Updated on Sep 27, 1999
With the arrival back in
the rings of international investors, the KSE 100 strengthened over the week to close at
1191.84 levels, depicting an upside movement of 3.13% over the week. Supplementing the
increased interest by the international investors, the market was also witness to the
larger domestic institutions entering the market.
Domestic institutions were portraying a shift in portfolio, moving out
of the illiquid stocks to re-enter in the more notable and tradable stocks in a bigger
way. This increased interest allowed the various blue chip stocks to finish the week with
handsome gains, all with the exception of Hub Power.
Hubco continues to remain immersed in controversy, the lingering tariff
dispute repeatedly discouraging investors to remain weary of any additional exposure to
this particular stock, despite the inherent earning quality of the Company. We believe
that Hubco continues to offer good value-maintain Accumulate rating.
During the end of the week the Finance Minister announced that the
government has no plans to increase petroleum prices, looking at previous such statements
we could not rule out the possibility of exactly the opposite happening keep
fingers crossed for any increase in petroleum prices, Pakistan State Oil could see
additional interest moving in.
For the coming week we could see the market further strengthening,
displaying an upside movement of 4-5% in the process. Any concrete signs of Hub Power
reaching a settlement with the government could further invigorate this strengthening of
Hub Power Company Ltd.
What Has Changed?
Hub Co announced results for FY99, with net profit of PKR6,705 mn. Most
importantly, the company skipped a dividend announcement, referring to the ongoing dispute
with WAPDA and GoP as the reasons for foregoing a dividend. The meeting of the board to
finalize results also voted in favor of invoking GoP guarantees to make good on payments
not made by WAPDA. A failure by the GoP to make good on its promises can potentially
result in a sovereign default.
Profits were low in line with the declining return profile of the
company. As we have stressed in the past, the all-important number for Hub Co. is
dividends, which were absent this year. This seriously impacts project IRR, with the
impact growing as a final resolution gets delayed.
Cash Flows Under Pressure: Very approximate cash flow
calculations for FY99 indicate that the company suffered a net cash outflow despite
earning a net profit of PKR6 billion plus.
Lower payments being made by WAPDA to the company have resulted in a
cash drain for the company. It is the continued reluctance of WAPDA to make payments in
full that have prompted the company to go a step further.
Sovereign Guarantee Invoked
Hub Co. has decided to ask the GoP to make good on its guarantee to
make up the difference between WAPDA's contractual obligations to Hub Co and actual
payments made by WAPDA in the recent past. The deadlock in negotiations was reached when
WAPDA rejected Hub Co.'s offer of a revised tariff, and Hub Co. rejected a counter
proposal made by WAPDA. At present, it is unclear what course of action the government
will adopt in response to Hub Co.'s latest move.
The Hub Co. GoP dispute has entered its home stretch with the latest
move by Hub Co. We continue to maintain our stance that a final resolution of the dispute
is unlikely to result in a material change to Hub Co. as an equity investment. Indications
by international lending agencies point to their reservations about the delay in settling
the IPP dispute the latest tranche from the IMF has also been delayed, possibly in
part due to this reason. We still believe Hub Co. offers good value-progress on reaching a
settlement is now more likely, maintain Accumulate rating.
Packages: Business a usual...
Earnings performance exceeded our expectations by 47%, further
strengthening our earlier Buy recommendation. In view of this performance, our current
growth estimates appear pessimistic which, for the time being, we are maintaining our fair
value target of Rs110. This represents a 102% upside potential. We reaffirm a strong Buy
on Packages given its ability to add value, which should provide sustainable earnings
growth, estimated at a 5-year CAGR of 25%.
Earnings grew by 75% on a y-o-y basis helped essentially by a top line
growth of almost 12% coupled with gross margins expanding over 600 basis points. This
expansion in margins, we believe, is due to the fundamental advantage held by Packages in
that its raw materials are largely locally procured (therefore costs not sensitive to
devaluations) whereas its competing importers need to price their imports factoring in
costs of Rs depreciations among other incidental charges. This, however, also highlights a
risk in that, if these margins are not sustainable, a margins decline may lower
profitability for Packages. Going forward, better sugar and cotton crops would imply lower
costs as waste products of these harvests are used as raw materials by Packages. Also,
having successfully attempted to replace imported wood pulp by cotton linter pulp should
imply a further reduction in imported element of COGS.
Operating margins expanded by 579 and net margins by 352 basis points.
The obvious question is whether such a performance is sustainable. These are by far the
best results the company has posted in the last 5 years. If the current performance were a
one-time affair, then we would need to lower our growth assumptions. However, a structural
change such as a permanent reduction in unit cost of production could result in
The main discrepancy came in that we underestimated sales by 4.6%
though we were spot on in under-estimating COGS, which showed a 1.9% (Rs57m) variance. The
result was a variance in gross profits of 14.2% or Rs117m, explaining 45% of the total 47%
variance in net earnings. We also overestimated the net interest expense, financial
expense less other income, by 85m.
Packages is presently earning between 5 - 6% on its FX deposits whereas
FX loans have not been sent into rescheduling. This implies that the net interest
component should continue to reduce. Machinery for additional capacity in the carton and
flexible packaging has been imported and should come online in FY 00. Whereas new
expansions suggest the company is looking forward to strong top line growth, depreciation
charge on these new assets may reduce profitability. The key to profitability will
therefore remain margin sustainability coupled with top line growth.