Updated on August 22, 1999
Contrary to our
expectations the KSE 100 surged upwards during the week by 109.04 points to close the week
at 1292.47. Though some domestic interest was present, the bulk of the volume was
seemingly the speculative element appearing in the rings. This 9.21% surge was buoyed
largely on the last trading day of the week when the market alone jumped up by 55 points.
Leading the price onslaught was PTCL, which jumped up 14.69% to close
at a high of Rs 24.20. Alone on Thursday PTCL moved up by Rs 2.15 largely supported by the
speculative element. Likewise Fauji and Hubco also came under heavy investor interest.
For the coming week we feel that this rally is unlikely to continue
with the profit takers likely to shed positions in the market as the clearing date draws
nearer. In that instance the market is likely going to witness correction. Due to
increased volatility investors should take advantage of selling at these levels and remain
on the sidelines for attractive levels to enter the market.
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.
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 feedstock 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 feedstock
& 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 17-18 months, meaning that the trend of falling margins will
continue even after the EBITDA level. Higher interest charges also raises 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 1HY98 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.
Lever Brothers half yearly results: Stronger than expected
Considering Lever Brothers (LBP) half yearly performance being above
our expectation, we reiterate our Buy. Main source of profitability has been a margin
increase achieved through availability of cheaper raw materials. Earnings increased 27.3%
and for the time being, we are maintaining our 38.7% EPS growth estimates. The company
declared a 50% (Rs25 per share) interim dividend, which is in line with our FY 99 forecast
of Rs50 per share.
Overall, the results were far better than we had anticipated, with
operating profit growth at 83% in comparison to our estimates of flat growth. The source
of this performance was an over 850 basis point increase in trading margin. COGS as a
portion of sales was 76% against our estimates of 81%. We believe this is where the
majority of the discrepancy crept in.
Sales growth was weak at 0.32% though presently we cannot ascertain
which divisions over and / or under performed, as the divisional breakdown has not been
published. This is an area of concern, as sales growth appears to be lagging far behind
nominal GDP growth expectations.
Operating expenses as a portion of sales jumped to 14.5% in the current
half as compared to 10.1% in the previous half. This is higher than we had anticipated and
is an important determinant of brand equity. We think stronger brands should further
strengthen LBP's leading position in the Pakistani FMCG market. Over all, operating
margins increased to 9.7% as compared to 5.3% in the previous half. Margin expansion here
might have been stronger had the company not increased its operating expenses. This
indicates that as trading margins normalize (resulting from stronger commodity prices) cut
backs in operating expenses, which should not weaken LBP's standing given its strong brand
portfolio, could allow management to stabilize margins at the operational level.
Financial charges more than doubled in the current half as compared to
the previous with interest cover reducing to 4.6x from 5.3x. LBP paid off its long-term
obligations over FY 98 and it is most likely that this increase has come about as a result
of greater reliance on short-term finance. Given the weak nature of interest rates and
LBP's ability at negotiating some of the lowest rates, for the time being it makes sense
to rely on a floating term structure of interest rates.
Up to this point earnings were set to show an over 70% gain had it not
been for another exceptional charge most likely in relation to restructuring costs
incurred in recent business acquisitions. It is unclear as to how much of the
restructuring cost remains to be charged. Over FY 98 restructuring costs were charged at
Rs231m as compared to Rs205m over the current half.
The end result has been a 27% earnings jump. Our expectation of
earnings growth for FY 99 is 38.7%. Our 5-year EPS CAGR is 17.9%.
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.
