PIONEER CEMENT LIMITED - Analysis of Financial Statements Financial Year 2004 - Financial Year 2009
OVERVIEW (November 18 2009): Pioneer Cement Limited (PIOC) was incorporated on 9th February 1986 as a public limited company. The project started in November 1994, when its first unit commenced production. The second unit was commissioned in January 2006.
PIOC is a medium sized company in the cement sector, which began its operations with an installed capacity of 2000 tons per day of clinker. The company underwent many expansion plans, due to which, its capacity was increased to 2350 tons per day in 2005 and in 2006 a new production line of 4300 tons per day of clinker capacity started production.
Its shares are quoted on all the three stock exchanges of the country. It is part of the Noon Group, which holds the majority stake of 60% in the company, followed by a leading brokerage house namely First National Equity Limited (FNE) 9% shareholding. The rest of the shares held by financial institutions, insurance companies and the general public.
PIOC is involved in manufacturing and marketing of cement. Its products include, ordinary portland cement suitable for concrete construction and sulphate resistant cement ideal for construction in or near the sea. The company's sulphate resistant cement has less than 2.0 C3A content whereas the maximum limit of C3A content set by British and Pakistan standards, is 3.5.
Thus, the company's sulphate resistant cement is highly preferred in the important projects such as the Thal Greater Canal project. PIOC's products are sold under the brand name of 'Pioneer Cement' and it was the winner of "Brand of the Year Awards 2006" in cement sector in the national category. The company's state-of-the-art European (FLS) plant is equipped such that it allows stringent quality control measures. PIOC is ISO 9001:2000 QMS and ISO: 14001:2004 certified. It meets local as well as international quality standards.
This year was really the turbulent for the cement sector due to overall deteriorating law and order situation and the economic recession in the country. The local demand for cement and clinker plunged to almost 15% and was highly affected by the large budget deficit and cut in the development expenditure by the government in line with the new demands of the IMF. The government reduced the expenditure on Public Sector Development Programme (PSDP) in FY09, which caused a reduction in demand of cement by 11.3m tons.
However this situation was shadowed by a huge 47% increase in the demand abroad. Also, the increasing inflation and rising prices of cement and clinker helped the companies to improve their profitability. The country now is the 5th in the world regarding the overall cement exporters, a feat, which has never been achieved before. Moreover, most of the companies this year, tapped the attractive markets of Middle East and Central Africa to overcome the shortfall in local demand, a decision which led to highly appreciable results despite the overall crisis in financial sector of the economy.
PRODUCTION AND SALES
At the year-end FY08, the local sales contributed 75% while exports rose to 25% of total cement dispatches of the company. PIOC clearly benefited from the growth in demand for cement in India and Middle East. As PIOC's plants are in close proximity to Indian border, the shortage of cement in India made it a lucrative and accessible market for the company and exports are made through roads. The retention prices in India are better than other export market.
As the cement prices in India are expected to rise further, PIOC can be expected to have increased value of sales and higher gross margins. PIOC exported 293,431 tons of clinker, mostly to Middle East due to depleted limestone reserves and idle installed grinding capacities. PIOC is also exporting to Europe and Africa. The production of cement decreased this year by 30% due to the shortage of power and crisis stricken political state of the country.
The volume of local sales decreased by 30% in line with the industry trends and the exports decreased by 45% this year but due to the high prices both on local and international front, the company was able to make profit after taxes of about Rs 36m.
The cement sector is experiencing strong growth in cement dispatches, but at the same time, is facing decline in profitability. The cost of production went up due to rise in the prices of imported coal. Crude oil prices shot up during FY09 and had impacted the prices of coal and natural gas. Fuel costs were the largest portion of production costs of the PIOC. For PIOC the prices of packaging material went up and formed 14% to total production costs.
Fuel and electricity costs form 60% of the cost of sales and higher electricity tariffs and fuel costs affected the earnings of the company. Company had an impact of Rs 149 million on earnings due to devaluation of rupee against the US dollar and Japanese yen in the form of exchange losses. Financial cost also increased due to higher interest rates in the economy.
The profitability ratios indicate that PIOC, like many other companies in the cement sector, has been plagued by lower earnings. PIOC's rising operating expenses and financial costs have led to negative impact on the net profit margins. Similarly, return on assets and return on equity have also fallen. The company improved a lot in FY09 as far as the profitability is concerned. The gross profit margin increased from 10% to 26.66% as compared to last year. The gross profit earned in FY09 (Rs 1,333 million) is 160% more than of FY08 (Rs 820 million).
Escalation in cost of goods sold was controlled and COGS was reduced by 16% in FY09 due to a sharp reduction in the international coal prices. The sales also increased by 3% in this year. But even then the Pioneer Cement's gross profit margin was less than the industry average of 30.36%. The same is the case with the net profit margin, the company, which incurred an overall loss last year, was able to bring its profit margin from -3.71% to 0.72% in FY09. The company has greatly reduced its distribution costs by 23% than last year.
However, Pioneer Cement is below the industry average net profit margin of 5% although the asset management and debt management this year was the best in the whole sector. Pioneer's ROA and ROE are less at 0.35% and 1.4% respectively as compared to the industry average, which is 6% and 8.4%, respectively. PAT was Rs 36 million as compared to Rs 180 million in losses in FY08.
The liquidity position of the company has been deteriorating over the years, due to substantial rise in the current liabilities. PIOC felt a liquidity crunch, like many other companies in the cement sector due to the price war and losses caused by that in FY08. The current liabilities of PIOC have also increased to Rs 2.987 billion during FY08, backed mainly by increased short-term borrowings by the company. To solve the liquidity problem, PIOC initiated a process of restructuring its debt by issuing Sukuk of Rs 2.5 billion in FY08.
This will help the company to liquidate its excessive current liabilities. It will also help to control company's finance costs. Also, in lieu of its payments to NBP, Pioneer will issue shares to the NBP due to its inability to pay its loans. This restructuring would give a breather to the company whose current ratio was steadily moving downhill.
During FY08, the composition of current assets changed such that the most liquid assets: cash and bank balances constituted 18%, trade debts 5% and inventory 9% of total current assets. Stores, spares and tools are highly illiquid assets and they form a major portion of the company's current assets. The liquidity position of the company improved a bit in FY09 despite the overall crumbling economy. The improvement was very minimal though 0.26 was the liquidity ratio in FY08 while the company ended up at 0.29 in FY09. This slight improvement was due to 30% increase in the current assets of the company.
Against the assets, the liabilities increased by 17%. The industry average for the liquidity ratio was 0.92 for FY09 with Attock Cement, as the market leader as far as liquidity was concerned. This shows that the overall industry's position, though not ideal, is at least much better than the Pioneer Cement. In fact, it is the only company in the cement sector, which has the liquidity ratio of below 0.5.
ASSET MANAGEMENT ANALYSIS
The asset management of the company seems to be quite effective during FY08, as the operating cycle of PIOC decreased to 9 days from 23 days in FY07. The operating cycle, however, has reduced due to faster sales turnover while days to collect trade debt remained the same in FY08. The days to sell the average inventory were 19 days in FY07 whereas in FY08 it took the company only 6 days to sell its inventory. The company's policy in FY09 to increase its inventory has affected the inventory turnover rate, which was reduced from 63 times to 25 times.
This year, the cost of sales of the company, were also reduced by 16%, which also played its part in reduction of the inventory turnover. As long as this policy is increasing, the profitability and sales of the company, the ratio inventory turnover of 25, is satisfactory considering the fact that the cost of goods sold were also reduced considerably by 16% although the main part in achieving that astonishing feat was played by the revaluation of the total assets of the company in FY08 due to which the depreciation expense was reduced by 13%.
The cross-country analysis tells that despite the reduction in the ITO, the company was well above the industry average in FY09, which was only 9.2 times. In fact, the ITO of Pioneer Cement was the highest amongst the sector. So the average days to sell the inventory in FY09 were increased from 6 to 14. All this happened due to the huge volume of cement export to the rebuilding countries like Iraq, Afghanistan, India and the Middle East by all of the companies in Pakistan. The increasing export volume also increases the amount of inventory recorded in the company's books.
This explains why the Inventory Turnover of the cement sector is 38.8 days on average and the Pioneer Cement is very well below the average indicating the good performance as far as supply chain is concerned. The company seems to be leading the market as far as the asset management is concerned as its operating cycle of 17.33 days is very less than the industry average of almost 48 days. This incredible performance is really plausible. Another noticeable achievement of the company is that 3% growth in the overall sales of the company was achieved even though the trade debts were reduced by 7% in the FY'09.
This step was taken by the company owing to the liquidity and credit crunch in the global market place and with in the country as well. The company's total assets turn over was also stable at 0.48 and it was almost the same as previous financial year. Even though the sales increased by 3% and the total assets decreased by 1%. Yet the company's turn over is less than the industry average of 0.61 which is a healthy sign for the company. Same is the situation with the equity turnover ratio which hadn't changed from the previous figure of 1.07 and is well below the industry average of 1.3.
DEBT MANAGEMENT ANALYSIS
In FY08 the debt to equity ratio has declined owing largely to a fall in the debt. The company is trying to restructure its financing composition in favor of equity by issuing Sukuk financing and convertible loan into equity. This will reduce the current liabilities in the future. In the wake of rising interest rates in the economy, this strategy will prove to be beneficial for PIOC in the future. The company's debt to asset ratio has not changed much from the previous figure of 0.57 and is 0.58 this Financial Year. The total liabilities of the company were decreased by 3% while assets were decreased by 1%.
However a closer look at the liability structure of the company tells that the current liabilities were increased by 17% due to the huge rise of 104% in the accrued interest and 68% increase in the short-term financing of the company to hedge itself from the dangerous after-effects of the long-term debt financing while on the contrary, the long-term liabilities were decreased by 23% and all the long term loans were either redeemed or significant portion of their principals was paid to the banks to reduce the increasing finance cost from the profit and loss account. Almost Rs 300 m were disbursed from the company for that purpose which affected the liquidity but the whole industry was doing it and that trend was followed by other manufacturing concerns as well.
The industry average in this ratio is 0.51 which is closer to that of the company. The company increased its equity by 1% in FY'09. But due to the redemption policy of the long term loans, the company's overall liabilities were also decreased by 3% yet the capital structure is dominated by the debt financing and trend will be continuing for a very long time in future. A cross country analysis tells us that the capital structure of pioneer cement has too much debt in it. This year's industry average is 1.41 and it is much lesser than that of the Poineer Cement.
This is probably because the company is not owned by the single family which doesn't allow ownership to transfer into the foreign hands unlike other companies of the sector. The company's long term debt to equity ratio reduction from 1.28 to 0.95 in FY'09 confirms its policy of getting rid of long term debts. In fact the average ratio tells us that the whole industry has blindly followed this course of action to save them from the inflation. The industry average of 0.35 suggests that Pioneer Cement has still got a lot of debt on its balance sheet but this is there because the share of equity in the capital structure is very less.
The company's Times Interest Earned ratio is 2 and has increased from the last financial year when it was negative last year due to loss it incurred from the operations. Even though the interest rates have increased the finance cost by 104%. The other companies who got rid of the long term debt fully have managed to save a lot of profit from being going to the interest account. The TIE industry average is 5.8 which is very much larger than that of Pioneer Cement but we have to keep in mind that the Pioneer Cement has got such a large amount of debt in its capital structure that it was not possible to get rid of it in one financial year.
SHARE PRICE ANALYSIS Share prices of the Pioneer Cement reduced from Rs 31 in June 2008 to Rs 13.58 in June 2009. The earnings per share were increased from negative to 0.18. Even though the price of the share reduced, the price to earnings ratio was still very high.
Cement dispatches are expected to continue growing in the future as the demand for cement may increase in response to construction activities in the private sector. Also in the budget FY09, the government has allocated Rs 550 billion for PSDP in the country. Despite this, the local cement dispatches may be depressed due to slowdown in the economy-led construction activities in the country and also due to inflation. But exports are expected to maintain their strong growth and support the total cement dispatches. Pioneer Cement is expected to have increased exports as it has received orders from new buyers such as Russia, Central Asia, Madagascar and Nigeria.
In the budget FY09 the central excise duty on cement was increased to Rs 900 per ton from current Rs 750 per ton. On each bag the CED increased by Rs 7.50 per bag (from Rs 37.5 per bag to Rs 45 per bag). But this increase is not expected to impact the profits of the cement sector because this increment in CED will be passed on to the consumers. However, the rise in the GST by 1% will increase the local cement prices and may dampen the demand for cement. Expenses are expected to increase for cement manufacturers due to the hike in coal prices and higher interest rates in our economy.
This will negatively impact the gross margins of the cement sector. During the past, our cement manufacturers shifted production from oil to coal or gas. Pakistan has huge reserves of coal but manufacturers need to import coal due to high sulphur content. Coal prices more than doubled during FY08 with average coal prices being around US $176/ton during the fiscal year. Rising coal prices coupled with a depreciating rupee will increase the cost of production for the cement companies and hit their gross margins hard.
From a wider perspective, the cement consumption in the domestic market is expected to fall because of the deplorable economic situation in the country. The declining GDP and volatile economic situation may restrict the construction activities in the country and may hit the demand for cement. The company's overall performance in 2009 was better than of FY08, which evident from its positive net income and increasing returns, but there are some concerning points as well.
The company's lavish expenditure on the social benefit when all the profitability ratios are below the industry average is not a good decision at all. The good asset and debt management is the key to success in future. The current owners will also have to think about increasing the free float of the company, as there is a lot of room for equity in the capital structure. This will have a positive affect on the net profit of the company, as the interest costs will reduce a lot. The stock market recovery should boost this decision. The liquidity position should also be improving in the nest year owing to the dependency of the company in short term borrowings.
The impediments in the good future income are of course the power shortages and the fluctuating oil prices but these factors are faced by the industry as a whole. But the local demand will of course pick up due to the construction work in Swat and NWFP. The reduction in the prices of coal will also be also helpful in reducing the costs of the company. However, there is hope for cement sector on the international front. Presently, Pakistan is exporting to Afghanistan and India. Regional shortage of cement has presented a favorable opportunity for our cement manufacturers.
Cement demand in Afghanistan is expected to be 1.5m-2.0m tons per annum for the next five years. Cement manufacturers have growing opportunities in Middle East and African countries. New export markets like Russia and European countries have been identified. Growth in export sales may boost the margins of the industry and reduce the negative impact of rising costs on its profitability.
COURTESY: Economics and Finance Department, Institute of Business Administration,