This was a commendable performance given the significant growth in cement imports which accounted for approx. 52% of domestic consumption for CY11. A significant growth in competition was witnessed from India & Pakistan with the entry of large players such as Dalmiah Cement and Lucky Cement, who benefit from zero tariffs on cement exports to Sri Lanka through free trade agreements (ISFTA& PSFTA).
In light of the price advantage enjoyed by importers, we have revised downwards the contribution from the household sector towards TKYO’s revenue from 7.2% to 6.1% with the exception of the North & East regions where TKYO enjoys a strong brand loyalty. We also do not expect significant improvement in the margins of the household sector despite the introduction of value added products such as tile adhesive and waterproofers, due to the minimal contribution from such products.Instead we expect the commercial and the public sector, which place a larger premium on technical superiority to account for the bulk of the firm’s revenue. In particular TKYO’s technically superior product is likely to attract demand from the local authorities for the rehabilitation of over 4,000 Km’s of roads using pre-cast concrete blocks as part of the “Maga Neguma” program. In addition given its past performance (Figure Vii), Tokyo Cements product is likely to remain the preferred choice for large scale infrastructure projects.
Moving forward, based on our revenue growth estimates and in lieu of the 9% increase in the price of bagged cement, we expect TKYO to achieve a turnover ranging from LKR 26.8bn– LKR 28.8bn in FY13E.Revenues from FY14E onwards would be supplemented by the energy tariff from the 6MW Dendro power plant which is expected to come online in 1QFY14E. Based on company disclosures, the firm has secured a power purchasing agreement (PPA) to supply electricity to the Ceylon Electricity board (CEB) for the next twenty years. However, given the governments agenda to promote the use of sustainable energy we expect greater private sector involvement in the power generation sector, particularly in the Dendro power subsector due to its relatively high tariff rates. Hence in anticipation of an escalation of raw material costs, we have revised downwards the ROI of the firm’s investment in its 6MW Dendro power plant from 21% to 14%. Based on current tariff rates for Dendro power plants we estimate the contribution from TKYO power to be LKR 235 mn p.a (See annexure 4 for assumptions).
The phenomenal growth in revenue translated into a 34% YoY increase in gross profit. Although gross profits for FY12 is above our initial forecast of LKR 3.6 bn in absolute terms, the overall GP margin for the full year witnessed a marginal decline. This was due to cost of production growing at a faster rate in 4QFY12 on account of the delay by the regulators in revising the price of a bag of cement. This was in the face of escalating clinker costs experienced throughout CY11 primarily due to the continuing construction boom experienced in South East Asian markets such as Indonesia and Thailand. The high demand has led to an escalation in clinker costs where the firm sources its chief raw material clinker from. The rise in clinker cost has been reflected in the Indian limestone index which witnessed a 5% rise over FY11/12. Further, the 65% QoQ rise in cost of production in 4QFY12 is a result of the significant depreciation of the Rupee and we expect it to put pressure on future gross and operating margins.
Despite the price regulated nature of cement, the low substitutability of cement as a building material as well as the oligopolistic nature of the cement industry in Sri Lanka has bestowed considerable bargaining power on local suppliers such as TKYO & Holcim Lanka. However given the governments agenda for a “construction led growth”, it was the regulators intention to keep building material costs low, which led to delays in price revisions.
In spite of these challenges TKYO continued to demonstrate its proficiency of effectively maintaining its gross margins. An analysis of the various cost drivers that impact the firm against the firms gross profit volatility confirms our hypothesis of effective cost management. The volatility of the gross margin over a 6-year period has been a mere 0.01%.
A growing trend in the cement sector in Sri Lanka in the post-war environment has been a move towards a cash based payment structure. This is partly due to the low shelf life of a bag of cement and end distributors preference for cash over credit. This has resulted in declining payables & Receivables days during FY11 & FY12. However given the current inflationary environment as well as the limitations on banking lending imposed by the Central Bank, we believe that the firm may have to extend its lines of credit to end distributors and consumers through its mega distributor networks. This is evident in the rise in both receivable and payables outstanding for FY12. Hence we expect an increase in the firm’s working capital requirements for the near future.