CPAC

Business Context and Reporting Period

Company: Cementos Pacasmayo S.A.A. (NYSE: CPAC)
Reporting Period: Third Quarter (3Q18) and Nine Months (9M18) ended September 30, 2018.
Business Overview: A leading cement company in Peru serving the construction industry, producing cement, concrete, precast, and quicklime. The company operates primarily in the northern region of Peru.

Key Financial Metrics

Margins (3Q18 vs 3Q17):

• Gross Margin: 36.4% (down 3.5 pp)
• Operating Margin: 21.6% (down 1.0 pp)
• Cement EBITDA Margin: 31.9% (down 0.5 pp)

Material Changes vs. Prior Period

3Q18 Performance:

• Volume: Sales volume of cement, concrete, and precast increased 1.9% year-over-year, driven by recovery in the self-construction segment and small/medium projects.
• Revenue: Decreased 4.4% due to a shift in product mix toward lower-priced cement and slight price reductions.
• Profitability: Net income fell 13.5% to S/ 33.4 million. This was primarily caused by higher coal prices, increased raw material costs (specifically seashells in Piura), and the product mix shift.
• Costs: Administrative expenses decreased 13.7% due to reduced consultancy and personnel costs.

9M18 Performance:

• Volume: Sales volume increased 3.8% year-over-year.
• Revenue: Increased 3.1% to S/ 921.6 million.
• Profitability: Net income rose 6.4% to S/ 86.7 million, driven by operational efficiencies and higher operating income.
• EBITDA: Cement EBITDA margin improved 0.6 percentage points to 30.8%.

Guidance, Outlook, and Risks

Management Commentary & Outlook:

• Recovery Trend: Management notes a reversal of the low construction activity seen during the World Cup season, with volumes returning to positive growth. Sequential volume growth was 14.3% in 3Q18 vs 2Q18.
• Strategic Initiatives: The company is expanding into "building solutions," including concrete pavement roads (e.g., Sanchez Cerro Avenue in Piura) and a new dry cement product line ("Rapimix").
• Infrastructure Pipeline: Expectations for 2019 include the execution of Piura and Chiclayo airport projects, the Chimbote Bypass, and accelerated El Niño reconstruction works.
• Ready Mix Growth: Ready mix sales increased 19% year-to-date; management expects this trend to continue.

Risks and Contingencies:

• Input Costs: Rising coal prices and raw material costs (seashells) are pressuring margins.
• Logistics: Road blocks by producers and damage from Coastal El Niño have impacted transportation costs and shipping ability.
• Market Mix: A shift toward selling to small and medium-sized companies increases logistics costs and lowers average selling prices compared to large infrastructure projects.
• Political/Economic: Regional elections and potential delays in large infrastructure projects remain variables, though the political climate is viewed as stabilizing.

Investor Verification Checklist

• Margin Compression: Verify the sustainability of the 3.5 percentage point drop in gross margin given rising coal and raw material costs.
• Debt Structure: Confirm the impact of the S/ 990 million debt load (US$ 300 million bonds) and the effectiveness of the cross-currency swap hedges against exchange rate volatility.
• Infrastructure Execution: Monitor the actual start dates and cement demand from the anticipated 2019 infrastructure projects (airports, bypasses) and El Niño reconstruction.
• Product Mix Shift: Assess the long-term profitability impact of the strategic shift toward lower-margin concrete and precast products for small/medium clients versus traditional cement sales.
• Quicklime Segment: Review the significant decline in quicklime sales (-47% in 3Q18) and its impact on overall diversification.