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THE KASB REVIEW

  1. The KASB review
  2. Finex week

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

Updated on August 15, 1999

Market Update

True to our expectations, the KSE 100 continued to flounder in uncharted waters causing the market to close down by 2.03 points. The market was overclouded with negative sentiments largely due to the apparent lack of any decision evident in the near future. This uncertainty was largely responsible for domestic financial institutions off loading positions in Hubco. Hubco during this bout of activity beared the brunt moving down 2.03 percent over the week as well..

The apparent weakness in investor confidence was further rocked by the escalation between India and Pakistan over the downing of a Pakistani naval plane by Indian jets. This sudden development did cause some initial jitters but the market has finally discounted the incident.

With uncertainty looming large, primarily due to increased border tension and the inaction over the Hubco issue the market will remain under pressure for the coming week. Further weakness is likely to provide attractive entry-level positions to start accumulating.

Sector Review

Engro Chemicals Pakistan Limited Interim Results: Going, going,...Gone!

When it rains, it pours. Ask Engro, and the company will most likely agree. If a difficult operating environment in itself was not enough, recent changes in taxation rules bringing fertilizer products under the GST net are not going to make life any easier for ECPL. Before moving on to a discussion of how fundamentals for the fertilizer sector are developing, a brief overview of interim results.

The key trend to identify in these results is what has happened to margins as we move down. First, gross margins improved by almost 200 bps, with gross profit rising by 15% compared to 1998. Second, at the operating level, margins fell by 50 bps with operating profit rising by just 5%. Finally, net margins fell by almost 400 bps, with after tax profits declining by 21%. This trend perfectly depicts the shape of things to come. It is useful to explore why this margin squeeze is happening, and what the implications are of such a development persisting for the near future.

Starting with gross margins, these rose on the back of better sales volume, and no increase in gas costs. Gas tariffs for feed stock were raised recently, meaning that the first half of the year was unaffected. We believe gross margins will come under increasing pressure due to a variety of factors — higher gas costs for both feed stock & fuel and imposition of GST in an adverse demand supply environment. There is little scope for any relief on the operating side, as selling expenses will remain high due to two main reasons — cheap imports creating a difficult marketing environment, and Fauji Jordan marketing it's produce in Engro's backyard, increasing competition for market share. It is interesting to note that operating expenses as a % age of sales have risen to 16% compared to 13% a year ago. We expect this trend to continue, putting further pressure on operating margins.

Coming to financial charges, these were expected to rise as normal servicing of loans drawn for the BMR started, and there is nothing alarming in the 128% rise in this expense y-o-y. However, what this means for earnings is that these will remain high for the next 12-18 months, meaning that the trend of falling margins will continue even after the EBITDA level. Higher interest charges also raise another interesting possibility, that of lower dividends. Although it is not against the interests of shareholders if dividend payout is reduced to save on interest charges, we are concerned that such a development would adversely impact share price — as a matter of fact, the adjusted dividend per share for lHY98 was PKR 2.08, which has already come down to PKR2, down by roughly 4%, we suspect this trend will continue during the remainder of the year. In summary, we expect earnings to fall anywhere between 18-20% for 1999. This puts ECPL at more than 7x '99 profits, at a 100% premium to Fauji Fertilizer, a totally unjustified premium. We expect Engro to under perform going forward, and remain aggressive sellers.

                                                              

RS mn 1HY98 2HY98 1HY99 y-o-y %Chg h-o-h
Sales 3,247 5,118 3,494 8 -32
CGS 2,083 3,057 2,159 4 -29
Gross Profit 1,165 2,062 1,335 15 -35
GM 35.9 40.3 38.2    
Op. Expenses 427 569 561 31 -1
% of Sales 13 11 16    
Operating Profit 738 1,492 774 5 -48
OM 22.7 29.2 22.2    
Other Income 65 40 91 40 127
% of Op. Profit 9 3 12    
EBIT 802 1,532 865 8 -44
Fin. Charges 158 370 360 128 -2
% of Sales 5 7 10    
EBT 644 1,163 504 -22 -57
Tax 158 161 119 -25 -26
Effective Rate 25 14 24    
EAT 486 1,002 385 -21 -62
Net Margin 14.97 19.58 11.03    
EPS 4.02 8.29 3.19