PPC pushes pricing power

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PPC confesses to cartel

Profits drop 40%.

PPC doesn't need a cartel to dominate.

JOHANNESBURG - Earnings plunged, the dividend is down, volumes have fallen and management is playing it safe by holding back more cash than last year. This, however, doesn't tell the full story of PPC (JSE:PPC).

The construction company's free cash flow (ie, the cash left after all the operational needs have been met) points to a rebound if it maintains volumes and margins. This was up 5% to R1.7bn, or R3.47 per share. This means PPC shares are trading just less than ten times the free cash flow.

Management admits that the cement producer is known and valued for predictability, strong cash flows and dividends. How are the pressures of the Competition Commission, Eskom, wages and BEE affecting PPC? What happens to shareholder's dividends under these pressures?

On the Competition Commission admission, CEO Paul Stuiver says "it's a huge disappointment and shock". He goes on to emphasise that it is only with regards to market sharing, not price fixing.

The commission also takes issue with the detailed sales data supplied by cement producers to the industry body (Cement and Concrete Institute). Stuiver says the data was too detailed and submissions have been stopped until the related investigations are concluded.

This is despite the fact that if one has an agreement not to go into a specific market then whoever is there has some form of pricing power.

Stuiver acknowledges the cost pressures on PPC, saying that as a number of long-term supply contracts came up for renewal, the company managed to push through significant price increases. Internal inflation over 2009 was 20%, compared to 2008 at 15%.

The source of these cost pressures are important going forward. The biggest cost is distribution, making up 27% of the total cost of a delivered bag of cement. This hints at one of PPC's advantages in the market place.

Stuiver elaborates on this saying "we're present in eight places in southern Africa whereas the rest are in one or two". PPC has flexibility and efficiencies that the other players don't have, he believes.

These efficiencies were present in the current results too. Stuiver enthusiastically relayed the story of how the new cement production equipment had significant efficiency benefits over the older equipment. This is mostly with regards to energy consumption, having dropped over 15% since 2000.

Stuiver believes this is one of the key reasons the company was able to maintain its EBIDTA margin around 42%. EBITDA stands for earnings before interest, tax, depreciation and amortisation, thus is essentially revenue minus cost of sales.

EBITDA is important as 16% of the decline in headline earnings was driven by depreciation. In fact, the depreciation charge was almost the same as the BEE charge. The biggest was tax, at 38%.

The story that cement demand has slumped is well-known. PPC says it has only had a contraction of 10% in sales versus an 11.4% decline in South African demand. This demand decline isn't all bad; it has provided the company with cost-cutting opportunities. For example, mines now only run at night thus paying lower off-peak electricity tariffs.

Stuiver gave some guidance to analysts, "assume demand for next year will be the same as this year". He also says management's aim is to maintain EBITDA margin and return on the assets the company has.

Stuiver really spoke about caution and tentative steps forward, believing the economic recovery both here and in Zimbabwe is tentative.

Write to Chris Blaine: chris@moneyweb.co.za

* Chris Blaine owns shares in PPC