We initiate our coverage of Pioneer Cement (PIOC) with a Jun21 TP of PKR 87/sh, offering an upside 34% based on its last close of 64/sh. Our optimism towards the stock’s performance is underpinned upon: 1) recovering sector dynamics with anticipation of a recovery in demand, 2) timely capacity expansion to benefit from the anticipated recovery in sector dynamics, 3) improved pricing discipline amongst cement manufacturers likely resulting in a convergence between north and south prices. 4) planned installation of cost efficiency measures including coal-fired power plants and Waste-Heat Recovery boilers, 5) subdued energy prices to further complement said efficiency mechanisms, and 6) sharp monetary easing to bolster bottom-line and valuations amid a highly levered balance sheet.

Cement demand to pick up as catalysts align
Pakistan’s cement industry is expected to benefit from a sharp recovery in cement demand from FY21 onwards. We anticipate demand to recover by 8% in FY21 following FY20’s slump, then grow at a CAGR of 7%, onwards. Our recovery thesis is based on anticipation of high participation levels on the construction amnesty scheme and the commencement of government sponsored large-scale construction projects including Diamer Bhasha Dam and the Naya Pakistan Housing Scheme.

Expansion commences at an opportune time
Pioneer Cement has expanded its plant size by 124%, increasing its annual cement
production capacity to 4.55mn MT (6.5% of industry capacity). This well-timed
expansion sets the ground for PIOC to capitalize on the anticipated recovery in
cement demand. As such, we estimate PIOC’s revenues to grow at a 4yr CAGR of
36% to PKR 28.2bn by FY24.

Pricing equilibrium in the North a welcome development
Improving sector fundamentals are expected to push the industry’s demand supply dynamics towards equilibrium, likely revitalizing the sector’s pricing power. Note that during FY19 and 20, the industry in the northern region, where PIOC is also situated, witnessed a price-war in the midst of its expansionary cycle. Widening demand-supply gap resulted in a discord amongst cement manufacturers, causing domestic prices to plummet by 30% to a low of PKR 450/bag. Consequently, industry margins are expected to fall to a low of 7% in FY20 from their peak of 40% back in FY17.

Installation of efficiency technologies to further enhance margins
Presently, PIOC has a 12MW Waste Heat Recovery (WHR) Plant installed at its production facility. The WHR contributes around 35% of the production line’s electricity requirements and yields an estimated savings of PKR 781mn (EPS Impact: PKR 2.44/sh). Moreover, the newer production line is also expected to be installed with another 12MW WHR facility to support the company’s margins, taking cumulative WHR capacity to 24MW. Overall, we estimate the WHR plant to yield savings of PKR 1,421mn (EPS Impact: PKR 4.44).

Coal-power plant in the new line to offer cheapest electricity source
PIOC has also installed a 24MW coal-fired power plant to operate its new production line. Coal-fired power plants offer one of the cheapest electricity sources due to the relatively lower cost of procuring the commodity. Moreover, coal power plants also synergizes well with the cement industry due to an already establish supply network given that all cement companies utilize coal to fire their kilns. We estimate that the
installation of the coal power will likely yield an estimated savings of PKR 985mn (EPS Impact: PKR 3.08).

Subdued energy prices another boon for PIOC
The recent weakness exhibited by global commodity prices bodes well for the energy intensive cement sector. As mentioned, coal is the primary fuel for Pioneer Cement, firing both its production kiln and power plant. In tandem with global oil prices, coal prices also witnessed a slump during CY20, falling down from a peak of USD 90/MT witnessed in Jan20 to current levels of USD 60/MT. We estimate that for every USD 5
reduction in coal prices, kilning costs reduce by PKR 9/bag.

Monetary easing further aiding optimistic prospects
With the recent shift in policy from economic stabilization towards economic recovery in the midst of the global pandemic, the central bank has slashed policy rates by a cumulative 525bps to 8.0%. Note that PIOC funded its expansion primarily by borrowings, bringing its outstanding debt to PKR 28.5bn. We estimate the 525bps reduction in interest rates will likely push the company’s profitability by PKR 1,500mn (EPS Impact: PKR 4.68) during FY21. Moreover, anticipation of improved fundamentals suggests healthy cash-flow generation in the coming years. These cash-flows will likely enable the company to de-lever its balance sheet, further reducing its financial charges.

Fundamental forecasts suggesting attractive valuations
Healthy cash-flow generation in anticipation of recovering dynamics considerably increases the attractiveness of the PIOC’s valuations. Presently, PIOC is trading at an EV/MT of USD 56, implying an estimated 44% discount to its replacement cost. Going forward, with debt levels likely to come off amid recovering profitability, valuations
appear to offer great value. We estimate EV/MT to decline to USD 42 and EV/EBITDA to fall to 3.6x by FY25.

Sensitivity Analysis
Sensitivity to Pricing
Cement prices are the prime influencers towards the industry’s profitability. As mentioned, we believe the industry is expected to regain its pricing power amid recovery in demand dynamics. The following table provides an overview of PIOC’s profitability over varying levels of pricing.

Sensitivity to utilization
The industry’s off-take also plays a key role in determining profitability. As mentioned, we expect off-take and capacity utilization to rise, onwards. The following table provides and earnings sensitivity to varying levels of offtake for PIOC.