Re rating Pioneer Cement Limited (PIOC) – BUY

Research - Intermarket Securities Limited

• We resume coverage of Pioneer Cement Limited (PIOC) with a Buy rating and a TP of PkR103/share, which offers a potential upside of 25.5% along with a DY of 7.6%. We expect EPS of PkR10.01/11.26 in FY16/17F, along with DPS of PkR6.25/6.75.
• Improvement in core operations due to (i) uptick in local cement demand, (ii) reduction in power tariffs, and (iii) commencement of WHR (12 MWs by 2HFY17) will be the triggers for PIOC, going forward. Since peak operating levels on Line‐I has been as high as 115% (FY05) and 78% on Line‐II (FY08), we highlight company’s low utilization levels in the last six years was a consequence of demand patterns only.
• PIOC posted 2QFY16 EPS of PkR2.45, up 7.5%YoY/29%QoQ (ex‐liability reversals of PkR557.8mn booked in 2QFY15), mainly due to (i) 5pptYoY/6pptQoQ rise in GP margins to 42.5%; (ii) 21%YoY growth in off‐take (97% were high‐margin local sales), and (iii) 69% dip in finance cost due to better liquidity position. PIOC also announced first interim cash dividend of PkR2.5/share. 

We resume coverage of Pioneer Cement (PIOC), with a Buy rating; our DCF based target price of PkR103/share offers a potential upside of 25.5%.

We believe PIOC is yet to fully capture the fruits of:

1. lower grid power tariffs;
2. ample unutilized capacity (utilization: 60% in FY15) to cater local demand; and
3. installation of WHR (expected to commence operations in FY17), which will further boost energy savings.

We revise our earnings estimate to PkR10.01/11.26 in FY16/FY17F, along with DPS of PkR6.25/6.75. The stock is trading at a FY16F P/E of 8.2x (4.2% discount to peers) and yielding 7.6%.

Lower utilization a matter of demand, not plant’s inefficiency 

PIOC is currently running at capacity utilization of 63%, which came down from 82% in FY08. The company lost market share in local sales, from 5.9% to 4.1%, amid spree of expansions between FY08‐FY12; particularly, Fauji Cement (in close vicinity; now operating at 79%) caused the greatest attrition, in our view. Historically, PIOC has operated its Line I at as high as 115% utilization (FY05), whereas Line II operated at 78% in FY08; which is contrary to concerns on company’s ability to produce more. We think modest utilization levels were more an outcome of limited local demand and thus competition and not because of operational inefficiencies obstructing higher utilization levels. Going forward, however, we think the foreseeable uptick in demand given CPEC projects in KPK, will serve to elevate PIOC’s utilization levels – in turn driving volume and earnings growth.

Commencement of WHR supporting margins in the long run 

PIOC plans to install PkR1.5‐1.7bn 12MW WHR plant (to be financed largely with internally generated cash), which is expected to commence operations by the start of FY17. The company has already paid in advance for the purchase of plant; however, we have incorporated the same from 2HFY17 in our estimates.

We believe effective utilization of the WHR plant will be lower, because it will be installed on Line II, whereas coal fired system built‐in on WHR will allow the company to operate the captive facility at a certain cost of coal if Line I kiln is utilized. We believe potential after‐tax savings from the WHR project can be close to EPS of PkR0.88/1.72 in FY17/18F, translating into valuation impact of PkR6.3/share.

2QFY16 Result Review: As expected, energy cost savings trigger earnings growth 

PIOC announced 2QFY16 EPS of PkR2.45, up 7.5%YoY (Ex‐liability reversals of PkR2.46/share before tax, booked in 2QFY15), mainly due to lower energy tariffs through fuel price adjustments, 21%YoY/QoQ dispatches growth, less than 3% share of exports in sales mix, and 69%/37% YoY/QoQ reduction in finance cost. Broadly, the result was in line with ours and market expectations. The company also announced an interim DPS of PkR2.50.