OXFORD BROOKES UNIVERSITY

RESEARCH AND ANALYSIS REPORT

AN

EVALUATION

OF

THE

BUSINESS

AND

FINANCIAL PERFORMANCE OF D.G. KHAN CEMENT COMPANY LIMITED (DGKCC) BETWEEN 1 JULY 2004 AND 30 JUNE 2007

(Word count: 6,498)

Presented by: KAMRAN KHALID ACCA reg. # 1431751 September 2008

CONTENTS
Page No.

1. Research Objectives and Overall Research Approach 1.1 Topic Chosen and the Selected Organisation 1.2 Project Objectives 1.3 Research Questions 1.4 Research Approach 2. Information gathering and business/accounting techniques 2.1 Information Gathering 2.1.1 Sources of Information and Methods used to Collect Information 2.1.2 Limitations of Information Gathering 2.1.3 Ethical Issues and their Resolution 2.2 Business/Accounting Techniques 2.2.1 Financial Ratio Analysis 2.2.2 SWOT Analysis 2.2.3 Porters Five Forces 3. Results, Analysis, Conclusions and Recommendations 3.1 Business Description 3.2 Cement 3.2.1 The Cement Industry of Pakistan 3.3 The Economy 3.4 Ratio Analysis 3.4.1 Sales Analysis 3.4.2 Profitability Ratios 3.4.3 Return-on-investment Ratios

4 4 5 5 6 7 7

7 8 9 9 9 11 11 12 12 13 13 14 15 15 16 19

3.4.4 Activity Ratios 3.4.5 Liquidity Ratios 3.4.6 Financial Leverage Ratios 3.4.7 Valuation Ratios 3.5 SWOT Analysis 3.6 Porters Five Forces 3.7 Conclusion 3.8 Recommendations List of References Appendices Appendix A Financial Statement Extracts Appendix B Questionnaire and Response

20 21 22 24 26 27 29 31 32

34 36

PROJECT OBJECTIVES AND OVERALL RESEARCH APPROACH

1.1 TOPIC CHOSEN AND THE SELECTED

ORGANSIATION
After careful consideration of my strengths and weaknesses and discussions with my mentor I have selected the topic The business and financial performance of an organisation over a three year period for my Research & Analysis Project. The focus of my research report is D.G. Khan Cement Company Limited (DGKCC) which is currently the second largest cement manufacturing unit in Pakistan. This report evaluates the financial and business performance of DGKCC, over a three year period (FY2005-FY2007), using various analytical tools. It considers both financial and non-financial factors and also includes the impact of other major internal and external events on the companys performance. The analytical techniques used are: the financial ratio analysis, SWOT analysis and the Porters Five Forces analysis. 1.1.1 REASONS FOR SELECTION Following are the reasons for choosing this particular topic and organisation: Ratio analysis has been an area of great interest to me since I studied it for the first time in Certified Accounting Technician course. The other two techniques: the SWOT analysis and Porters five forces are highly important strategic management tools and carry huge weightage in the professional level subjects of ACCA. Thinking of applying these theories in the practical world motivated me to select this topic.

Cement industry stands in the second place in Pakistans economy, after textile. Therefore, analysing the cement industry helps to gain a better understanding of Pakistans economy. I used to wonder why do not I see advertisements of cement products in my country yet it is a basic commodity. This made me curious to know more about the cement industry. DGKCC has been the industry leader since 1990s but lost its top slot to Lucky Cement Limited (LCL) during 2005. This arouse interest in me to analyse the performance of DGKCC and find out the reasons of losing its market share. Selecting the second largest company allowed me to benchmark its performance against the industry leader LCL.

1.2 PROJECT OBJECTIVES

To gain an understanding of the cement industry of the country. To analyse the business and financial performance of DGKCC over a period of 3 years (FY2005-FY2007) giving sufficient consideration to its profitability, liquidity, asset management, financial leverage and equity analysis. To carry out the corporate appraisal (SWOT analysis) of DGKCC, thereby identifying any profitable opportunities matching its strengths and counter major weaknesses and threats. To analyse the competitive intensity of the industry and the companys position using Porters five forces model. To provide a quality report interpreting the business and financial performance of DGKCC over the period under study.

1.3 RESEARCH QUESTIONS

After selection of the topic and the target organisation I jotted down the following research questions to further clarify my project objectives: What research approach I should adopt to meet the set objectives? What are the reliable sources of information? Are they easily accessible? Can I rely on the secondary data?

Which areas do I need to concentrate if my research work exceeded the prescribed words count? What conclusions can be drawn from my analysis? Are there any ethical issues resulting from my research project? Do I need to refresh my technical skills reviewing my text books? What IT skills do I need for the preparation of my research project? What are the key elements I should present to my mentor?

1.4 RESEARCH APPROACH

After setting the project objectives and stating my research questions I adopted the following research approach: I set a time outline for my project, taking into consideration the collection of data, estimated time to be spent on my analysis, the next two meetings with my mentor, the final deadline for my project completion; and the anticipated hurdles. As I entered the implementation stage of my project I started doing the required actions to complete my research project within the specified time, meeting my project objectives. I followed a sequenced approach; first of all gathering data about the company, then the industry, the economy and then started carrying out most crucial part of my project the analysis. After drawing conclusions from my analysis I gave some time, almost two days, to review my work and presented it to my mentor in the second meeting. My research work had exceeded the words constraints so I obtained my mentors advice on to which areas I should put more weightage and which areas can be shortened. Finally, I made the companys information brief and optimised the length other less important areas to effectively meet my project objectives by putting more concentration on my analysis work.

INFORMATION GATHERING AND BUSINESS/ACCOUNTING TECHNIQUES

2.1 INFORMATION GATHERING

The first step involved in ensuring the accuracy of a research is the verification of the validity and reliability of data used; and hence the source of data carries great importance. Keeping in view the requirements of my selected topic, I managed to gather data from reliable sources and before finalising my RAP I had collected sufficient corroborative evidence from different sources to confirm the validity of the data used for analysis.

2.1.1 SOURCES OF INFORMATION AND METHODS USED TO COLLECT INFORMATION

2.1.1.1 PRIMARY DATA Primary data is the original data derived from a new research study and collected at source, as opposed to previously published material. (dictionary.bnet.com) To gain an insight of the cement industry and DGKCC I interviewed Mr. Hafeez Ahmad, an assistant manager at the companys registered office, Lahore. Mr. Hafeez briefed me about the operations of the company and gave me an insight to the cement industry. I gained an understanding of the corporate structure of the company, as well as the major challenges faced by the company and its future plans. 2.1.1.2 SECONDARY DATA Secondary data is the data that was collected previously and not for the particular study at hand. (www.marketresearchterms.com)

I visited the Lahore Stock Exchange to obtain the audited annual reports of DGKCC for the periods FY2005, FY2006 and FY2007 plus the audited annual report of LCL for the FY2007. Then I started looking for reference books in the Punjab Public Library to understand the global cement industry and read reports on the cement industry of Pakistan. During my period of analysis, I always tried to find the related news and articles, in the newspapers, about my countrys cement industry and especially the updates and prospects of DGKCC. Web archives of leading newspapers were of great help in collecting the past information about the company as well as the cement industry. ACCA publications such as the Student Accountant magazine along with my BPP study course material helped me a lot in refreshing my technical skills thereby conducting a quality analysis. I also consulted other books specialising in the interpretation of financial and business performance of an organisation. The World Wide Web served to be one of the most cost-efficient sources of information in carrying out this analysis and gathering corroborative evidence to ensure the validity and reliability of information. As I have a broadband internet facility at home, I did extensive search related to DGKCC and the cement industry keeping in mind the project objectives. Whenever I came across the information of my concern on the websites which were previously unknown to me, I started finding their supporting evidence on other websites to ensure the validity of information.

2.1.2

LIMITATIONS

OF

INFORMATION

GATHERING
I remember I had to visit the Lahore Stock Exchange for three times to get the audited annual reports. On my first visit, the record room had been closed according to a new timetable. During my second visit, I came to know that I need to get the annual reports photocopied as there were only two sets left in the record room. Due to shortage of money I

photocopied the financial statements sections only. Then finally, on my third visit I had the whole set of annual reports. Finding the right and precise information was one of the difficult and time-consuming tasks in information gathering. I spent hours on reading the newspapers, trade magazines, reference books and surfing the internet to collect the most up-to-date and reliable information.

2.1.4 ETHICAL ISSUES AND THEIR RESOLUTION

As anticipated, I came across an ethical issue while gathering primary data. When I reached the companys registered office and told them that I was carrying out a research project on their company. Initially they were reluctant to provide me with the desired information. Then I briefed them about my project and convinced them that majority of my project was based on already published information. However, when I ensured them about keeping confidentiality of the provided information they were happy to direct me to an assistant manager at the companys office.

2.2 BUSINESS/ACCOUTING TECHNIQUES

The business/accounting techniques used to support this analysis are as follows:

2.2.1 FINANCIAL RATIO ANALYSIS

Ratio analysis enables the evaluation of past performance, assessment of current financial position and gives insights that are useful for projecting future results. Financial ratios provide insights into: the micro economic relationships within a company that help analyst to project earning and free cash flows; a companys financial flexibility, or ability to obtain the cash required to grow and meet its obligations; and managements ability (CFA Level 1, 2008)

Financial ratios have been further sub-divided into following categories: 1. Profitability Ratios: Profitability ratios measure how well a company is performing by analyzing how profit was earned relative to sales, total assets and net worth. (kbr.dnb.com) 2. Liquidity ratios: Liquidity reflects the ability of a firm to meet its short-term obligations using those assets that are most readily converted into cash. (Fabozzi & Peterson, 2003) 3. Financial Leverage Ratios: These ratios are used to calculate the financial leverage of a company to get an idea of the companys methods of financing or to measure its ability to meet its financial obligations. (www.investopedia.com) 4. Turnover ratios: The financial ratios that measure an assets activity or efficiency in generating or turning-over cash are known as turnover ratios. (www.businessdictionary.com) 5. Valuation Ratios: A valuation ratio is a measure of how cheap or expensive a security (or business) is, compared to some measure of profit or value. Valuation ratios compare the cost of a security to the benefits of owing it. (moneyterms.co.uk) 2.2.1.1 Limitations of Ratio Analysis: Ratio analysis is based on accounting data which is subject to manipulation by changes in accounting and management policies. Ratio analysis does not tell us the entire story. There may be good business reasons to support managements decision to reduce or increase liquidity or fixed assets in a different manner than the rest of the industry. Having a single ratio out of line with an industry,

therefore, does not necessarily mean there is a problem. (www.collegecram.com)

2.2.2 SWOT ANALYSIS

The SWOT analysis provides information that is helpful in matching the firms resources and capabilities to the competitive environment in which it operates. (www.quickmba.com) SWOT analysis (corporate appraisal) is a critical assessment of the strengths and weaknesses, opportunities and threats affecting an organisation to establish its condition before the long-term plan is prepared. (BPP 2008, ACCA Paper P5) 2.2.2.1 Limitations of SWOT Analysis The SWOT framework has a tendency to oversimplify the situation by classifying the firms environmental factors into categories in which they may not always fit. The classification of some factors as strengths or weaknesses, or opportunities or threats is somewhat arbitrary. (jobfunctions.bnet.com)

2.2.3 PORTERS FIVE FORCES

Porters model outlines the primary forces that determine competitiveness within an industry and illustrates how those forces are related (www.1000ventures.com). The model provides a simple perspective for assessing and analysing the competitive strength and position of a corporation or business organisation. (Chapman, 1995-2005) However, one of the major drawbacks of this model is that the model assumes relatively static market structures. This is hardly the case in todays dynamic markets. (www.themanager.org)

RESULTS, ANALYSIS, CONCLUSIONS & RECOMMENDTAIONS

D.G. KHAN CEMENT COMPANY LTD.

3.1 BUSINESS DESCRIPTION

D.G. Khan Cement Company Limited (DGKCC), a unit of Nishat group, is one of the largest cement manufacturing units in Pakistan. It has a countrywide distribution network and its products are preferred on projects of national repute both locally and internationally due to the unparallel and consistent quality. It is listed on all the stock exchanges of Pakistan. (www.dgcement.com) 3.1.1 - History DGKCC was established under the management control of State Cement Corporation of Pakistan Limited (SCCP) in 1978. Nishat Group acquired DGKCC in 1992 under the privatization initiative of the government. (www.dgcement.com) 3.1.2 - NISHAT GROUP Nishat Group is one of the leading and most diversified business groups in South East Asia. With assets over PKR 300 billion, it ranks amongst the top five business houses of Pakistan. (www.pakistanaviators.com) 3.1.3 - Major Shareholders Nishat Mills Ltd. is the major shareholder of DGKCC holding 79,614,700 ordinary shares which make up 31.40% of the total ordinary shares of DGKCC. (DGKCC Annual Report, 2007) 3.1.4 - Products Two different products are produced at DGKCC namely Ordinary Portland Cement and Sulphate Resistant Cement. (www.dgcement.com)

3.1.5 - Operations The operations involved are power generation, purchasing, mining, crushing, grinding, burning, storing, packaging and marketing. (www.accessmylibraray.com) 3.1.6 - Exports Currently the company exports 10,000 to 12,000 tons of cement per month to Afghanistan and is also eyeing the potential Indian market. Our first preference is naturally to capture the local market and then we will be more interested in exports, said Innayat Ullah Niazi, the chief financial officer of DGKCC. (sg.biz.yahoo.com)

3.2 CEMENT
Cement can be regarded as one of the basic materials required by construction programmes for various infrastructures such as transport, water and power supply, communications, water treatment and disposal as well as housing and industrial plants. Temporary shortages of cement can, as a result, frequently halt or disrupt construction programmes. (Pheng & Bee, 1993)

3.2.1 THE CEMENT INDUSTRY OF PAKISTAN

The cement industry of Pakistan comprises 27 companies, of which 21 are listed on the stock exchange. The industry is divided into two regions, Northern and Southern Zones. The Northern region caters to almost 70 per cent of the total cement dispatches. Between DGKCC and the other giant in the sector, the Lucky Cement Company Ltd. (LCL), the race even if quietly has been to be the biggest. DGKCC which had stood aloft as the largest player in the industry since 1990 lost its top slot to LCL in 2005, after the latter went into huge expansions. (Dawn News, 2008) Cement industries in Pakistan are currently operating at their maximum capacity due to the boom in commercial and industrial construction within

Pakistan. Consumers face a tough decision with regards to prefer which brand over which because of the similar pricing of the cement industry. The demand of Pakistani cement is expected to continue to grow at the rate of 20 per cent for about four years to come. It may then follow traditional growth rate of seven per cent per year. (Industrial and Competitive Analysis, 2007)

3.3 THE ECONOMY

Pakistans economy has shown 7.0 per cent growth in FY2007 for another consecutive year as against the economic growth of 6.6 per cent in FY2006. Now it has achieved a growth rate of almost 7.0 per cent per annum during the last five years (FY2003 to FY2007). With this performance it has achieved a status of one of the fastest growing economies of Asian region. The growth momentum is due to dynamism in industry, agriculture and services, and the emergence of a new investment cycle supported by growth in investment demand. (www.lasbelachamber.com)

3.4 RATIO ANALYSIS 3.4.1 SALES ANALYSIS

DGKCC FY2005 Sales volume growth Sales revenue increase/(decrease) 21.81% 35.97% FY2006 15.80% 50.69% FY2007 12.31% (19.31%) LCL FY2007 111.29% 55.47%

The performance of the production plants of DGKCC at D.G. Khan site, during FY2006 and FY2007, was remarkable as it surpassed its rated production capacity. Capacity utilization during the FY2005, FY2006 and FY2007 was 94.97%, 112.10% and 113.40% respectively. The new plant at Khairpur site also started its commercial production in the last quarter of the FY2007 and after a few months it has reached its rated production capacity. During the FY2007, the sales revenue of DGKCC declined by 19.31% as compared to the FY2006 despite the surge in sales volume. This is because the cement industry suffered an over-supply situation due to new capacities coming on stream, consequently putting pressure on prices. The sales revenue of the company for the FY2006 was very impressive as compared to its previous year i.e. FY2005. During the FY2006 the company generated a sales revenue of PKR 7,956 million, 50.69% more than the FY2005. Both the volume growth and better selling prices contributed to this increase in revenue. During the second quarter of the FY2006 there occurred a catastrophic disaster in the country the earthquake on 8th October 2005, which wrecked hundreds of thousands of houses, buildings and roads. The rehabilitation work started thereafter suddenly increased the demand for construction material including cement and the selling prices rose by exception. This resulted in

favourable sales price variance of PKR 1,842 million in the FY2006 allowing DGKCC to enjoy huge profits. The sales volume of LCL during the FY2007 increased by 111.29% owing to more production capacity than DGKCC as a result capturing most of the cement demand in the country. While studying its sales price variance, the results are similar it also suffered an adverse sales price variance during FY2007.

3.4.2 PROFITABILITY RATIOS

DGKCC FY2005 Gross profit margin PBIT margin Net profit margin 36.91% 45.94% 31.86% FY2006 49.81% 49.13% 30.40% FY2007 31.65% 34.31% 25.27% LCL FY2007 29.35% 28.38% 20.34%

3.4.2.1 Gross Profit Margins During the FY2007, the gross profit (GP) margin of DGKCC was 31.65% i.e. for each rupee of sales the company made a GP of 31.65 paisa. The GP margin has declined as compared to the FY2006. Looking at sales and cost of sales in depth it is revealed that the major factor which resulted this decline was the fall in per unit selling prices. As per the general economic trend, energy and fuel prices are steadily rising in both international and local markets. Also the rising inflation is a threat to cost of production. The fall in GP margin in the FY2007 could have been much higher but due to the companys decision of using gas for heating the kiln it was prevented. As almost on average the energy expenses of DGKCC comprise over 55.00% of the cost of sales, the in-time decision of replacing coal with gas helped the company to save its profit margins by going further down.

DGKCC Profit Figures over the 3 year period

4,000 3,500 3,000 PKR million 2,500 2,000 1,500 1,000 500 0

Gross Profit PBIT Net Profit

FY2005

FY2006

FY2007

The GP margin during FY2006 was 49.81% which was a direct result of increased selling prices and sales volume. However, the fuel & power expenses made up 65% of the cost of sales. In the FY2005, the GP margin was 36.91% which can also be depicted by growth in sales volume and favourable selling prices. Comparing the GP margin of DGKCC with LCL for the FY2007, DGKCC still has a healthy GP margin i.e. 31.65% compared with 29.35%. While studying the cost of sales of LCL, the difference can be explained in terms of high proportion of fuel and power expenses comprising 65% of the cost of sales. Due to a better alternative solution of energy, DGKCC was able to secure a better GP margin than its industry competitor.

3.4.2.2 Net Profit Margins The net profit (NP) margins of DGKCC have shown a decline over the last three years but compared with the net profit of LCL, it is still a healthy margin. During the FY2007, although the company made lesser GP margin because of

lower selling prices, yet the NP was not affected with the same percentage. This is because during FY2007 the companys other operating income increased by 42.93% compared with FY2006, with MCB Bank Limited being the major contributor in dividend income i.e. PKR 420 million. Another factor contributing to this was the good control over its expenses by DGKCC. During the FY2006, the NP margin of DGKCC was 30.40% i.e. for each rupee of sales the companys NP was 30.40 paisas. While the GP margin in FY2006 was the highest of all the periods under study it was expected that its NP margin will also differ with the same percentage. But during FY2006 the company made provisions for deferred taxation of PKR 1,027 million, which eroded its NP margin. The reason of 121.34% high deferred tax in FY2006 as compared to FY2005 was the Khaipur site expansion project of the company inaugurated in the last quarter of FY2005. The NP margin for the FY2005 was 31.86% which is not much less than its GP margin i.e. 36.91%. This was the result of the fair value gain, included in other operating income, of PKR 527 million on derecognition of investment in shares of Umer Fabrics Limited upon its merger with Nishat Mills Limited and Nishat (Chunian) Limited.

3.4.3 RETURN-ON-INVESTMENT RATIOS

DGKCC FY2005 Basic earning power Return-on-assets ROCE ROE 13.46% 9.34% 16.21% 18.05% FY2006 11.39% 7.05% 13.82% 12.55% FY2007 4.26% 3.14% 4.97% 4.78% LCL FY2007 13.81% 9.90% 18.34% 27.23%

3.4.3.1 Return-on-assets The return-on-assets (ROA) is the ratio of net income to total assets. In FY2007, the ROA of the company was 3.14% i.e. for every rupee invested in assets the company earned 3.14 paisas. This ROA is 55.46% less than that of FY2006. The main reason was the company revalued both its long-term and short-term investments resulting cumulative revaluation surplus of PKR 14,986 million. As already during 2007, the profits margins were lower because of the fall in selling prices. This revaluation of assets resulted in decreased ROA. Had the revaluation not been done the ROA would have been 4.4%. The ROA for the FY2006 was 7.05% which was lower compared with that of FY2005 i.e. 9.34%. During FY2006 as the Khairpur plant was under construction, more investment was required in capital work-in-progress and the company was not getting any return as the plant had not become operating; plus a revaluation surplus of PKR 8,985 million arising on investments resulted in lower ROA. Otherwise, as the earnings during the FY2006 were the highest of the three years under study, the ROA would have been higher as well. 3.4.3.2 Return-on-equity The return-on-equity (ROE) is the ratio of the net income shareholders receive to their equity in the stock. The ROE for FY2007 was 4.78% which is very less as compared to 12.55% of FY2006. The main reasons are lower profits

margins because of lower selling prices; increased revaluation surplus on investments plus the right issue made during the year increased the equity. Similarly the ROE of FY2006 was affected by the revaluation in investments and the provision for deferred taxation hence resulting 12.55% ROE. The ROE for FY2005 was good among all three periods stemming from higher NP margin. LCL enjoyed a very high ROE compared with DGKCC. As in FY2007 the ROE of LCL was 27.23% which is very high as compared to 4.78% ROE of DGKCC. This is because of a huge revaluation surplus of PKR 22,868 million standing in the equity of DGKCC.

3.4.4 ACTIVITY RATIOS

DGKCC FY2005 Inventory turnover Debtors turnover Operating cycle Total assets turnover ratio Fixed assets turnover ratio 11 days 5 days 16 days 0.29 0.48 FY2006 21 days 3 days 24 days 0.23 0.41 FY2007 25 days 8 days 33 days 0.12 0.27 LCL FY2007 28 days 14 days 42 days 0.49 0.62

The inventory turnover days have increased during last three years which is probably because of the increase in demand and the company following high level stock policies. The debtors turnover days have also increased and were highest in the FY2007; this depicts lenient credit policies exercised by the company to boast its sales. Compared the operating cycle of DGKCC with LCL, we come to know that DGKCC has a healthier operating cycle and for FY2007 its average inventory was converted into cash in 33 days. The total assets turnover ratio shows the productivity of the assets. During the FY2007, the total assets turnover ratio was 0.12 i.e. for every rupee

invested in assets, the company generated 12 paisas of sales. The productivity of DGKCCs assets has decreased over the years. This is because of the upward revaluation of assets and the company not getting returns from its new expansion as the plant had not been become operating.

3.4.5 LIQUIDITY RATIOS

DGKCC FY2005 Current ratio Quick ratio 1.37 : 1 1.34 : 1 FY2006 1.65 : 1 1.61 : 1 FY2007 2.60 : 1 2.56 : 1 LCL FY2007 0.85 : 1 0.74 : 1

3.4.5.1 Current Ratio The current ratio indicates the firms ability to meet or cover its current liabilities using its current assets. The current ratio of DGKCC for the FY2007 was 2.60:1 i.e. the company has rupees 2.60 current assets to meets its 1 rupee current liability.

DGKCC Current Assets Vs Current Liabilities

Current Assets 20,000,000 18,000,000 16,000,000 14,000,000 12,000,000 10,000,000 8,000,000 6,000,000 4,000,000 2,000,000 0 FY2005 FY2006 FY2007 Current Liabilities

The current ratio of DGKCC has been continuously increasing during the period under study. This is due to the increased fair value of short-term investments during the FY2006 and FY2007. Other factors contributing to this increase are more stores, spares and loose tools and improved cash and bank balances. Moreover, the ideal current ratio is 2:1; DGKCC enjoys a much healthier ratio which depicts its strong position in terms of liquidity. 3.4.5.2 Quick Ratio The quick ratio of DGKCC has also been on the rise since the FY2005. Also the quick ratio is not much different from its corresponding current ratio which reveals that DGKCC has less investment tied up in inventory the least liquid asset, which is a good sign. Since the ideal quick ratio is 1:1, the quick ratios of DGKCC are going far above this. Measures should be taken to optimize the investment in working capital so as to avoid any opportunity losses. The current ratio and the quick ratio of DGKCC, when compared with the ideal figures and with those of LCL, are very strong and there are very rare chances of company not meeting its obligations when they become due.

3.4.6 FINANCIAL LEVERAGE RATIOS

DGKCC FY2005 Debt-to-equity ratio Interest coverage ratio 37.67% 7.98 times FY2006 31.89% 8.67 times FY2007 24.03% 4.71 times LCL FY2007 51.53% 4.12 times

3.4.6.1 Debt-to-equity Ratio Debt-to-equity ratio, also known as gearing, tells us how the firm finances its operations with debt relative to the book value of its shareholders equity.

Debt-to-equity ratio of DGKCC has decreased over the last three years which is a good sign. Although the debt has increased over this period but the equity has also improved by exception. The increase in equity is because of the exercised fair value of the investments during FY2006 and FY2007 and the right issue made during FY2007. Presently the company is low geared and its risk of solvency is also very low whereas LCL is highly geared with debt-to-equity ratio of 51.53%. It shows that LCL finances its operations more from debt as compared to DGKCC. 3.4.6.2 Interest Coverage Ratio The interest coverage ratio tells us how the firm can cover or meet the interest payments associated with debts. The interest coverage ratio of DGKCC for the FY2007 was 4.71 times which means that PBIT of DGKCC during this year was 4.71 times of its interest charges. Although the finance cost of FY2007 as compared with FY2006 has just increased by 3.88% but because of the lower PBIT this year, the interest coverage ratio has almost become half than the pervious year. Comparing this with the financial leverage of LCL it is still a healthy ratio. During the FY2006 the finance cost increased by 48.24% as compared to FY2005. But because of higher earnings during FY2006 the interest coverage ratio was 8.67 times of the PBIT becoming the highest of the period under study.

3.4.7 VALUATION RATIOS

DGKCC FY2005 Market value per share (PKR) Dividend per share (PKR) Earnings per share (PKR) Price earning ratio Dividend yield 80.40 1.50 9.12 8.82 1.87% FY2006 107.95 1.50 13.12 8.23 1.39% FY2007 91.28 1.50 6.43 14.20 1.64% LCL FY2007 100.71 1.25 9.67 10.41 1.24%

The market value per share of DGKCC was highest at the year end FY2006, thereafter, declining by 15.44% at the year end of FY2007. This is because during FY2007 the company made lower profits; plus there was a bonus issue and right issue during the year leading to an increased number of shares. EPS of FY2006 rose remarkably stemming from improved profitability and higher realised prices. However, in the following year, it declined. Major factors aforementioned were reduced selling prices per unit resulting lower profits, and bonus and right shares issued during the year leading to increased number of ordinary shares. The company has maintained its cash dividend per share of PKR 1.50 during all the three years even the company was carrying out its expansion project which involved huge expenditures. On the other hand, LCL declared a smaller dividend of PKR 1.25 per share for the FY2007. The price earning ratios of FY2005 and FY2006 have a nominal difference as the market value per share and EPS increased by almost the same percentage. However, in FY2007 it was highest which suggests that investors are expecting higher earnings growth in the future compared to the overall market, as investors are paying more for todays earnings in anticipation of future earnings growth.

In Pakistans market where majority of the investors seek capital gains on their shares i.e. growth investors, the high P/E ratio of FY2007 attracts these investors to buy DGKCC shares, whereas LCL with 10.41 P/E ratio stands second to it. A stocks dividend yield depends on the nature of a companys business, its posture in the marketplace (value or growth oriented), its earnings and cash flow, and its dividend policy. The dividend yield of DGKCC has been fluctuating with the market value per share of the company. Since, growth investors are concerned with capturing capital gains; dividend yield ratio is meaningless to them. However, it is a matter of historical record that dividend-paying stocks have performed better than non-paying-dividend stocks over the long term. (www.investopedia.com)

3.5 SWOT ANALYSIS

STRENGTHS DGKCC is the second largest cement producer in Pakistan with a production capacity of 4.2 mtpa. Unmatched preventive system resulting in remarkable capacity utilisation during the last couple of years. The company has European origin plant at Khairpur site which is a competitive advantage over other companies as Western plants carry lower long-term maintenance costs compared with the Chinese plants. DGKCC production processes are environmental friendly and comply with the World Banks environmental standards. It is the only cement factory in Pakistan certified for both ISO 9002 & ISO 14001. DGKCC has a diversified investment portfolio of group companies, which envelops entities like MCB Bank, Nishat Mills and Adamjee Insurance, providing sufficient cushion to its value against any volatility in the cement sector, besides making hefty contributions to the income of the company in the form of dividends. (www.fortunesecurities.com) Confidence of European Investment Bank, Luxembourg, which approved 35 million euro as a seven-year term loan facility for DGKCC to facilitate the expansion of its Khairpur cement plant. The loan carries a very competitive rate compared with local lending rates. This is the first ever finance facility extended by EIB to any private entity in the country. During the FY2007 DGKCC replaced 60% of its coal with gas used for heating the kiln which will result in energy cost savings in the future. High quality cement commanding premium prices. WEAKNESSES Since DGKCC is confined to Northern region only, it has to suffer huge transportation costs for development programmes in the Southern region. Its focus on the export market is very low.

OPPORTUNITIES Huge potential for the export of cement and capturing new international markets like India and Sri Lanka. Construction of mega dams as well as other ongoing infrastructural development by the government of Pakistan Expansion or acquisition in the Southern region to strengthen its position in that region THREATS Capacity additions by competitors can result in price wars and thereby erode companys profitability. Delay in construction of major dam projects due to shortage of funds as well as political obstacle will dent cement demand in the short run. Ongoing tussle between the cement manufacturers and Monopoly Control Authority (which is being given increased regulatory powers). The threat of political unstability is true for all the industries. Currently Pakistan is the major exporter of cement to Afghanistan and it also aiming to export to Middle-East and India. However, it should be noted that Iran is going to enter these markets soon. Iran, one of the major producers of low-cost cement in the world, is likely to capture the market in Afghanistan in the next two years. Iranian cement industry is planning to undertake two giant projects in India and Nigeria. (www.iran-daily.com)

3.6 PORTERS FIVE FORCES

Porters five forces model identifies the five forces that drive

competition within an industry. These five forces have been applied to the cement industry of Pakistan as follows: 1. Threat of new entrants The existing large companies are enjoying economies of scale which is a competitive edge over the smaller players and new entrants. Cement is a

commodity business and sales volume mostly depends upon the distribution reach of the company. Since the industry requires a heavy investment to set up a project for cement manufacturing, a wide distribution network; and looking at the performance during FY2007 when new capacities resulted an over-supply position and eroded profit margins, the risk of new entrants is very low. However, the government may encourage imports from cheaper markets by reducing excise duty if the local prices went exceptionally high. 2. Bargaining power of the buyers Bargaining power of the buyers is very low because the price is derived out of demand. Also there is similar pricing in the cement industry and lack of unity among the buyers. Another reason of this low bargaining power is the urgent need satisfaction. As even temporary shortages of cement can, as a result, frequently halt or disrupt construction programmes, larger users usually find it convenient to afford prevailing market prices to avoid any losses resulting from disruption. 3. Bargaining power of the suppliers Pakistan is fortunately rich in the deposits of limestone, clay and gypsum, which constitute basic raw materials for manufacturing of cement. (Jang News, 2004) As the raw materials are easily available and there exist a large number of suppliers as well, the prices of raw materials are very competitive. Whereas the prices of coal, gas and oil fluctuate with the International market. Due to both these factors, the bargaining power of suppliers is perceived to be low. 4. Threats from substitute products At present, there are no known substitutes of cement and thus there is no threat of substitute products. Cement is a basic commodity required by construction programmes for various infrastructures. Other building materials such as timber are only

suitable for low-rise buildings. On the other hand, although steel can be used for medium to high-rise buildings, building regulations normally require structural steel to be encased in concrete for fire protection purposes. This increases the importance of cement and hence reduces the threat of its substitutes. (Pheng & Bee, 1993) 5. Rivalry among competitors Although the industry giants are enjoying economies of scale and greater market share, the competition in the cement industry has become more intense because of the capacity additions by a large number of companies. The cement industry in the past has exploited the consumer by forming cartel and increasing the rates arbitrarily. However, with excess supply coming online, as evidenced by FY2007, the likelihood of violation of quotas and price floors under marketing arrangement has increased, especially by weaker players. This might lead to price wars and erode profit margins.

3.7 CONCLUSIONS
Keeping in view my project objectives, I have drawn the following conclusions from my analysis: Sales Analysis: Besides the positive trend in sales volume the sales revenue suffered a decline in the FY2007 which can be traced back to lower retention prices. The situation arose as the expanded capacities of various companies came online, leading to an over-supply situation in the industry. Performance Analysis: DGKCC has been enjoying increasing GP margins in the years under study with the exception of FY2007. The NP margin, on the other hand has been going downhill since FY2005. The FY2006 was most favourable in terms of increase in sales volume as well as higher prices. However, despite these increments, the NP margin of the company declined. This was because of a large amount of provisions for deferred taxation made in this year.

The ROA and ROE of the company have followed a trend similar to the profit margins but remained below that of the competitors averages. This situation may improve in the coming years as the Khairpur plant has started its commercial production. Other than being cost efficient, DGKCC has an advantage due to its equity investments, which act as a buffer in times of low prices. The companies in the portfolio are stable, safe and profitable. MCB Bank Ltd. has been the major contributor in the dividend income of DGKCC since FY2005. The productivity of the assets has declined over the years. This is because the company was not getting returns from its expansion project which involved huge investments in assets. Another reason contributing to poor productivity is the increased fair value of the companys assets. The liquidity position of the company has been strengthening since FY2005, at the same time remaining above the industry average. This can be depicted by the increased fair value of the companys short-term investments. The debt management ratio of DGKCC has shown a positive trend during the last three years. This has been a result of increased revaluation surplus plus retention of profits as well as issuance of new shares. On the other hand, the interest coverage ratio of the company declined in the FY2007 owing to lower profitability. Equity Analysis: In spite of huge investments in the expansion project and lower profitability during the FY2007, the company has maintained its dividend per share of PKR 1.50 for all the 3 periods under study. The increasing trend of EPS was broken in the FY2007 which can be attributed to the lower profits due to lower sales prices as well as an increase in the number of shares issued. The P/E ratio after suffering a nominal decline in the FY2006 increased to 14.20 in the FY2007. This increase attracts the investors seeking capital gains, to buy DGKCC shares.

SWOT Analysis: High quality cement, cost efficiency, secure and profitable investment portfolio and the confidence of lenders have been the key strengths of DGKCC. The attractive opportunities existing in the local as well as export market have been exploited very well according to the up-to-date news about DGKCC. The company is on its way to minimise its weaknesses. It has been planning an expansion in the Southern region and eyeing the potential Indian market as well. However, there exist a number of threats like delay in the construction of major dams, political unstability, tussle with the Monopoly Control Authority and Irans entrance into the export market. Porters Five Forces: At present, DGKCC has a very strong competitive position. It has no threat of substitutes whereas the barriers to entry in the cement sector are very high. The bargaining power of the buyers and suppliers of DGKCC is also very low. However, there exists an intense competition among the cement companies. As the cement companies carry huge fixed costs, they tend to operate at their full capacity thereby, at times, result in an over-supply situation which might lead to price wars.

3.8 RECOMMENDATIONS
The overall performance of the company has been very good. However, based on my analysis, I would recommend the company to focus more on its exports. As in the FY2007, the local cement industry suffered an oversupply situation; it would be profitable in the long-term to secure more of the export market. Doing an expansion in the Southern region or acquiring any Southern cement industry are also considerable options.

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Nishat group. http://www.pakistanaviators.com/group.html (visited 2 September 2008) Pakistans DG Khan Cement Eyes Indian Market. (2008) http://sg.biz.yahoo.com/070314/3/479jq.html (March 14) Pheng Low, S., Ong Bee, Tang. (1993). The Global Cement Industry. Published by NUS Press Porters Five Forces For Industry Analysis: Description. http://www.1000ventures.com/business_guide/mgmt_stategic_ca_byporter.h tml (visited 29 August 2008) Porters 5 Forces, Recklies Management Project Gmbh http://www.themanager.org/pdf/p5f.pdf (visited 30 August 2008) Profitability Ratios. http://kbr.dnb.com/help/ratios/Profitability_Ratios.htm (visited 28 August 2008) Ratio Analysis: Limitations. http://www.college-cram.com/study/finance/presentations/1150#sectop7 (visited 28 August 2008) Sabir, I. (2004) Cement Industry in Focus. Jang News. (August) Strategic Management: SWOT Analysis. http://www.quickmba.com/strategy/swot/ (visited 29 August 2008) SWOT Analysis (2008). Advanced Performance Management. ACCA Paper P5, BPP Learning Media SWOT Analysis: Limitations. http://jobfunctions.bnet.com/abstract.aspx?docid=72035 (visited 29 August 2008) Valuation Ratios. http://moneyterms.co.uk/valuation-ratios/ (visited 28 August 2008) Wazir, S.; Syed, F.; Rauf, Q.; Rehman, A. & Ahmed, Z. (2007). Industrial and Competitive Analysis, Cement Industry of Pakistan. National University of Science & Technology (NUST), Lahore, June 30

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APPENDIX A FINANCIAL STATEMENTS EXTRACTS

DGKCC Statement of Financial Position as at: FY2005 FY2006 FY2007 (all figures in PKR thousands) EQUITY AND LIABILITIES CAPITAL AND RESERVES 1,843,937 1,843,937 2,535,412 Issued, subscribed & paid-up capital 8,351 Share deposit money 7,196,568 15,085,354 29,630,084 Reserves 277,493 2,330,558 1,757,689 Un-appropriated profit
9,317,998 19,268,200 33,923,185

NON-CURRENT LIABLITIES Long-term finances Liabilities against finance leased assets Long-term deposits Retirement and other benefits Deferred taxation CURRENT LIABILITIES Trade and other payables Accrued markup Derivative foreign currency forward opt. Current portion of non-current liabilities Short-term borrowing secured Provision for taxation

4,899,225 131,985 28,674 45,765 537,000 5,642,649

7,372,468 28,886 33,814 26,572 1,559,000 9,020,740

8,686,447 1,141 79,467 39,862 1,624,000 10,430,917

1,154,426 960,620 306,048 599,674 35,090 3,055,858 18,016,505

1,406,869 340,757 2,613,695 1,619,025 35,090 6,015,436 34,304,376

1,027,274 342,612 3,942,972 2,042,281 35,090 7,390,229 51,744,331

ASSETS CURRENT ASSETS Property, plant and equipment Assets subject to finance lease Capital work in progress Investments Long-term loans, advances and deposits CURRENT ASSETS Stores, spares and loose tools Stock-in-trade Trade debts Investments Prepayments & other receivables Cash and bank balances

6,637,237 317,262 3,983,175 2,610,634 271,428 13,819,736

7,521,723 295,058 11,759,677 4,482,213 335,810 24,394,481

22,117,551 133,376 1,907,063 8,174,474 196,913 32,529,377

1,035,081 100,994 76,238 2,769,134 121,486 93,836 4,196,769 18,016,505

836,049 226,286 74,165 8,543,763 152,465 77,167 9,909,895 34,304,376

1,496,291 295,140 144,245 16,933,790 229,315 116,173 19,214,954 51,744,331

DGKCC Statement of Comprehensive Income: FY2005 FY2006 FY2007 (all figures in PKR thousands)
Net sales Cost of sales Gross Profit Administration expenses Selling and distribution expenses Other operating expenses Other operating income Profit from operations Finance cost Share of loss of associated companies Profit before tax Taxation Profit for the year
5,279,560 (3,330,769) 1,948,791 (76,480) (60,905) (93,786) 707,692 2,425,312 (304,041) 2,121,271 (439,193) 1,682,078 7,955,665 (3,992,822) 3,962,843 (121,953) (34,352) (191,850) 294,114 3,908,802 (450,696) (9,573) 3,448,533 (1,030,078) 2,418,455 6,419,625 (4,387,640) 2,031,985 (104,169) (65,122) (139,307) 479,420 2,202,807 (468,173) (14,163) 1,720,471 (98,000) 1,622,471

The above stated financial statements have been extracted from the audited annual reports of DGKCC.

APPENDIX B QUESTIONNAIRE & ITS RESPONSE

D.G KHAN CEMENT COMPANY LIMITED

QUESTIONNAIRE
1. Please provide me with an insight to the cement industry of the country? 2. What is the corporate structure of the company? Its group? 3. What are the main products and brands of the company? 4. Where are the production factories located? 5. What are the basic operations of the company? 6. How does the company distribute its products? 7. What are the future plans of the company?

RESPONSE
1. The cement Industry of Pakistan is divided into two regions; the Northern region and the Southern region. As northern region is most rich in the raw materials of cement as compared to the southern region it caters most of the cement demand of the country. The industry stands second in contributing to Pakistans economy after textile. 2. DGKCC is the second largest project of Nishat group which is among top five business houses of Pakistan. Although DGKCC does not own any subsidiary, the companies in its investment portfolio are strong and give healthy returns. DGKCC owns 9.20% equity of MCB Bank Ltd. (4rth largest bank of the country) along with 12.00% of Nishat Mills Ltd. (largest textile exporter in Pakistan) and 3% of Adamjee Insurance Company Ltd. (a leading insurance company). In the last five years the company has been involved in joint ventures with Shuaiba Paper Products Company, Kuwait and Gulf Baraka Apparel of Bahrain. The names of the associated companies are Nishat Shuaiba Paper Products Company Ltd. (NSPPL) and Gulf Nishat Apparel Limited (GNAL) which produce paper sacks for packing of cement and all forms of apparel products respectively. During the FY2007 the company invested in a new business of Hotels and Properties to further diversify its investments. The associated companys name is Nishat Hotels and Properties Limited (NHPL) and is under control of Nishat group.

3. DGKCC produces two different products namely Ordinary Portland Cement and Sulphate Resistant Cement. These products are marketed through two different brands: DG brand & Elephant brand Ordinary Portland Cement DG brand Sulphate Resistant Cement 4. At present the company has two production sites. The DG Khan site plant located at Khofli Satti, district Dera Ghazi Khan and the Khairpur site plant located at a distance of 12 kilometers from Choa Saidan Shah Road, Khairpur, Tehsil Kallar Kahar, District Chakwal, Pakistan. 5. The operations in which the company is involved are: power generation, purchasing, mining, crushing, grinding, burning, storing, packaging and marketing. 6. The company has a wide distribution network and its products are distributed through its four regional sales offices which are located in Lahore, Multan, Dera Ghazi Khan and Karachi. Moreover, direct sales are also made to institutional clients for mega projects. 7. The company is considering the acquisition of Pioneer Cement Company to expand its production capacity and market share as well as the evaluation of an expansion in Hub is under consideration. The new expansion would result in increased exports as the proposed site is located near the sea.