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 |
|
|
