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Equities remain volatile in Jan-Mar 2019 quarter on news of IMF, FATF, Pak rupee and MSCI frontiers

Pakistan equities remained volatile during the outgoing quarter (Jan-Mar 2019). The benchmark index of Pakistan Stock Exchange (PSX) KSE-100 gained 4.3% QoQ. The highest (one day) gain during the quarter was 2.70% posted on 2nd January due to positive investor sentiments after securing a US$3 billion support package from UAE, at the beginning of quarter. The sharpest single day decline of 2% was observed on 26th February due to Indo-Pak conflict, though subsequently the market recovered on the intervention of global powers.

During the quarter the key concerns remained 1) negotiations between International Monetary Fund, 2) apprehensions about Pakistan’s demotion to MSCI Frontiers, 3) FATF reservations and 4) ongoing depreciation of Pak rupee, keeping investors on the sidelines during the outgoing quarter.

The average daily trading volume for the quarter was recorded at 131 million. Foreigners emerged net buyers of over US$29 million as against net sellers of US$215 million in the previous quarter.

State Bank of Pakistan (SBP) has announced an increase of 50 basis points in its Policy Rate to 10.75% (almost 7-year high), taking cumulative increase since January 2018 to 475bps. It is a signal by the central bank that the macroeconomic situation of the country remains constrained. Stated primary reasons for the hike were: 1) persisting inflationary trend, 2) worsening fiscal situation and 3) continuing external account deterioration. Moreover, SBP now expects real GDP growth rate to fall to 3.5% as against 5.2% posted in FY18. Pakistan has received US$2.1 billion earlier during this past week from China, a total of US$9 billion inflow since the incumbent government was installed in July 2018. The latest hike in interest rate came after the visit of the new country chief of the International Monetary Fund (IMF). According to the news reports, Pakistan is likely to secure a bailout package from the IMF ranging from US$6 billion to US$12 billion by the middle of May 2019.

D. G. Khan Cement (DGKC) has revised its depreciation policy that has helped it in boosting gross margins to 18.5% for 2QFY19 from 12.7% for the previous quarter. Had the depreciation policy not revised, DGKC’s profit before tax for 1HFY19 would have been Rs0.60 billion as against Rs1.59 billion. To note, Rs518 million were charged under the depreciation head as a part of cost of sales for 2QFY19 as compared to Rs1.16 billion for 1QFY19. Expected lives of plants at DG Khan and Kahirpur were revised upwards, but no changes were made to the policy regarding Hub. Though, the change in depreciation policy provided respite to DGKC for second quarter, the same will not continue to support in future as utilization for 2HFY19 is expected to decline to 85%, from 91% for 1HFY19, resulting in a lower base to absorb fixed costs. With a significant slowdown in dispatches in North (local dispatches for the region down by 6%YoY for 8MFY19) and DGKC opting for clinker exports to support utilization, working capital needs of the company have increased significantly as trade debts rose to Rs1.4 billion at end of December 2018 from Rs0.2 billion at end June 2018, taking days sales outstanding to 7.4 against an average of 2.4 for last three years. Moreover, a negative net operating cash flow of Rs292 million for 1HFY19 has led to the company opting for short term borrowings to finance capital expenditures and repayment of long term loans (short term borrowings rose to Rs14.4 billion as at end December 2018 as against Rs12.2 billion at end June 2018. DGKC commands the highest 3-year (FY19-22) earnings CAGR, as the company’s presence in both the regions provides support in times of significant pricing pressure.


However, EBITDA margins of 23% for FY19F as compared to 27% and consequently an EBITDA/ton of US$9.7 as compared to USD11.4 for other companies offsets the positives. Moreover, in-line with the overall sector, DGKC’s stock price is expected to remain under pressure in near term as pressure on local cement prices builds up in North on the back of capacity additions amid non-supportive demand outlook.

Pak Suzuki Motor Company (PSMC) has announced its 4Q2018 results, posting loss after tax of Rs94 million (LPS: Rs1.15) as compared to EPS of Rs8.86 for the same period last year. Earnings were below expectations due to significantly higher margin attrition. This was despite a tax reversal during the outgoing quarter. The company also announced a cash dividend of Rs3.16 per share. Despite 8%YoY decline in volumes in 4Q2018, net sales of the company rose by 6%YoY due to multiple price hikes in 2018. Average revenue per car was up by 15%YoY. Cost of sales rose by 12%YoY that led to a significant gross margin reduction. Gross profit fell by 56%YoY, dragging gross margin down to 3.2%.

Analysts attribute the decline in gross margins to a sharp depreciation of Pak rupee value during 2018, declining by 24% during December 2017 to December 2018. This depreciation not only increased cost of imported materials, but also the prices of components acquired from local vendors. Administrative expenses rose by 34%YoY but remained relatively flat QoQ. The company booked finance cost of Rs237 million (reversal of Rs72 million in 4Q2017) which further dragged the quarterly earnings down. Other income was down 57%YoY as interest income from investments declined. It is believed that the decline was the result of reduction in advances received from customers that were used to earn interest income. The company booked a tax reversal of Rs313 million, which kept losses restricted.

Analysts outline following key risks facing the company: 1) further unfavorable movement in exchange rate and commodity prices, 2) regulatory changes, 3) increased competition from existing and new players and 4) disruptions in operations of principal company.

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