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Index down over lack of IMF talks courage, Saudi prince visit a delight

Building on last 5-week momentum, the market started the week on a positive note as the market participants were carried away by the announcement of potential financial assistance of US$2.5 billion from China. However, the KSE-100 Index lost earlier gains in the following three sessions due to the lack of concrete developments on the IMF bailout package. The benchmark Index of Pakistan Stock Exchange (PSX) closed the week at 40,887, down 226 points. Cement scrips remained in the limelight, initially gaining on softening coal prices, but lost earlier gains on disappointing January 2019 offtakes. Trading activity picked up slightly up 9.5% WoW to average daily turnover of more than 191 million shares. Key news flows impacting the market during the week included: 1) Government officials hinting towards another financing support of US$2.5 billion from China, 2) international credit rating agency Standard & Poor’s downgrading Pakistan’s long-term credit rating to ‘B-Negative’ from ‘B’, citing fragile external position and weak growth outlook, 3) Pakistan and Russia inking an inter-corporate agreement for the laying of more than 1,500 km offshore gas pipeline costing US$10 billion, 4) total cement dispatches declining by 10.7%YoY to 3.6 million ton in January 2018, with a more pronounced decline in local offtake and country’s foreign exchange reserves marginally rising to US$14.88 billion during the week ended 1st February 2019.

Key performers over the week were: FCCL, DGKC, CHCC, MLCF and INDU, while laggards included: HASCAL, HBL, PSO, UBL and EFOODS. Market performance is likely to remain range-bound until clarity emerges on the IMF program. However, upcoming Saudi Crown Prince’s visit to Pakistan, with the likely announcement of multibillion-dollar investment deals could trigger a short-lived euphoric rally. The most important will remain foreigners buying interest in setting market direction and continuation of the trend could keep the market upbeat.

Engro Fertilizer (EFERT) recorded 22%YoY growth in its 4Q profitability, driven by growth in DAP volumes coupled with increase in urea and DAP prices. While urea sales during 4Q2018 were down 2%YoY. Gross margins fell short of analysts’ expectations at 41.5% for urea segment (unconsolidated) as compared to 47.4% in 3Q2018 despite increase in urea prices by Rs130/bag becoming effective in October 2018 on back of increase in gas prices (feed and fuel both). This increase in gas price was applicable only to 30% of EFERT’s gas as remaining of its gas is on concessionary fixed rate and Petroleum Policy 2012.

Analysts believe, gross margin (GP) of Company trimmed QoQ due to impact of currency devaluation as 70% of Company’s gas prices are indexed to US$ PKR parity. Finance cost remained flat during 4Q2018, while increased 22%QoQ due to higher debt borrowing and increase in policy rate. Admin cost of the company increased by 42%YoY, while other income dropped by 88%YoY. Company declared dividend of Rs3.00/share. We believe the company is maintaining stock of surplus cash to finance its upcoming GIDC resolution. The threats faced are: 1) PKR depreciation, 2) regulatory control on fertilizer industry, 3) poor crop season and 4) unfavorable decision related to GIDC as key risks to our earnings/valuation forecast.

EFOODS posted 4Q2018 LPS of Rs0.59, contrary to market expectations, as lower than expected margins and higher distribution expense weighed down on bottom-line. However, the company’s net sales, for the first time in last 13 quarters, witnessed increase, up 13%YoY. Analysts attribute this to higher sales from dairy segment on the back of new products and gradual improvement in UHT market share. The company reported gross margins of 8.7%, down 465bps in 4Q2018. Inflationary pressure, higher imported raw material cost on the back of Pak rupee depreciation (24% since Dec 2017) and higher fixed charges led to lower margins.

 

EFOODS’ distribution expenses were higher by 36%YoY during the outgoing quarter. Analysts attribute this to higher advertising expense as the company had been aggressive in media campaigns to re-position its Olpers and Tarang brands. Financial charges were up 53% owing to increase in the company’s short term borrowings and higher interest rates, up 450bps since Jan 2018. Likely potential threats are: 1) rising competition 2) decline in processed milk consumption, 3) any unanticipated regulatory change and 4) volatility in international raw milk prices as key risks for EFOODS.

Local cement dispatches continued their disappointing run into CY19, falling by 18%YoY to 3.1 million tons in January 2019. North led the decline, with a decrease in total dispatches of 22%YoY, while South’s local dispatches declined marginally by 1.1%YoY. The overall economic slowdown has taken a toll on dispatches as MoM decline of 6.4% is on the back of seasonality where heavy rain/snowfall and cold weather leading to a slowdown in construction. Cumulatively, local dispatches for 7MFY19 were reported at 22.6 million tons, down 4.0%YoY. Moving forward, analysts expect the local demand to remain dismal with no major demand catalyst on the horizon in medium term as government adhered to its policy of fiscal consolidation resulting in slowdown in infrastructure spending as 43% of PSDP has been released so far whereas only 28% of the budgeted amount has been released under the head of ‘Planning, Development & Reforms.’

Exports on the other hand have been the saving grace for the sector, increasing by 67.5%YoY in January 2019, as south based players capitalize on the lack of clinker capacity in Bangladesh and Sri Lanka, though hurting their margins along the way with the clinker export price ranging between USD35-40/ton as compared to cement export price of USD50-55/ton. Consequently, the region’s utilization stands at 89% for 7MFY19. For January 2019 alone, utilization was registered at a stellar 92%. Moving forward, with no significant clinker capacity additions lined up in Bangladesh or Sri Lanka, exports will continue to avert the threat of price war in South despite significant excess capacity in the region.

The surplus capacity and soft demand make the market dynamics ripe for a price cut where the initial signs have been unveiled in Peshawar with prices decreasing by Rs10/bag in January 2019. However, prices in Punjab seem to be firm though the supply in the market has started to increase after commissioning of CHCC’s expansion. Commissioning of MLCF’s expansion of 2.2 million tons, scheduled for April 2019, can be a trigger in this regard with the company located in Mianwali (closer to the Punjab market). Analysts reiterate a decline in average prices of the region by Rs30-40/bag in 2HFY19 and consequently highlight a threat to margins, but declining coal prices may provide some respite.

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