the shares of Lucky or if we already
own its shares, should we sell them? My recommendation is that those people who
already own its shares should definitely not sell them. With share price
relatively equal to the book value per share, I believe that the company has
got a lot of potential to bounce back to its previously strong financial
position and increase its share price given a change in the economic
environment in which it is operating right now. This is not unlikely with the
regional economies around Pakistan growing far stronger compared to the western
economies which will lead to a boost in cement exports of the company to
countries like India, Iran, Afghanistan and other Central Asian states.
Those people who are contemplating
buying the company’s shares, I would recommend them that this is the prime time
to purchase the company’s shares while they have not achieved their true
potential. Obviously, there are risks in this investment but as they say there
is no gain without pain. Hence, my recommendation is that Lucky’s shares should
be purchased and those who already own them should not sell them.
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