THE KASB REVIEW
STOCK MARKET AT A GLANCE
An exclusive weekly Stock Market report by Khadim Ali Shah Bukhari
Updated on Jul 10, 2000
The market moved within a
very tight band during the week. The KSE 100 Index began the week at 1520.73 and closed at
1514.86, showing a decline of 0.39 per cent.
In the absence of fresh buying, volumes remained modest at an average
of 71 million, and trading continued to remain dull. Domestic institutions indulged in
minimal activity, while overseas funds were conspicuous by their absence due to peak
holiday season in the US, Europe and the Far East. The present phase of inertia, the worst
this year has seen, can be attributed to the after shocks of the speculative bubble burst
in June. With the whole episode now taking a legal twist, market participants fear a can
of worms opening up, as a result of which investor nervousness is not likely to subside
any time soon. If an early resolution in the Lahore court does not occur, there remains a
possibility of a sharp slip in the index of 50-100 points before stability and liquidity
return to the market.
CEMENT SECTOR: BACK IN THE NEWS
Developments on several fronts during the last few weeks are likely to impact the
cement industry in Pakistan. We provide highlights of these and also our take on possible
First, the good news. The Chief Executive has reportedly given a
deadline of three months to various ministries for arriving at a consensus regarding the
fate of Kalabagh Dam. With previous governments having made half-hearted attempts to
address political sensitivities and then backing off, the whole project's future appeared
bleak. With the army-backed government now appearing to take up the issue seriously, the
probability of the project actually getting beyond the drawing board has risen.
Theoretically, if the Kalabagh Hydroelectric Project is approved and
implementation begins, it would provide the much-needed shot in the arm for the
beleaguered cement industry. Industry sources suggest that additional demand of upto 1.0
mtpa could be generated during the construction phase, which can reportedly range from
8-12 years. Add to this the need to resettle villages and provincial population centers
and one can see how capacity utilization of the northern zone producers, in particular,
can rise from the present 60-65 per cent.
There is no doubt that a large new reservoir is desperately needed.
Tarbela, the Tarbela, the country's largest water reservoir, has lost its original 11.9
billion cubic meters water storage capacity by 24 per cent after having crossed 24 years
(average age of a dam is 55 years). Heavy silting is another grave problem that Tarbela
and Mangla face.
If the Kalabagh Dam Project, with 6 MAF storage capacity, does pull
through, it will be the third largest dam in Pakistan after Tarbela (also on the Indus)
and Mangla. The cost of the project is estimated to be over $6 billion, and is expected to
be completed in 12 years.
The current situation spells ominous implications for agriculture as
well industries, that, according to news sources, lose production worth Rs. 100 mn daily
due to water shortage / irregular supply. Despite the technically accepted necessity for
Kalabagh Dam, the project has become a political football with politicians from smaller
provinces, particularly NWFP and Sindh, using the issue to accuse the largest province,
Punjab of supporting Kalabagh to usurp water from them.
Our assessment, however, is that these arguments are not justified.
Some political observers have stated that the real opposition comes from the feudal lords.
It is these large land holders who currently benefit from the seasonal flooding and river
overflows as they get free water. As soon as a dam is constructed, they will only receive
their respective share and have to pay for the supply, which of course is anathema to
The current administration is in a strong position to bring together
the various competitive constituencies and convince them in the technical feasibility of
the project while creating sufficient legal safeguards to allay concerns of the smaller
provinces. We are, therefore, cautiously optimistic that progress on the dam front is
likely to be seen over the coming twelve months.
In terms of investment implications, as the Kalabagh Dam story slowly
moves towards a concrete blueprint over the next 12-18 months, we expect long-term
investors will begin to factor this into the share price, and a gradual sector re rating
is likely to ensue.
And now, the bad news. A recent stay order by the Supreme Court has
over ridden Lahore High Court's earlier directive restricting the government from imposing
sales tax on the cement industry. Market expectations are that the government will now go
ahead and impose sales tax. If that occurs, then the sales tax exempted companies will
immediately gain a competitive advantage, which they could use to undercut other producers
and gain market share. Should this happen, it would spell the end for the cement cartel. A
price war would reverse the nascent recovery in earnings that the sector has seen in lH00.
We feel however, that the above outcome is not necessarily the only
scenario going forward. The Supreme Court, while staying LHC's decision, has also turned
non-sales exempt units' petition into appeals, for which hearing has been postponed until
September, 2000. In the meantime, more non-exempt producers are reportedly planning to
file appeals. Once the legal process gets fully underway, it is likely to drag on well
into FY 2001. The original sales tax exemption was in any case set to expire in June 2001.
Thus, even if the final decision goes in favor of the sales tax exempt units, their
competitive advantage will be rather short-lived.
In view of the above, we feel that investors should not get distracted
by the market's 'noise' on this issue and remain focused on specific company fundamentals
in terms of core earnings generating capacity of specific companies and long term outlook
for the industry as a whole, which we believe, is gradually turning positive.
Another point to be highlighted is the potential for electricity tariff
increases during the next few months, as the power utilities attempt to cope with the
higher furnace oil prices, and the recent 15 per cent gas price increase. While
electricity price increase certainly raises the production cost per ton, the effect is not
spread equally for all cement producers. More efficient producers are affected less
adversely than the less efficient ones. Moreover, the cement companies which have captive
plants (e.g. D G Khan), are insulated even more. Therefore, while we expect electricity
charges to rise during the current fiscal year, we believe that margins of efficient
producers will not be significantly dented.
In conclusion, we maintain our positive outlook on the cement sector
and continue to recommend long term BUY on D. G. Khan Cement which we feel has fundamental
competitive advantages over its peers that are likely to translate into its long term out
performance in the sector.
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