DG Khan Cement Company Limited valuations still attractive – JSGCL Research
By: Furqan Ayub,
+ 9221 111-574-111 Ext: 3103
JS Global Capital Limited
We trim our earnings estimates for DG Khan Cement Company Limited (DGKC) by 3%/2%/1% over FY14E/15F/16F. The revision in earning estimates are driven by (1) lowering our sales volume assumption and (2) tweaking down our gross margin assumption.
Recall that on a pre-tax basis DGKC’s earnings in 1QFY14 registered a growth of only 2%YoY as maintenance shutdown of one of its plants decreased the utilization levels and margins.
Consequently post the revision in earnings, our SOTP based Target Price has been revised down by 2% to Rs95. That said we reiterate our liking for DGKC within the cement space as the stock offers 25% potential upside to our revised target price.
DGKC currently trades at FY14E P/E of 5.6x, reflecting a 33% discount to the market, which in our view is unjustified given the prevailing strong sector fundamentals.
Earnings trimmed on lower sales volumes and margins
We trim our earnings estimates for DGKC by 3%/2%/1% over FY14E/15F/16F. Now we are anticipating the company to register an EPS of Rs13.70 in FY14E, up 9%YoY. Changes in our estimates are driven by lowering our sales volume assumption by 4-2% over FY14E-16F post the disappointing sales volumes of the company in 1QFY14 (-6%YoY). In tandem with decreasing our volumetric growth assumption we have tweaked down our gross margin assumption for FY14E to 36% from 37% previously on the back of higher than expected costs of sales in 1QFY14. Consequently, our Target Price has been revised down by 2% to Rs95 from Rs97 previously. That said we re-iterate our liking for DGKC within the JS Cement Universe where the stock offers 25% potential upside to our revised target price.
1QFY14 – GP margins dip but debt burden reduced as well
DGKC posted an EPS of Rs2.44 in 1QFY14, down 26%YoY as the company had booked deferred tax in 1QFY13. Note that on a pre-tax basis earnings registered a growth of 2%YoY. The striking aspect of the 1QFY14 result was the decline of 4ppts YoY in gross margin to 34%. However, we believe this to be a temporary phenomenon because the company undertook a maintenance shutdown on one of its plants during 1QFY14. We also do not consider the recent phase of monetary tightening as a major threat to DGKC given that the company continues to reduce its debt burden (repaid Rs1.0bn of debt in 1QFY14) where currently the Interest Bearing Debt/Asset ratio of the company stands 13%. Note that every 100bps increase in interest rates would lead to ~1.1% annualized EPS downside for DGKC.
Outlook: Compelling valuations too attractive to ignore
Amidst fears of a breakdown in pricing arrangement in September 2013, cement stocks took a battering as investors switched to more defensive sectors. However, fears have largely subsided since then but DGKC has remained a laggard, underperforming the market by 6.2% since September 2013. With DGKC currently trading at FY14E P/E of 5.6x, translating into a 33% discount to the market FY14E P/E of 8.3x, we flag this as an opportunity for investors to ‘Buy’ DGKC given the strong sector dynamics (strong margins and largely unleveraged balance sheets) are still intact.