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Geopolitical tensions keep bulls away; mini-budget, IMF package and Sukuk may retake shine

The movements at Pakistan Stock Exchange (PSX) during the week ended 1st March 2019 were largely reflective of the prevailing geopolitical tensions between Pakistan and India. The benchmark Index touched a low of 37,323 points, but managed to close the week at 39,539, posting a paltry decline of 477 points or 1.2%WoW. The Index declined by 6.7% mid-week as cross border tensions escalated and panic kicked in leading to an across-the-board sell-off. However, market recovered 1,369 points as investors took positions on dips. The increasing possibility of de-escalation amid calls from international community brought back the confidence in the following days.

In the wake of volatility, average daily volume at the bourse rose to 152 million shares, up 45%WoW. Volumes leaders of the week were: BOP, KEL, PIBTL and EPCL, while laggards included ASTL, EFOODS, HASCOL and PIOC.

Key news flows during the week were: 1) violation of LoC by Indian aircrafts, 2) escalation of cross-border tension after Pakistan brought down two IAF jets in a brief engagement, 3) Prime Minister Imran Khan offering peace talks to India while announcing the release of captured Indian pilot, 4) decline in repatriation of profits by 33%YoY during first seven months of current financial year, 5) oil prices increasing after OPEC’s statement to continue oil output cuts and 6) Fitch anticipating a US$12 billion IMF bailout for Pakistan.

The first round of cross-border engagement ended with the return of captured Indian pilot. The upcoming week is likely to be affected by how the two nations deescalate the recent geo-political tensions, especially in the face of the upcoming elections in India. With the result season behind us, in addition to geo-political news, market action will be shaped by passage of mini-budget through parliament, clarity on IMF package and any news-flow regarding issue of Sukuk for the resolution of circular debt issue.

The total liquid foreign exchange reserves held by the country were reported at US$14,815.8 million on 22nd February 2019. The break-up of foreign reserves indicated State Bank of Pakistan (SBP) holding US$8,036.8 million and net foreign reserves held by commercial banks at US$6,779.0 million. Reserves held by the central bank decreased by US$6 million to US$8,036.8 million during the week under review.

During February 2019 profit-taking was evident in equity market from the decline in benchmark index by 4.3%MoM to close at 39,054.61 points. Average daily traded volume rose to 148 million shares, higher than 133 million shares during January 2019. Geopolitical tensions kept market under pressure, where knee-jerk movements remained the major driver. Nevertheless, wider systemic constraints (fiscal and external) weighed on sentiments, where clarity on a potential IMF program (salient points of contention, calls for specific reforms) is the major milestone to cross. Profit-taking was on the back of: 1) economic considerations, 2) financial results of heavy-weight companies failing to impress investors, with the energy chain forgoing key mid-year payouts and 3) geo-politics (at the tail-end of the month) giving rise to risk-off sentiments. Foreign participation witnessed a progression with inflows reported at US$32.3 million in February as compared to US$16.2mn in January. Cumulative Inflows were centered around Cements (US$11.0 million) and Commercial banks (US$9.8 million).


According to a report by Topline Securities, cement manufacturers have posted profitability growth of 4%YoY during 2QFY19 as compared to 26%YoY decline witnessed in 2QFY18, mainly on the back of lower effective tax rate as pretax earnings were down by 15% YoY. The working of brokerage house is based on result analysis of 13 listed producers out of a total of 17 that represents 97% of total cement companies’ market capitalization.

An interesting observation of 2QFY19 result was the significant contraction in effective tax rate of the industry where effective tax rate lowered 15ppts to 14%, which was the only reason for the sector’s profitability growth. This was amid tax benefits given under 65B of the Income Tax Ordinance, 2001 on account of investment in new cement lines to select companies in addition to adjustment of deferred taxes.

DGKC and CHCC booked tax reversal, cumulatively amounting to more than Rs700 million due to aforesaid reasons. DGKC booked investment credit on its new line (carried forward from last year) and benefit of deferred tax asset arising in 2QFY19. Moreover, the company is still left with huge deferred tax assets on account of depreciation on new (South) cement line which DGKC can avail in the coming quarters.

Industry volumes grew by 5%YoY in 2QFY19 due to exponential growth in exports, up 60%YoY, while local dispatches remained almost flat. This hike can be attributed to: 1) Pak rupee depreciation, 2) additional production from new capacities in South and 3) higher clinker sales to regional countries on the back of closure of some clinker production lines in China owing to strict environmental regulation.

Gross margins dropped to 26% during the quarter under review. Margins contracted amid increase in production costs during the period under review, on the back of: 1) higher coal prices along with currency depreciation, 2) increase in re-gasified liquefied natural gas (RLNG) cost due to rising international oil prices and 3) inflationary pressure.

However, on QoQ basis, gross margins improved due to higher net retention prices and lower depreciation charge for DGKC. The Company has extended useful life of some of its PP&E that led to lower depreciation charge during the quarter. Top three cement producers that witnessed improvement in their gross margins on QoQ basis were KOHC, DGKC and FCCL.

Financial charges were up substantially as producers’ books are now heavily leveraged owing to capex requirement to fund new lines or upcoming expansions, coupled with higher interest rates. Benchmark interest rate has now reached 10.25% per annum, up 450bps since Jannuary 2018 to date. The heavily leveraged companies are DGKC, MLCF, CHCC, POWER and PIOC.

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