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Updated on Sep 29, 2001

The KSE - Overview: Low valuations offer ample opportunities

The KSE was closed for business initially for three days after it took a plunge of 115 points on September 14, 2001 but the duration was extended to a week amid fears of further losses due to political uncertainty prevalent in Pakistan. We do agree that the crisis in the US did play a major role in the fall of world indices and also KSE-100 Index but the weakness was widespread even before the attacks it just added fuel to fire. The Index this week closed at 1133.44 only 6 points lower than its close of 1139.64 on September 14, 2001.

The KSE management changed the 'circuit breaker' (CB) rule to 5% from 25% to avoid any panic selling it witnessed on the last day before the weeklong closure. The market maintained its downward drive despite news/promises of economic incentives, debt write-offs/rescheduling and lifting of nuclear sanctions and lost 34 points on the very first opening day after the closure. In our opinion, the general public's fear of the heightened risk of war at Pakistan's borders initially ignited the exit of the local as well as foreign investors from the local stock markets. As a result, the drop in share prices of KSE-100 Index exposed a large market investor to margin calls. The investment bank, as reported in the press, had a large portfolio of major blue chip stocks and was unable to service margin calls from brokerage/badla traders as the market plunged. The management of KSE and SECP came to the rescue of large market investor through big five local commercial banks (NBP, HBL, MCB, ABL and UBL) and provided enough liquidity in the market to absorb the sale of it's stock portfolio reported to be around PkR1.7bn.

The long awaited entry by the B5 banks plus CB rule provided enough protection to halt the downward slide of the market. In our opinion, even though the market stabilized for the moment through artificial support measures, it would have been even more positive in the longer term had the SECP and KSE had left the market to its own devices depicting a clear picture of the overall market sentiment. We could have seen one or two causalities in the market but ... that's the nature of the business. As we have witnessed in the past, every sharp drop in KSE-100 Index is followed by a surge in buying at the lowest levels especially by the institutional investors. However, the fall was prevented by SECP and KSE.

So what is next? We believe that the current easy monetary regime as a result of declining international interest rates and a ease in pressure on the US$/PkR parity making depreciation of PkR less likely in the near term is likely to initiate a response by individual as well as institutional investors towards entering the stock market at these low and fundamentally attractive levels. The Index has a strong support at 1100 with next strong support at 1080 level. The low valuations at present in the market with a limited downside risk and dividend yields touching as high as 37% is bound to attract investors interest back in the market going forward. Our advice would be to our existing and potential clients (we strongly believe that the market has bottomed out and is bound to consolidate and recover going forward) to stick to fundamentally strong dividend paying stocks especially focusing on large cap stocks.


Polyester Fiber: The King of Fiber

According to the International Fiber Journal, during FY00, worldwide production of textile fiber rose by 3.5% to a total of 52.7 million tonnes (mt), where the volume includes man-made fiber, cotton, wool and silk. They attribute this growth to the recent upward trend in production of man made fibers where the production volume increased by 6.2% to a total of 31.3mt and the production of natural fibers declined slightly by 0.3% to 21.4mt. The share of polyester fiber in man-made fiber was around 60% last year where the global production has increased by 6.4% to 18.9mt.

Polyester staple fiber is versatile, has good physical and chemical properties, and can be engineered for a wide variety of applications. It is the best man-made fiber for blending with natural fibers, with good processability on both cotton and woollen spinning systems. Keeping the above in mind with healthy growth rate of PSF, one can assume that the industry has been enjoying a period of good profitability and sound financial performance globally. Unfortunately, this has not been the case. Unrestrained installation of new capacity during late 90's has caused supply and demand imbalance globally. No producer has a share of worldwide capacity greater than 5%. The top 20 producers hold only 55% of capacity and there is a large number of small players with 1% or even lower production capacity.

Reportedly, much of the capacity expansion during the decade of 90's occurred in Asia. From FY90-FY00, capacities grew by 121% in South and Southeast Asia, by 75% in China and 54% in Korea and Taiwan. Currently, about two third of world's total capacity is installed in Asia. However, much of the PSF consumption by textile mills occurs in Asia as well. China is the largest consumer of PSF with a forecasted demand of 2.4mt in FY0,1 while South and Southeast Asia are the second largest consumers with forecasted demand of 2.2mt in FY01 and the third largest are the Americas with consumption of 1.6mt. Mills in the US consume about 70% of that total.

With production of only 1.6mt, China is a huge net importer of about 800kt of PSF. The primary suppliers of that fiber are Korea and Taiwan, which have an excess of almost 1.4mt over their domestic usage. These countries have installed much capacity at export markets both within and outside the Asia region and in order to gain the market share, they priced their fibers at lower than fair market value. Recently, due to the worsening in the supply/demand balance in Asia, both of these countries are accelerating industry restructuring where major South Korean companies, reportedly accounting for 40% of PSF production in South Korea, are contemplating reducing capacity.

Current Scenario

The oversupply condition is expected to continue plaguing the Asian PSF industry into CY01, even though some restructuring efforts appear to be underway to bring supply discipline into the industry. It is expected that prices may decrease by US$0.30/kg (4%) in 3Q01 as compared to 4Q01 in view of the current excess supply in the face of depressed demand. Furthermore, a record cotton crop is expected globally this year, thanks to favourable weather conditions. According to the US department of Agriculture, world cotton production is likely to reach 95.55mn tonnes this season, a 7.42% growth against FY00-01. Due to this reason the international price of cotton, a close substitute for PSF, has slipped to historically low levels and thus it is likely that under the current scenario PSF prices will remain susceptible to further downward slippage in the months ahead.

Meanwhile, the recent terrorist attacks on WTC in US may cause the world's textile market to plunge into crisis. Consumer confidence is likely to be shaken (as shown by recent UK consumer confidence data) and even economists who were forecasting a rebound in the short term; now predict recession a full-blown. This directly or indirectly is likely to affect international demand of PSF, causing prices to weaken further globally.

Domestic Industry: An Overview

The polyester staple Fiber (PSF) Industry has seen its fair share of volatility in the last few years. Since the early 90's, the fiber/cotton blended consumption ratio in the country has been steadily rising. From a mere 7:93 in FY90, it had grown to 21:79 by FY00. Due to the divergence from the global average ratio of 58:42, we feel that potential for PSF demand in Pakistan is likely to remain high at 10-11% growth. Currently, the total installed capacity of PSF within the country is around 360ktpa against an approximate demand of 405-410ktpa, with a healthy ten-year demand CAGR of 18%.

At present, the domestic PSF industry is going through a restructuring of its own. One of the MNC companies operating in Pakistan (ICI Pakistan Ltd.) has decided to de-merge its PTA production plant into a new entity. Furthermore, the company has plans to expand its installed capacity by entering into an arrangement with a consortium of financial institutions and forming a Modaraba company to finance this expansion. The company claims that it is reducing its exposure to the business, since Pakistan is the only market in which the MNC is involved in the polyester fiber industry.

The Ibrahim Group has also announced a proposed merger of four of its textile related companies into Ibrahim Fibers, Ibrahim Textile, AA. Textile, Zainab Textile and Ibrahim Energy. The scheme of arrangement of amalgamation envisages merging all the companies under the flagship of Ibrahim Fibres. As a result of this, the other companies will stand delisted from the stock exchange and IFL will be the only listed textile related entity of Ibrahim Group.

After recent acquisition of Dhan Fibers Limited by Dewan Salman Fibers Ltd., and planned capacity addition by Ibrahim Fibres Limited in 2002, the market structure of local PSF industry is likely to be a duopoly with IFL and DSF commanding almost 70% of the 587ktpa projected installed capacity, followed by ICI at 18.6%. Profitability

At the same time, the domestic situation is somewhat more complicated with a price war underway amongst the local PSF producers. This has occurred because the second largest player in the industry has begun supplying PSF outside its group textile units. This prompted the largest producer, already struggling with tight cash flows after acquiring another PSF facility, to counter by offering large discounts. And, lo and behold: we have a full-fledged price war in progress!

The slowdown in textile exports due to lower growth in major G-8 markets has meant that the demand side of the PSF sector which has historically remained fairly robust has also started showing some sign of weakness. The saving grace has been that key raw material prices (PTA and MEG) have remained stable in 3Q01 so far. Thus, while margins of domestic PSF producers are likely to be lower in this quarter, this has more to do with lack of pricing power rather cost-push factors.

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