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THE KASB REVIEW
STOCK MARKET AT A GLANCE

  1. FINEX WEEK
  2. STOCK WATCH
  3. STOCK MARKET AT A GLANCE

Updated on July 28, 2001

This week we step back and take a look at the PROCESS of building an intermediate term investment portfolio (equities) given that the market has now 17.7% down at 1242 from its start at the beginning of the year at 1509. Some may say that what is the point of it all if the market continues to head only in one direction i.e. DOWN. While we empathize with this sentiment, we believe that investors, fund managers, pension fund trustees need to make an objective assessment of the market environment and risk return dynamics in order to perform their role as sensibly as possible. Thus, this week we start with the investment perspective first and discuss the market next.

Investment Perspective

We have been inundated with inquiries from both institutional and retail clients regarding what investment approach to adopt at the moment. Rather than going into longwinded discussion about macroeconomics, corporate sector fundamentals or specific stock stories, we decided to keep our response short and sweet.

Let us assume that we have a risk averse investor whose principal requirement is very limited downside, at least one year investment horizon, a total return potential of savings deposit rate plus 10% annualized return, with income being an important consideration.

Such an investor can very easily be an institution such as a provident/pension fund, insurance or leasing company, a modaraba, investment bank or other financial institution or a corporation. Equally, such an investor can be a retail/individual with say PkR250,000 or more in surplus savings after accounting for liquidity/emergency needs.

For investors with broadly above profile, our selected stocks might be considered a portfolio covering financial sector, manufacturing sector, services (Telecom) sector and utility (Hubco) sector. It should be noted that the above portfolio is a fairly defensive portfolio and not a growth portfolio. However because of Hubco and PTCL, it may have a higher Beta than a "pure" defensive portfolio.

Total Return Potential of 30% over 12 months

Looking at our sample, it will be noted that the weighted average expected dividend yield of such a portfolio (assuming last year's dividends are more or less repeated) is close to 19% p.a. This is despite the fact that we have assumed a full-year dividend for Fauji of PkR6.50/share versus PkR8.00 last year. Now, 19% p.a. may seem too high to some. We believe, however, that even if one reduces this by say, 200bp, and assumes 17% p.a. dividend yield, the total return potential over the next 12 months for this portfolio is fairly high. The question is how high? And, can we quantify this?

One approximation can be arrived at as follows: The FY01 market PER is estimated by us around 5.4-5.6X. The FY01 PER (weighted average) for our sample portfolio is 4.1X. This means that our sample portfolio is trading at around 25% discount to the market. In theory, this means that as and when the market normalizes over the next TWELVE months, this sample portfolio's discount to the market should narrow significantly, leading to capital gains for the investors. Let us assume, that the discount does not disappear but narrows to, say, 10% to be very conservative. This implies a potential gain of at least 15% from current levels.

In our opinion, the total expected (potential) return on such a portfolio would then be in the range of 32-34% over a twelve month period. (15% capital gain plus 17% to 19% dividend yield).

This, we believe, is by any measure a very decent return expectation from the equity market in Pakistan even after factoring in the high-risk premium attached to domestic equities. Of course, let us not ignore the risks. If an external factor causes the equity markets to tank, of course the above expectations will not be met. Or if there is a major inaccuracy in our earnings forecast, our dividend yield number might turn out to be wrong. So investors need to independently weigh the risk-return equation for themselves prior to investing.

Sector Review: Manufacturing Performance in FY01

Economic Survey of FY00-01 stated that Large Scale industry grew by 8% last year. When we highlighted that this was due to a few factors and the broader industry was suffering we were literally scolded by our good friends in several ministries. Out of deference we did not go into rebuttal at the time but it is necessary to accept realities and call a spade a spade. This week we present our findings based on representative sample of 74 industrial companies listed on the stock exchange. We looked a FY99 and FY00 results as well as 1H00 and 1H01 results. We excluded Oil & Gas, Telecommunication and the entire financial sector in order to focus on manufacturing. However, OMCs (Oil Marketing Companies) were included as they are good indicator of overall industrial activity.

And lo and behold, what did we find? Manufacturing sector was indeed suffering from contracting margins, rising debt, higher inventory and deteriorating Current Ratio. The result is that by 1H01, ROA and ROE had been badly hit.

The above is despite the fact that in 1H01 YoY sales growth had been commendable at over 29%, while the YoY sales growth between FY99 and FY00 was itself a high 32%. So where did the problems crop up? Going through the consolidated P&L of our sample provides some clues.

Margin Squeeze has been Severe

The gross margin for our sample was 16% in FY99. In FY00 it reduced to 14% despite the stellar performance of the textile sector. In 1H00 the gross margin was 13% but by 1H01 the gross margin had declined to 11 % (and this does not include large loss makers like ICI, FJFC or Pak Electron).

Looking for reasons, one can postulate that several factors led to the above result in 1H01. Major ones may include:

Sharp rise in fuel costs

Inability to pass on full impact of cost increases down the line due to sub optimal demand that reduced firms' pricing power

Continually rising imported raw material costs after the rupee depreciated by around 20% YoY between July 2000 to June 2001

A silver lining is that the manufacturing sector was able to contain operating expenses so that the damage remained limited to gross margin effects, which flowed down to the operating margin levels. Thus operating margins in 1H01 were 7% versus 9% in 1H00. In FY99, these were 10%. So, on a longer-term perspective, there has been a clear deterioration.

Beyond this point, the sharp rise in the interest rates over the last twelve months appears to be the major reason for deterioration in manufacturing sector's earnings. While long-term debt and short-term debt rose by 41% and 29% respectively, on a YoY basis by 1H01, the rise in interest rates massively increased financial charges. The result was a collapse in net margins to 2% in 1H01 versus 5% in 1H00. As a reference, the net margins for the sample group were 6% in FY99 and 5% in FY00.

Stock Market Synopsis

 

Last week

This Week

%Change

Mkt. Cap (US $ bn)

4.99

4.94

-1.00

Total Turnover (mn shares)

244.07

247.03

1.21

Value Traded (US$ mn.)

144.58

120.04

-16.97

No. of Trading Sessions

5

5

Avg. Dly T/O (mn. shares)

48.81

49.41

1.21

Avg. Dly T/O (US$ mn)

28.92

24.01

-16.97

KSE 100 Index

1260.16

1242.83

-1.38

KSE All Share Index

810.83

801.13

-1.19

 


 

ASIA PACIFIC & AUSTRALIA
EXCHANGE INDEX LEVEL CHANGE EXCHANGE

Bombay

BSE

3251.53

-7.50

-0.23%

Hong Kong

Hang Seng

12182.2

+142.35

1.18%

Singapore

Straits Times

1640.4

+1.04

0.06%

Sydney

S&P ASX 200

3292

+8.60

0.26%

Tokyo

Nikkei

11798.1

-60.48

-0.51%

 


 

EUROPE & UNITED STATE OF AMERICA

EXCHANGE

INDEX

LEVEL

CHANGE

EXCHANGE

Frankfurt

DAX

5754.86

+79.10

1.39%

London

FTSE

5403.1

+117.00

2.21%

Paris

CAC

4967.15

+125.03

2.58%

Dow Jones

Industrial

10416.67

-38.96

 

Nasdaq

Composite

2029.07

6.11