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  1. The KASB review
  2. Finex week

An exclusive weekly Stock Market report for PAGE by Khadim Ali Shah Bukhari & Co.

Updated on 5th July, 1999

Market Update

True to expectations the KSE 100 has finally taken a breather from the tumultuous downside witnessed during the course of the events at the Line of Control. This has reiterated our earlier call that any movement by the KSE 100 will largely be dictated by the LoC. The KSE 100 went up by almost 61 points closing the week at 1104.82, translating into a gain of 5.82 percent. An upsurge of 30 points on the last day of trading was witnessed primarily on the back of positive news relating to the LoC. Prior to that the increase in the rates by PTCL saw activity and prices both picking up in the stock.

During the course of the week, the market has been in a matured state, quietly awaiting the developments of the market. With institutional investors mainly on the sidelines, the market has been in a pensive throughout the week. With the border dispute holding back the investors from taking a decisive direction, any news whether positive or negative is likely to have a corresponding affect on the KSE 100. For the coming week initial support is likely to be witnessed around the 1050-1000 levels.


Sector Review

Pakistan State Oil-Ready to Rock!

Pakistan State Oil (PSO) is one of the stocks that stood out in the market's dramatic fall after the nuclear tests in May last year. Although price has recovered by more than 100% from those lows, we argue that there is still substantial room for upside. Summary earnings estimates follow:

With an earnings yield of 16%, PSO is yielding a whopping 500 bps above the t-bill yield, which we believe is not justified. Considering that PSO is a pure oil marketing company, which eliminates a host of cyclical risks inherent in other oil companies. As margins continue to be regulated by the government, the only risk worth discounting in PSO is growth in sales volume. Sales volume is a broad function of economic growth, which is set to recover in FY00 and beyond. We have tried to be as conservative in our forecasts as possible, assuming only nominal growth in the future. Earnings will also benefit from increases in product prices, as the government is likely to remain dependent on development surcharge for making up persistent revenue shortfalls. With international oil prices likely to remain stable/ firm, the government will be forced to increase domestic POL prices to maintain its revenue collection from development surcharge.

A major factor behind PSO's fall from grace has been the triangular debt problem in the power sector. This was caused by a sharp build up in trade debts for PSO as WAPDA and KESC failed to pay for purchases, and PSO consequently failed to make payments to refineries for POL products purchased. This resulted in PSO's trade debts rising to 14% of sales in FY98 from less than 4% in FY96. With the army taking over WAPDA's management and enhancing revenue collection by 65% (for the first 5 months of 1999), the problem of power sector debt is being tackled aggressively. PSO has also started making cash sales to both electric utilities since July last, which should also improve cash flow. Although operating cash flows are not a good means for valuing a company with extremely thin net margins (as true value tends to be understated) we still use DCF to retain our conservative bias. The discount rate used in DCF analysis is extremely important for the final output, and we use an aggressive rate of 25% to price in all perceived risks for PSO. Even then, what we get as our valuation estimates is impressive.

Only in a doomsday scenario of zero growth and 33% required return does NPV of cash flows fall below market price. We believe a 5% terminal growth rate is appropriate for PSO, as its business closely tracks nominal GDP growth. Hence, given historical double-digit nominal GDP growth, we believe a 5% growth assumption is fairly conservative. Trading at a 45% discount to NPV, we are firm BUYers of PSO. Reaffirm BUY.

PKR mn 1998 1999 2000
Net Income 1,846 1,632 1,904
EPS 15.5 13.7 16.0
P/E 6.4 7.3 6.2
EPS Change -9.7 -11.6 16.7
Cash Flow/Share 17.2 13.7 30.3
P/CFPS 5.8 7.3 3.3
EV/EBITDA 3.1 3.6 3.3
Gross Dividend 6.7 8.0 9.6
Gross Yield-% 6.7 8.0 9.6