A quick review of the regulatory developments during 2017 suggests that these played a key role in shaping the performance of Pakistan’s economy. The key sectors benefitting from various policy actions taken during the year under review included: 1) Textile — benefiting from export package offering various incentives to the export sector, 2) Fertilizer — gaining strength due to permission to export urea and payment subsidy, 3) Steel manufacturers — coming out of red due to imposition of regulatory duty on imported CRC/billets/re-bars, 4) Oil & Gas Exploration – benefiting from revision in wellhead gas prices and 5) OMCs – bottom line improving with increase in margins on motor gasoline and deregulation of high speed diesel pricing. While significant additions to generation capacity were made, operational sustainability of the power sector, particularly furnace oil based power plants, came under pressure with the Government of Pakistan (GoP) announcing abrupt closure towards the end 2017. Adverse impact of the decision was evident on Refineries, OMCs and Exploration sectors in terms of lower offtake. Going forward, following popular policies by the incumbent government seems inevitable as elections draw nearer:
Independent power producers
Recent policy changes by the federal government had clear and definite negative impact on independent power producers (IPPs). Lowering the load factors enhanced uncertainty over their long term performance and outlook of the entire power chain. While recent devaluation bodes well for the sector in general (5% additional devaluation leads to 5.3/8.3% increase in HUBC/KAPCO earnings). Analysts highlight that payout streams solely depend on disbursements from the power purchaser (GoP through NTDC & WAPDA) to the entire energy chain. With outstanding receivables of HUBC were reported at Rs72.21 billion and that of KAPCO at Rs80.13billion for 1QFY18, added another Rs5.8billion and Rs3.2billion FYTD respectively. Honoring the capacity payments remains the key to sustained payouts for investors. Since both the IPPs are classified as relatively inefficient, the government might as well plan to run them at significantly lower load factors (less than annual 50%). This will in-turn create a burden on the total cost of generation (CPP+EPP) as mandatory capacity payments will be paid for HUBC/KAPCO as well as other plants which have been commissioned.
With 60% share in total exports, textile sector would be the key beneficiary from recent rupee depreciation of 5%. In this backdrop, analysts expect textile exports to grow by 7.5%YoY in FY18. However, already benefitting from export subsidy, industry demands further incentives (electricity tariff reduction) has a low likelihood of materializing given lack of fiscal space. On a cumulative basis, textiles and clothing exports during 5MFY18 has been largely supported by recovery in final product prices. Going forward, recent rupee depreciation coupled with approval of 50% unconditional export subsidy is expected to drive exports growth.
Pakistan’s total exports during November 2017 registered an encouraging growth of 12.35%YoY/4.56%MoM to US$1.97 billion where both textiles (up 7.45%YoY) and food exports (up 22.19%YoY) witnessed an upward trend. A likely impact of increase in final product prices, textile exports maintained its recovering trend in November 2017, rising 7.45%YoY to reach US$1.12 billion. Segment wise, value added-segment once again led the exports growth, up 11.6%YoY to reach US$826 million, while low value-added segment remained under pressure, declining 2.6%YoY to US$264 million. Failing to maintain recovering trend seen in October 2017, low value added exports once again declined primarily due to strong domestic demand for cotton yarn, leading to 13.7%YoY decline in yarn exports.
Being the second of the ongoing pandemic expansion cycle (first in the south region), Lucky Cement (LUCK) has successfully commissioned its brownfield expansion of 1.30 million tons per annum (mtpa) at Karachi plant. This would be followed by a 1.2mtpa brownfield expansion of by ACPL and 2.8 mtpa greenfield expansion by DGKC at Hub, Balochistan. Post completion of the first expansionary phase (5.3 mtpa) in South, capacity utilization in the region/total industry is expected to drop at 57%/82% by 1QFY19 from 93%/86% in FY17, assuming demand growth of 8%. Consequently, this is likely to create significant supply side pressures, exert pricing pressure in the short term, where the prices have so far remained stable. As against this in the North region cement prices have declined by 6.5% since June 2017. Out of the ten announced expansions in North (totaling 19.6mtpa), only 5 have been able to achieve financial close for 9.30mtpa).
Analysts see the pace of expansion to be gradual in North with additions coming online in a phased manner — the first expansion is expected to commence commercial production in 4QFY19. This should allow prices in the North region to stabilize at current levels as capacity utilization is anticipated to hover around 90% in the medium term. In the North region, the first expansion by MLCF (2.20mtpa) will be followed by 4 expansions of cumulative 7.10mtpa, likely to commence commercial production by the end FY20. Despite these supply additions (totaling 9.30mtpa), analysts see capacity utilization of North to settle around a comfortable level of 85% by the end of FY20 against 84% in FY17. In this backdrop, analysts expect prices in the North region to stabilize at current levels. Furthermore, the remaining additions also pose no significant threat in our view as they currently stand at very initial stages with completion likely to take time. Assuming these units come online by FY22, capacity utilization of North region would still remain above 82% by the end of FY22.