Updated on Aug 25, 2001

The KSE - Overview: Back to square one or a second chance?

The consolidation of 67 points of KSE-100 Index, last week, ended up in a plausible downward correction of 21 points this week where it closed at 1268.61 level on Friday. The average daily volume also declined by 37% from 119.49mn shares to 74.62mn shares, reflecting the declining interest of the investors in the market.

Currently the market is moving within a tight band with mixed investor sentiments. The news of National Bank along with other financial institution moving in for market support if the KSE-100 Index breaches certain level was the main trigger for it to jump from 1226 level to 1290 level last week. This however seems to be losing its charm as not much evidence was visible that it actually happened up till now. This was evident from the market behavior as the market slowly lost its last week gains during the current week.

The overall market remained rumor driven and the main hit came on Monday with news regarding Hubco and WAPDA agreement which halted the upward climb of the market - shaking investors confidence on Hubco's lenders ability to approve the long awaited interim dividend. This led the index to fall by 8.7 points on Monday. However, to provide some relief to the declining market, the news of a probable increase in distribution margins of the Oil Marketing Companies triggered some buying activity in OMCs shares and cushioned the fall to some extent on Wednesday. The interest of smaller investors and traders however slowly died down, which manifested itself in declining daily volume that fell to 52mn shares on Friday — as there was little sign of any institutional support in sight — which forced some profit taking in the market and it finally closed 21 points down.

We believe that the market is poised for further marginal correction as starting next month all the shares would be transferred to the T+3 rolling settlement system. This, in our opinion, would force the punters and speculators to square their position more frequently. The market volumes as a result may decline somewhat, as the main badla activity would then be transferred to the futures counter going forward. This we believe would provide good buying opportunity to genuine long-term holders and income driven investors who earlier missed out on entering the market on the lower side.

Technically, this downward correction was expected after a jump of 67 points in the market last week. In the intermediate term the Index is presently trading in a very critical mode where for any upward positive trend the main resistance is at 1320 level which if crossed then a positive rally can be expected. This may lead the Index to 1380 levels. However, it does not seems to be a very easy task at the moment where in our opinion the market is likely to move within the range of 1290-1245 until the resistance is crossed. As for a week's horizon, in our opinion, further weakness should be taken as an opportunity to enter in the market for short term trading purposes.

Fundamentally, the news flow over the next 4-6 weeks is likely to be focused on corporate earnings announcements for FY01 ending, June 30. We are expecting positive earnings surprises for Hubco, PTCL, Honda Atlas Cars, Indus Motors and most financial instruments. On the other hand there are likely to be negative earnings surprises from the insurance sector, PSF and textile industry. Our fundamental valuation data below may be a good starting point for investors to assess how to separate the potential winners from hangers-on, in the relative performance game.

Sector Review: Faysal Bank Limited & Al-Faysal Investment Bank: 'The Patron and the Prodigy'

For a very long time there has existed a school of thought which believes that Pakistan's corporate sector is relatively immature for mergers and acquisitions. However, the recent wave of mergers and acquisitions in the financial and non-financial sector disproves this impression, and implies that times are changing. The culture of mergers is surfacing at a point in time when the country's corporate outlook desperately needs a fresh perspective to perk up interest and attract new investment.

Following this trend, Faysal Bank Limited and Al-Faysal Investment Bank, on August 10, 2001, proposed a merger and resolved to change their registered office from Lahore to Karachi.

The reasoning behind this move was stated as greater market and commercial activity in Karachi. We believe that tighter management, operating and audit control imperatives also played a role in the decision, particularly after a spate of large loan problems in Faysal Bank prior to the new management coming in two years ago.

There are several issues that need to be assessed when looking at this proposed merger:

Rationale, particularly financial and marketing implications for the two entities in question

Implications for the controlling shareholders and management

Impact on minority shareholders and potential minority valuation of the combined entity

In order to assess how the two sister concerns would have looked as a combined entity in terms of their first half performance for 2001 we did a 'proforma consolidation" of their recently announced six month Profit & Loss Statements.

Financial Impact

We find that the Return on Funds lent out to clients or placed on deposit with other institutions has shown a declining trend YoY. This has declined by 9% on a consolidated basis from PkR2,585million in lH00 to PkR2,354million in lH01. At the same time the cost of funds has also come down by 13% from PkR2,243million in lH00 to PkR1,947million in lH01.

The sharp reduction in funding cost in lH01 for Al-Faysal Bank can be attributed to one time government related transactions of PkR130mllion, in connection with the US special dollar bonds, which inflated funding costs for lH00.

As a result of the above, the net spread earned by the consolidated entity between 'return on funds' and 'cost of funds' rose by 19% to PkR407million in lH01 versus PkR342million in lH00. Non-funded income for the entity rose by about 10% to PkR467million in lH01. This would have been higher but for a sharp fall in non-funded income by 34% for Al-Faysal Bank. The culprit here of course has been the much lower capital gains from the stock market this year as compared to last year. Faysal Bank, on the other hand, showed substantial growth of almost 40% in the non-funded income which constituted 23% of total revenue in lH01 versus around 20% in lH00. In contrast, for Al-Faysal, non-funded income constituted 9% of total revenue this year versus 10% last year. In the combined PLS proforma, administrative expenses escalated by 13%, although this is mainly attributable to Faysal Bank where the rise was 17% while in the case of Al-Faysal Bank, administration expenses were almost flat at approximately PkR66million.

Thus the combined entity was able to project growth in pre-provision income of 14% YoY in lH01 to PkR624million from PkR545milion in lH00. At the same time however, there was reversal in provisions in the case of Faysal Bank to the tune of PkR9lmillion and in case of Al-Faysal Bank, PkR4million. As a result, the pre-tax profit of the Proforma combined group rose a hefty 49% YoY.

And then the tax man struck!

Lo and behold it appears that the taxman moved in quickly to share these gains, or at least the management has recognized that he shall do so. This is because the effective tax rate assumed by Faysal Bank has jumped to 77% of pre-tax profit in lH01 versus 53% in lH00. Similarly, in the case of Al-Faysal Bank the effective tax rate has risen to 19% in the half year just ended as against 7% in the previous half year. The effect on the combined entity would be that its effective tax rate has surged massively to 58% from 28% in lH00. As a result, EAT has declined by 13% on a consolidated basis from PkR348million in lH00 to PkR304million in lH01. And all this in a year when banking sector tax rates are coming down. However, beyond the jest, we expect the effective tax rate to come down to 50% for the full year as the tax cut effects begin showing over the next six months - for the assessment year FY02.

Corporate and Marketing Impact

If one combines the balance sheets of Faysal Bank and Al-Faysal Bank as at Dec 2000, one very clear picture which emerges is that this merger is going to create a heavyweight amongst the 'new' private sector listed commercial banks in Pakistan.

In terms of total assets, shareholder's equity, EAT and ROA, the Faysal - Al Faysal combination would have ranked Number 1 in this comparative group in FY00.

The combined total assets as at FY00 of Faysal - Al Faysal were approximately PkR43billion as at Dec 2000. This is a full 15% higher than the current leader i.e. Askari Bank which had total assets of PkR37billion on that date. More importantly the combined entities earnings after tax of PkR496million in 2000 were 57% higher than Askari. But lets not talk absolute numbers, in terms of Return on Assets the Faysal - Al Faysal combination again comes out on top with 1.15% in 2000 with Metropolitan following close by at 1.12%, while Askari gave a ROA of 0.85% in FY00. We can therefore see that the new bank is going to be a force to be reckoned with for the other commercial banks outside the group of Big-5. No wonder the controlling shareholders have decided to combine the resources of the two sister concerns to leverage the synergies and greater market power in order to face future competition.

Stock Market Synopsis
	Last week	This Week	%Change
Mkt. Cap (US $ bn)	5.05	4.97	-1.58
Total Turnover (mn shares)	477.95	373.11	-21.94
Value Traded (US$ mn.)	209.18	198.88	-4.92
No. of Trading Sessions	4	5
Avg. DlyT/O (mn. shares)	119.49	74.62	-37.55
Avg. DlyT/O (US$ mn)	52.30	39.78	-23.94
KSE 100 Index	1290.25	1268.61	-1.68
KSE All Share Index	826.39	814.99	-1.38