Increasing cost of inputs and declining price of PSF have eroded the advantage of sales tax exemption

Dec 07 - 13, 1996

The increasing cost of inputs and declining prices of polyester staple fibre (PSF) in the country have adversely affected the profitability of Dewan Salman Fibre to the extent that the net profit after-tax declined by 81% in 1996 as compared to 1995.

The Unit-2 having production capacity of 56,000 tonnes per annum of PSF started commercial production on June 15, 1995. During the twelve-month period ending June 30, 1996 Dewan Salman's sales increased by 46% amounting to Rs. 6.291 billion as against Rs. 4.309 billion in 1995 but the cost of sales which was 70.85% of sales in 1995 increased to 89.41% reducing the gross profit margin to 10.59% as compared to 29.15% in 1995.

In spite of the fact that Unit-2 was completed in the record time of just one year, at a significantly lower cost than originally estimated and entitlement to the area-specific incentives namely, exemption of sales tax on finished products and corporate tax holiday of 8 years, due to change in sales tax regime in 1995-96 budget the benefits were completely eroded.

The erosion of sales tax incentive has adversely affected the profitability of the company. Operating margins of the company came under pressure due to increase in the cost of inputs as a result of depreciation of Pak rupee and hike in raw material prices. The operating profit declined nearly 50% in 1996 and amounted Rs. 556 million as against Rs. 1,184 million posted last year.

Net profit after tax reduced from Rs. 888 million in 1995 to just Rs. 163 million. The company was able to declare only 10% cash dividend as against 20% paid to the shareholders for 1995 operations offering dividend yield of just 2.8%. The company has also transferred Rs. 400 million to general reserves from past many years' unappropriated profit of Rs. 484 million brought forward.

The year1996 was the most difficult year for PSF manufacturers in Pakistan as prices of two of the basic raw materials, PTA and MEG rose by 20% and 48% respectively. Prices of PSF also declined by about 40% squeezing profit margins of all the manufacturers.

The sales tax advantage available to the company has become an impediment and the company is forced to sell its product at a discount. Spinners buying fibre from Dewan Salman will be at a disadvantage as they will not be able to adjust their sales tax on raw material against the final product because the company does not pay any sales tax. This will virtually take away the advantage of sales tax exemption currently enjoyed by the company.

Dewan Salman was established in 1989 in the tax-free industrial estate of Hattar with aan installed capacity to produce 52,000 tonnes of PSF and added the second unit enhancing the capacity to 108,500 tonnes per annum. The sales tax exemption on unit-1 will expire on January 1, 1997 but it will continue to enjoy this benefit on unit-2 (approx 52% of its total capacity).

According to an analyst at AKD Securities, even after doubling EPS from Rs. 1.3 in 1996 to Rs. 2.5 in 1997 the stock is trading at 15x prospective 1997. A 60% premium to the market simply could not be justified. However, he was of the opinion that the supply over-hang in 1997 when Dhan Fibre, Ibrahim Fibre and ICI Pakistan's expanded capacity came on line, would lower Dewan's capacity utilisation. Increased local competition and falling international PSF prices would limit Dewan's ability to increase prices and thus the margins. The local prices are expected to continue sliding down as there are no signs of improvement in the internatioal markets.

Despite the recent fall in input costs, company fundamentals are not expected to improve significantly. Dewan Salman will continue to operate under difficult conditions where fundamentals are expected to go from bad to worse.