By: Syed Abid Ali, Arif Habib Ltd.

We reaffirm our buy stance on Lucky Cement Limited (LUCK) with an upwards revision in our Dec-12 target price to PKR 170/share, offering an upside potential of 32.5%. Our positive stance stems from the strong pricing scenario, softening coal prices and a healthy demand outlook with the government’s renewed interest in PSDP spending. The company’s strategic investments in the Democratic Republic of Congo and Iraq along with its diversification strategy of venturing into a wind power project will further unlock its potential going forward. Lucky Cement is on a course to diversify its earnings through 40MW power sales and carbon credits. In addition, Lucky Cement is also planning to acquire ICI Pakistan Limited, which if successful, will further diversify its earnings.

Lucky Cement: the biggest beneficiary of strong pricing

Economies of scale and energy efficiency make Lucky Cement the lowest cost cement manufacturer in the country having 18.3% lower cost than its competitors. This makes Lucky Cement the biggest beneficiary of the current pricing scenario, which is evident from its 37.8% gross margin in 9MFY12 as compared to 24.5% by the industry. With a resilient cement price outlook and softening cost pressures, we expect Lucky Cement to earn its highest ever gross margin of 43% in FY13. Before this, such a rosy margin scenario was witnessed in FY04, when company achieved 37.8%.

Power sales likely to add PKR 1.4/share in FY13

The company has entered into power sales agreements with HESCO and PESCO for 20MW each. The company has already started its 20MW power dispatch to KESC since July 02, 2012 where as commission of power sale to PESCO is expected in 2HFY13. Under the New Captive Power Policy, LUCK is expected to generate PKR 1.8bn and PKR 2.8bn in FY13 and FY14, with bottom line impact of PKR 1.4/share and PKR 2.2/share, respectively.

Softening coal prices to expand the margins further

In line with crude oil, coal price has crashed in June 2012 to USD 87/ton (Richards Bay fob), lowest since October 2010. Besides fall out in commodity prices, coal prices were also affected by the sluggish demand from China. In our base case assumption we expect coal prices to cool off by 9% and 16% in FY13 and FY14, respectively. Coal is the biggest cost component of cement manufacturing process constituting around 41.2% of the total production cost for Lucky Cement. Thus, this declining trend in coal prices will further boost the margins for Lucky Cement going forward.