Cost containment strengthens Tokyo Cement financials despite worsening construction environment

• 2Q and 1H financial results show big jump from low base a year ago
• Deployment of aggressive cost management policies and efficiency improvements proactively reduce operational and marketing cost but warns some of these efficiency optimisation tools to deal with the economic downturn would not be sustainable in the long-term
• Opines cement demand projected to continue on its current trajectory until economic reforms in place to stimulate consumption and interest rates are revised to encourage investments in new construction projects
• Cautions until a positive momentum of industry is clearly indicated, the company will continue to apply the cost containment measures 
• Says higher income tax proposed will have a significant impact on future earnings 
• Two back-to-back price reductions of Rs. 100 and Rs. 125 per 50 kg bag on 5 Oct. and 1 Nov.
• Industry absorbs VAT increase of 15% from 3% and 2.5% of SSCL without transferring additional cost to customers

Tokyo Cement Company (Lanka) PLC has posted commendable financial performance in the 2Q and 1H of FY23, largely due to cost containment measures amidst worsening construction industry status quo.

In the 2Q ended on 30 September 2022, Tokyo Cement Group (Tokyo Cement) reported a turnover of Rs. 14,010 million (up 18% year-on-year) and a profit after tax of Rs. 3,176 million (up 2,314%). 

The company said this margin growth is underscored by the base effect of the low profitability across comparative quarters, in addition to strategic cost containment implemented by the Group to address the urgency of the economic situation.

Tokyo Cement said throughout the six-month period, the Group deployed aggressive cost management policies and efficiency improvements that proactively reduced operational and marketing expenditures and restructured overhead costs in the ready-mix business. 

Due to reduced cement demand, the plants were running at their lowest capacity utilisations, further containing operational costs with only essential maintenance, reduced costs associated with labour and overtime, and lower energy consumption.

Whilst this contributed to a superficial hike in profitability, some of these efficiency optimisation tools deployed to deal with the economic downturn would not be sustainable in the long-term. As such, once demand picks up with the gradual resumption of construction activities, the company would be obliged to fully operationalise production functions, which would be proportionally reflected in operational expenditure.

Turnover for the six months ended 30 September 2022 grew by 34% to Rs. 30,317 million. However, the Group recorded an Exchange Loss of Rs. 3,674 million. The Group was negatively impacted by a total exchange loss of Rs. 8,733 million accumulated over the course of the calendar year thus far, exerting significant pressure on the Group’s cash flows and negating the positive performance. 

In this period, the company imported raw materials on Letters of Credit which are incurring interest at an average rate of 30% thereby elevating finance costs. After tax profit amounted to Rs. 3.7 billion, up year-on-year by 764%.

Tokyo Cement said the construction industry continued to contract with cement demand halving against the same quarter of the previous year. This downward trend is a culmination of factors including currency depreciation, economic and political instability, reduced availability, affordability of construction materials and labour and spiking interest rates, all of which disincentivised the commencement of new construction projects. 

Additionally, the sector was considerably impacted due to the pausing of infrastructure projects and billions worth of overdue payments outstanding to Government sector contractors. Ongoing power cuts and fuel shortages added further pressure on daily life and businesses throughout the quarter.

At the beginning of the quarter the price of a 50 kg bag of cement increased to Rs. 3,200 from Rs. 3,000, to reflect the 22% depreciation of the rupee in the prior quarter (to be settled in 02), and the 59% increase of Auto Diesel prices that inevitably hiked up transportation costs. Furthermore, Tariff rates of almost all utility services including telecommunication, electricity and water were also increased substantially, further pushing up the cost of operations.

In early July, the Central Bank of Sri Lanka (CBSL) increased the Standing Deposit Facility Rate and the Standing Lending Facility Rate by 100 basis points to 14.50% and 15.50% respectively. To assuage the impact of dollar shortage on domestic consumption, import restrictions continued throughout the quarter. 

Meanwhile, the headline inflation, as measured by the Y-o-Y change in the National Consumer Price Index (NCPI, 2013=100) increased from 70.2% in August to 73.7% in September 2022. 

Given this scenario, the cement industry absorbed the increase of Value Added Tax by 3% (to 15% overall) from 1 September, and the introduction of the 2.5% Social Security Contribution Levy (SSCL) from 1 October 2022, without transferring the additional costs to the consumers.

Falling global oil prices towards the end of the quarter eased the pressures on country’s foreign reserves, whilst tight fiscal controls enforced by the CBSL helped the rupee to stabilise to a certain extent at around Rs. 367-370 to the dollar. This contributed to the reduction of the price of essential goods including fuel and LP Gas.

This also allowed the cement industry to announce a price reduction of a 50 kg bag of cement from Rs. 3,200 to Rs. 3,100 to take effect from 5 October 2022. Local cement manufacturers announced a further reduction of Rs. 125 on a 50Kg bag of Cement, bringing it down to Rs. 2,975 from 1 November 2022, corresponding to the gradual decline of production costs.

The Government remains confident of receiving an Extended Fund Facility of about $ 2.9 billion from the International Monetary Fund (IMF) by the end of the year, as part of the preliminary Staff-Level Agreement reached in end August. Subsequently the country anticipates borrowing upwards of $ 3 billion from other sources next year, required for essential imports to ease the pressures on daily life.

Tokyo Cement statement acknowledged that the Government is in the process of implementing key policy reforms advocated by the IMF in the form of increasing direct taxes and restructuring state income and expenditure. Accordingly, the newly announced corporate income tax increase from 18% to 30% for manufacturing companies, is slated to come into effect from 1 October 2022. This will have a significant impact on the company’s earnings during the remainder of the current Financial Year.

“However, cement demand is projected to continue on its current trajectory until economic reforms are in place to stimulate consumption and interest rates are revised to encourage investments in new construction projects. Until a positive momentum of the industry is clearly indicated, the company will continue to apply the cost containment measures already in place to safeguard its financial position,” Tokyo Cement added.