Updated on Oct 11, 1999
Buying interest in blue
chips reinvigorated the market with the Index closing the week at 1235.84 points, a gain
of 3.2% over the previous week. A couple of our key recommendations, Lever Brothers and
Pakistan State Oil outperformed the market rise with both stocks registering gains of 6.6%
and 3.4% respectively. Interest in PSO is being fueled on expectations of an increase in
POL product prices, which implies inventory gains for the company. Engro continues as an
anomaly, backed by rumors of a hostile take over, the stock registered an almost 30% gain.
We continue to believe that fundamentals for the fertilizer sector have weakened though
there may still be some ground left for Engro to cover before it stabilizes. Institutions
should utilize this price surge reducing their weightage in the stock diverting the cash
thus generated towards other undervalued Scripps such as PTCL, Lever Tripack Films and
Packages. Going forward the market is likely to strengthen backed on continued interest in
blue chips and a likely performance by HubCo that closed the week down 0.5%.
Lever Brother: Buy while it available
Lever Brothers Pakistan (LBP) continues to trade at a 25% discount to
our estimated fair value of Rs1,130 per share. We believe the key reasons for this
discount is lack of marketability and the current absence of foreign institutional
interest. Whereas marketability will remain a concern, we believe foreign interest in LBP
should result in LBP's comparison to Hindustan Lever. This comparison is likely to result
in fair value estimates for LBP ranging between Rs1,500 and Rs3,000 per share. Local
institutions therefore caught on the wrong side, i.e. those which fail to accumulate at
current levels are likely to lose out on a strong opportunity for capital gains. Buy.
There are essentially two reasons we believe which explain the discount
at which LBP trades to our estimated fair value:
1. The ill-liquid nature of the stock.
2. The current lack of foreign institutional interest in Pakistan.
Whereas, not accommodating for a share split, the scrip should continue
to attract a discount for lack of market ability, we believe foreign institutional
interest should begin to trickle back. When this happens, by virtue of its relative under
valuation to Hindustan Lever and its MNC blue chip status, LBP should quickly move up.
The following table shows the approximate discounts at which LBP trades
to Hindustan Lever.
Price Earnings (PE) 4.0
PE /5 Yr. EPS CAGR 2.8
Price / Sales 8.8
The largest disparity is in the Price to Sales ratio which shows that
Hindustan Lever is trading at 8.8 times the price to sales ratio as compared LBP. This
ratio is most relevant in valuing fast moving consumer goods companies such as LBP and
Hindustan Lever as the quantum of sales is a key determinant to the franchise value
attached to brands being marketed. Based on FY 99 sales, if we were to assume a 2.0x price
to sales ratio, LBP should trade at Rs3,000 per share. Valuing LBP at 1x price to sales
would result in a fair value of Rs1,500 per share.
The point being that when foreign institutional interest does arise for
Pakistani scrips, the key valuation methodology is likely to be the one demonstrated
above. Foreign investors may then be valuing LBP at between Rs1,500 to 3,000 per share.
Lack of marketability also implies that when foreign interest arises the stock should move
up rapidly. This would disallow institutions that had not accumulated earlier to benefit
from the price upsurge.
Whereas on grounds of comparative valuation, LBP appears cheap it may
be argued that so do most Pakistani scrips when compared across the region. This is a
valid argument and our response is that unlike LBP, most Pakistani scrips fail to display
the fundamental strength that is inherent to LBP. Our premise in recommending LBP as an
essential portfolio holding is based not entirely on its valuation relative to Hindustan
Lever, though we believe there is a gross mismatch here, rather, our reasoning stems from
the strong franchise value inherent to LBP by virtue of it owning majority of the popular
brands in Pakistan and having access to a strong distribution network through which to
market them. The eventual implementation of GST should also help reduce the cost
differential between LBP brands and those being either smuggled or produced without
payment of government levies. This would allow LBP to gradually capture market share
currently serviced by the unorganized sector.
CBR flying high???
The week began with the "wonderful" news (CBR chairman
announces 0.6 mn more taxpayers, to 1.7 mn) that less than one percent of Pakistan's
population no longer had to contribute the whole of the direct fiscal revenues of the GoP.
Central Board of Revenue (CBR) announced that 1.7 million taxpayers now exist in Pakistan.
This achievement has now brought 1.27% of the population (estimated at 134 million not
including corporate legal entities) under the tax umbrella, now all we need are more
worthwhile projects, like providing support prices to our non-taxpaying cotton-growers, to
fully realize this boon.
Further news on the revenue front, the CBR released figures for the
first quarter of FY00, the gross collection amounted to Rs 84 bn, and after allowing for
rebates, the final collection figure came to Rs 72 billion. An interesting fact to note in
the announcement pertains to the fact that of these collections Rs 32 bn is provisional,
in other words, CBR is not completely sure of 44% of the final collection amount.
On a more optimistic note, the Sales Tax receipts continue to rise. In
comparison with the same quarter last year, Sales Tax receipts have grown by 90%, not only
that, the increased documentation in the retail and wholesale sector spells a statistical,
if not real, rise in GDP growth for FY00. A point to note in this regard is that the GST
on POL products has had an off-setting decrease in Development surcharge, so the bright
aspect is not really that bright in terms of revenue generated.
Customs duties have risen from Rs 14.7 bn to Rs 17.03 bn in first
quarter collections between FY00 and FY99, while they are still 7% below the amount
collected 1QFY98. As a source of revenue in the future, customs duty must be declared
redundant. We expect further falls in custom duties will come into effect following the
millennium moot of the WTO, but its effects should not be seen for at least a year.
The continuing story of the mismatch in expenditure outflows and
revenue inflows spells more bank-borrowing under the frowning gaze of the IMF. This will
lead to further dryness in the market, implying upward pressure on interest rates.
Hence the government must engage in a trade-off, balancing financing
needs with the policy benefits accruing from low interest rates. While it is our belief
that the low interest rate policy has had no real benefit, at present the GoP and SBP do
not seem to agree. In its last auction SBP accepted only one bid of PKR 2.1 billion at a
cut-off yield of 10.35%. Notice a drop of 40 bps from the preceding SBP mopping up spree.
Given the pressure upon NBP to provide PKR 10 bn to TCP, there will definitely be upward
pressure on the market, yet we do not expect the SBP to let the yield rise to more than
10.75% in this calendar year.