An exclusive weekly Stock Market report for PAGE
by Khadim Ali Shah Bukhari & Co.
Updated on 12th July, 1999
Hanging on to every piece of news coming out from the border dispute,
the KSE 100 continued its shaky descent on the absences on any concrete development on the
ongoing Kargil conflict. Though with the news of the US involvement has largely dispelled
the possibility of an actual breakout of war, stemming the onslaught of the bears on the
KSE 100, however the manner in which Pakistan came out of it has shaken investor
confidence. The KSE 100 fell by 19.76 points breaking the 1100 levels to close at 1085.06,
translating into a drop of 1.79% over the week. The docile manner in which Pakistan agreed
to the US terms has shaken local investor confidence.
Attention for the near term is likely to center on the relationship
between the military and the political leadership over the surprise softening of
Pakistan's stance after the PM's US visit. This is likely to keep the market under
pressure for the near term. Choppy price movements could be witnessed.
We see initial support at 1080 and major support appearing around the
1050 levels. Resistance is likely to be encountered near the 1140 levels with major
resistance being felt at 1180 levels.
Cement Industry: Forget margins, focus on volumes.
We believe the cement industry is at a phase where stock prices have
discounted all the negatives. While we are not implying that the industry is going to
start churning profits, there is reason to believe that it will start bottoming out. We
base our judgement on the following two reasons:
1. Supply side policies being pursued by the Govt.
2. The industry is skimming cash breakeven at the gross level implying
consolidations and closures.
Given our expectation of a re-rating within the sector, we recommend DG
Khan Cement as our top pick.
Supply side policies: Overall the government's focus appears to be
towards re-flating the economy through easy access and availability of capital. Interest
rates and inflation have been lowered and elements of dis-intermediation in the banking
sector reduced. Also, external debt restructuring made available to Pakistan is allowing
the government to pay down its domestic debt and reduce dependence on the banking sector
to meet expenditures. Going forward, this should imply lower interest rates and inflation,
which should, in turn, increase consumption.
The majority of the Pakistani population resides in the relatively
under developed rural areas. The policy focus of the government appears to be towards
enhancing rural incomes directly, through enhanced credit and indirectly, by investing in
infrastructure. Allocation for credit disbursement towards the agricultural sector has
been increased by 50% for FY 00 while investments are planned towards building 5,000km
farm to market roads over a number of years.
The creation of infrastructure should not only enhance farm incomes but
also feed demand for cement. Whereas construction of roads per se is not cement intensive,
the creation of link bridges and ancillary infrastructure, such as rest houses and service
stations, do feed cement demand. The extension of road networks should also makes it
easier to deliver cement to areas where the flow of heavy traffic was earlier difficult.
The government is also planning on constructing 0.5m housing units, this should again
directly support demand for cement.
Industry skimming cash breakeven: Over the last 3 years the cement
industry has been hit by a severe recession. The cause has been related more to over
capacity and increasing input costs rather than any severe slowdown in demand. While we do
not believe that the demand supply imbalance will be remedied any time soon, the severe
stress being faced by the industry should result in closures and consolidations.
The most significant point to note is that the reduction in cash gross
margins to 8.5% over FY 98 has resulted through a sharp increment in COGS per ton over FY
97, i.e., increments in the prices of electricity and furnace oil have eaten away at the
margins. This sharp decline in cash flows, we believe, has sent shock waves through the
industry as all the new units have been financed keeping in mind strong cash generating
abilities and cash gross margins of over 35%.
The immediate outcome has been the closure of certain plants based on
the wet process, which is more expensive than its successor, the dry method. While the new
units are all based on the dry manufacturing method, high leverage has resulted in the
need to reschedule loan agreements. This should also ease the burden on cash flows.
Finally, the closure of the wet units has eased some of the pressure on supply providing
some breathing space to the more efficient manufacturers.
Conclusion: Despite expectations of higher consumption and
industry consolidation, margins are unlikely to expand and appear to have stabilized.
Also, given the closure of certain wet manufacturers, alleviating some of the oversupply,
margins should not decline further. Thus, given the competitive structure of the industry,
margins appear to have reached a sustainable level.
Under this scenario, companies likely to outperform will be those that
can post volume gains. Here the location and the capacity utilization of the company
become critical. Our top pick would be DG Khan cement based on the following facts:
1. Operated around average capacity utilization at 56% over FY 98.
2. A marketing region with no other cement plant in close vicinity.
3. Practical closure of Zeal Pak cement implying lack of market share
erosion from the South.
4. The most efficient cement producer in Pakistan.