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THE KASB REVIEW
STOCK MARKET AT A GLANCE

  1. FINEX WEEK
  2. STOCK MARKET AT A GLANCE

Updated on Sep 19, 2001

The KSE - Overview: Pakistan comes First

In his address to the country, President Musharraf, we felt, presented some very solid arguments for Pakistan's support for the US in its global war against terrorism. Indeed, we felt the speech itself was extremely good, and if other decisions are taken in the country with the same concise analysis, then we can expect some good times ahead.

The Bourses were shut

In the last week, the KSE board of directors and SECP kept the domestic bourses closed, wherein there was reportedly concern that the uncertain domestic situation may lead to large scale losses. The closure has followed the SECP forbidding blank selling and the easing of margin requirements by the SBP. This is in contrast to the country whose financial community was dealt a massive blow by the recent attacks, the US. The US stock exchanges were opened as soon as possible, and the government and regulators did not introduce measures to artificially support the market, and even discouraged investors who wanted to do some 'patriotic' buying. There were no restrictions whatsoever, even blank selling was acceptable, with the commonly held view that the market knows best and would sort itself out. The authorities in Pakistan seem to have taken a more paternalistic view of the situation, and have resorted to shutting down the market, to protect the "small investors." We have a very simple opinion about the market, that the SECP would do well to take its cue from its US counterpart-where the focus has been on the smooth functioning of the market following the hiatus. In the absence of any concerted effort to underscore the health of the exchanges, regulators are well advised to stick to their mandated task of regulating, as opposed to controlling the market. Though we admit that they may have been prompted to do so by practical considerations.

Consequences of the US attack

Before we go into what, in our view, will be the impact of the GoP's decision to support the US, we would like to point out the key impact (excluding political considerations) of the terrorist attack in the US. One thing that is often not known or ignored by investors and economists alike is that the tourism industry is by far the largest globally, and unfortunately it is likely to be the hardest hit as a consequence of the US attack. While we did feel that the US economy would slip into recession, and hence the global economy, before the attack, the growing consensus view currently is that the US and hence the global economy, is now slap bang in the middle of a recession.

What should equity investors do?

The basic message here is: investors who are risk averse, should stick with our defensive portfolio, while investors who are more comfortable with risk should put their money where our mouths are (somebody really should introduce the smiley as a part of the English alphabet!).

Over the next three months, we feel that the 'practical considerations' (read: bailout) will keep the bears in ascendancy. But as external benefits begin to flow in, in terms of tangible cash and kind, we expect the market to outperform the regional markets. Buy on the way down.

Sector outlook

Century Paper & Board: Solid Growth

Bears almost wholly dominated the market last week, following the attacks on the US the day before. We have since been advising investors to restrict themselves to investing in companies with solid fundamentals and/or high dividend players. This type of investment promises to be a safe bet, in the current scenario, for both retail and institutional investors. These companies are likely to be highly undervalued by the market, following the political and economic repercussions of the US attacks on the Pakistani market, and are thus expected to prove to be good investments. With regard to the above, we have been recommending those scrips, which have a sustainable earnings generating capacity and high dividend yields. We are of the opinion that Century Paper and Board Mills belongs to this group.

Historical Earnings Summary

To establish the earnings potential of Century, we analyzed its historical earnings. Although the company has historically shown steady growth, its earnings surprise during FY01 has been impressive.

Table 1:
Earnings Summary

 

FY98

FY99

FY00

FY01

Net Sales

1,422

1,629

1,743

2,143

Gross Profit

157

178

226

350

Operating Profit

121

137

179

301

EBIT

151

185

206

295

Financial charges

75

77

55

54

EBT

77

107

151

241

EAT

66

74

95

145

Source: Company Data

Sales increased by 23.0% in FY01. The closest to this high sales growth over the four-year period under consideration is the 14.6% sales growth in FY99. Sales growth during the last year may be attributed to increased capacity utilization of 107% (FY00: 101%). Correspondingly sales volume grew by 6.7% to 64,145 tonnes in FY01 (FY00: 60,120). Furthermore, in view of the devaluation of the Rupee against the dollar of about 21% during FY01, the company was able to revise its selling price per unit higher. The positive effect on total revenues was heightened, since the company operates in the higher margin end of the Paper and Board sector.

In uncertain times we recommend investing in companies that have lower financial leverage weighing down net profits for equity shareholders. Thus, an additional factor that we would like to point out in Table 1 is the falling financial charges component. This indicates the reduced reliance of the company on external debt. This too is a positive sign for potential investors.

Margin Analysis

Even though historical earnings indicate satisfactory historical growth, we are as much, if not more, interested in looking at the margins which indicate the inherent profitability of the company.

Table 2:
Margin Analysis

 

FY98

FY99

FY00

FY01

Gross margin

11.1%

10.9%

13.0%

16.3%

Operating margin

8.5%

8.4%

10.3%

14.0%

EBIT margin

10.7%

11.3%

11.8%

13.8%

Net margin

4.6%

4.5%

5.5%

6.7%

Sources: Company Data; KASB Research

Core operating margins, i.e. gross margin and operating margin, dwindled somewhat in FY99 before they turned around in FY00 and hence into FY01, to indicate substantial improvements in profitability. Even though EBIT margins show steady growth during the period, net margins tell a similar story with a slight dip in FY99, before picking up with strength in FY00 and FY01.

Investment Indicators

The three investment indicators that we plan to discuss here are return on assets, return on equity and dividend yield.

Table 3:
Investment Indicators

 

FY98

FY99

FY00

FY01

ROA

4.8%

5.5%

7.0%

10.3%

ROE

10.1%

10.8%

13.3%

18.5%

Payout ratio (dividends/net income)

0.0% 63.9% 65.8% 54.4%

Sources: Company Data; KASB Research

•Return on Assets

The return on assets for Century Paper and Board Mills has more than doubled over the last four years. This indicates that the company is taking full advantage of its astute investments in a fragmented industry where it faces real competition from not more than one or two players. It is apparent that Century has shifted its production to higher margin products over the last four years, which has resulted in a rising ROA.

•Return on Equity

The ROE like the ROA has shown steady growth over the period. A DuPont analysis indicates that core profitability has improved substantially YoY, except in FY99 when it dipped somewhat.

Table 4:
ROE Decomposition Analysis

 

FY98

FY99

FY00

FY01

Operating margin (operating income/sales)

8.5%

8.4%

10.3%

14.0%

Asset turnover (sales/total assets)

1.04x

1.21x

1.28x

1.53x

Leverage (total assets/equity)

2.09x

1.97x

1.90x

1.80x

Financial burden (PBT/operating profit)

0.63x

0.78x

0.85x

0.80x

Tax effect (PAT/PBT)

0.86x

0.69x

0.63x

0.60x

ROE

10.1%

10.8%

13.3%

18.5%

Sources: Company Data; KASB Research

As we had mentioned earlier, Century has in the period under review decreased its dependence on external sources of funds. This is reflected in the decline in its leverage ratio between FY98 and FY01, which weighs down the ROE. However, correspondingly, the financial burden ratio has shown an improvement over the period, contributing to a higher ROE.

The ROE decomposition also indicates a very high, and in fact, rising asset turnover relative to the industry in which Century operates. This indicates that Century's high capacity utilization has also contributed to an increasing ROE%.

•Dividend History

Picking up on the dividend discussion from where we left off, Century's dividend yield picked up from 0% in FY98 to a high of 15.6% in FY01, respectable by any standard.

Table 5:
Historical Dividend Analysis

 

FY98

FY99

FY00

FY01

DPS

0.0

1.50

2.00

2.50

Dividend Yield

0.0%

9.4%

12.5%

15.6%

Sources: Company Data; KASB Research

Currently, the stock has gone spot and potential investors may take this opportunity to buy the stock and pick up a cash dividend of PkR2.50 per share.

Valuation

Table 6:
Valuation Multiples

 

FY98

FY99

FY00

FY01

EPS

2.10

2.35

3.04

4.60

EPS

.

11.9%

29.4%

51.3%

PER

7.62x

6.82x

5.27x

3.48x

BVPS

20.88

21.73

22.77

24.86

PBV

0.77x

0.74x

0.70x

0.64x

Sources: Company Data; KASB Research

Earning per share has grown substantially over the period, and the EPS growth over the period has been tremendous. We are of the opinion, that this indicates the fundamental strength and earning potential of the company. Similarly book value per share too has shown growth, albeit in a more sedate fashion.

Century's PER has concurrently decreased quite noticeably over the period under review, particularly on FY01 earnings. Furthermore, we feel that the company's PER is also low relative to the sector. The price to book value shows a similar decline, underlining the fact that the scrip is under priced relative to its fundamental value.

Recommendation

Our strategist feels that the market is unlikely to show significant performance in the next 3-4 months, as some over-exposed market players ease their long positions. But over the next 6-8 months the market should show significant performance through external benefits flowing into the economy. For those and the above mentioned reasons we rate Century as a short term Accumulate and a long-term Buy.