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Updated on Oct 27, 2001

The Last Week

The KSE-100 Index put in a resounding week climbing 10.6% from 1267 to close above the psychologically important level of 1400, at 1401. Perhaps more important was the doubling of volumes from last week, where ADV in shares climbed 94% from 134mn to 260mn, and 110% in US$ terms from US$50mn last week to US$105mn.

The Hub Power Story

The leading performer in the market was Hub Power which climbed 25.5% in the week to close at PkR23.60 with 114mn shares traded on average daily for the week. The scrip was buoyed early in the week by news of the board meeting drawing close, and expectations that the Hub Power board may approve a final dividend of over PkR4/share on top of the interim dividend of PkR1.7/share. Market consensus is that a minimum payout (interim + final) will at least be PkR4/ share, and hence investors took up positions in the scrip. The Hub Power board is due to meet on 5th November.

Where Did The Liquidity Come From?

A pertinent question that should be asked is, where did this liquidity come from? The market has been in the doldrums for quite some time and despite compelling dividend plays did not rise, where the SECP had to run from pillar to post to try and entice large financial institutions to increase their participation in the market. Hence the creation of the market support fund. The problem in the market was how to absorb all the floating stock left by the foreign fund selling, and then the stock of some large market players who were caught wrong footed in the decline after 9/11. There are four key sources of these funds:

1- The large financial institutions, who have supposedly put in about PkR5bn into the market

2- Re-entry of some foreign funds and in some cases some new entrants

3- Lower interest rates on government securities leading some financial institutions to enhance asset allocation towards badla

4- Re-allocation of funds from Rupee speculation, and new funds coming into the country via the kerb

The purpose of the above discussion is to point out the dangers in over-exuberating as this liquidity condition may not, actually we would venture to say is not, permanent. The rise in the market has now become increasingly dependent on the availability of badla funds, and any factor which reduces this liquidity could hamstring the market, somewhat similar to the rise and fall in the market 4Q99 and 1Q00.

So Where Is The Market Headed?

Factoring in expected corporate profitability in the coming year and factoring historical earnings yields, we believe that the fundamentally based fair value of the KSE- 100 Index is between 1550-75, and barring any sharp reversal in monetary policy or a major political blowout, this is where the market should find its equilibrium. Stay Bullish, But Stay Fundamental.

Strategists' Note

Our portfolio performed with the market in the past week maintaining its 15% outperformance against the KSE-100 Index since 9/11. We do not think there is any major argument for shifting our portfolio from its current stance, except we are reducing our exposure to Cherat Papersack to 0%, and shifting the available funds to D G Khan Cement as we believe that it should perform exceptionally in its next financial year, and it has b qualities that we like. Please note that the views expressed in this section may not necessarily agree with those of KASB's fundamental analysts.

Sector outlook

Sui Southern Gas: Nothing but the facts

We have decided to take a slightly different approach while covering the natural gas sector in this weekly in order to clarify some of the procedures that not only impact the operations and thus bottom line of a natural gas company, but also give rise to the debate of deregulation in the gas sector. Any of our investors who simply are interested in looking at the specifics of Sui Southern Gas Company instead of an understanding of issues facing natural gas companies (Downstream) regarding their return structure in Pakistan are welcomed to skip to the section on SSGC's analysis.

Pricing and Return Structure

The government is currently working on deregulating the gas sector, in the current regulatory environment is likely to attract little investment if the GoP attempts to privatize the industry as is. The Ministry of Petroleum and Natural Resources controls the pricing and return structure of the gas industry. For example, the existing return formula pays a fixed EBIT of 17% on average net operating assets of SSGC (the southern gas distribution company). As the differential between the wellhead price and sale price widens or narrows, the government uses the Gas Development Surcharge (GDS) figure to balance the return to SSGC. GDS equals the difference between the actual EBIT and the fixed EBIT @ 17% on average net operating assets. Positive GDS means the company has to pay the difference to the government. It also translates into positive cash flows for the company reducing short term borrowing to pay off current liabilities. Positive GDS enables the company to plan ahead for any future capex requirements. The problem arises when GDS turns negative. The company ends up having huge receivables from the government on its balance sheet for an indefinite period. This increases the financial cost to the company as it is forced to borrow short term to meet current liabilities due to negative cash flows. The GDS figure has been shrinking during the last couple of years due to increases in wellhead prices (linked to international oil prices) while gas tariffs to ultimate consumers have not been increased commensurately. Under the new economic structural balancing program, the government has recently revised the sale price of gas by 15% in July 2000 and another 20% in March 2001. The upward revision of gas sale prices and a decline in the international oil price should result in a positive GDS for SSGC over the coming years.


The GoP has been considering a revision in the return formula for the T&D companies for the past four years. However, disagreements within ministries and bureaucratic hurdles have effectively derailed the process repeatedly. The World Bank has reportedly recommended a switch from asset-based return of 17% to a 21% return on equity. The existing formula is designed to provide incentives to SSGC and SNGPL to expand their T&D network to provide coverage to remote towns and villages, which otherwise would not be economically feasible, due to subsidized gas prices. Since the formula is on a pre-tax and pre-interest basis, the hefty financial charges due to large Capex, constrain the companies growth of profits. Thus, in order to ensure better returns to the international investors, the government is considering various return formulas so as to make the companies more attractive for privatization.

The recent move by the GoP announcing an increase in return from 22.5% to 30% to Mari Gas Company Limited (a government owned company which is providing 70% of its gas to the fertilizer sector at subsidized rates) and the new fertilizer prices whereby the subsidy on natural gas as feedstock would be gradually removed hints towards a more than probable scenario of higher returns going forward for other gas distribution companies.

We expect that the GoP is likely to introduce either a change in the formula i.e from ROA to ROE or simply increase the existing rate of return on Assets. Under the ROA formula, the companies have been increasing their size by taking up projects, which destroyed shareholder value. With ROE formula the distribution companies, instead of expanding just for higher returns through higher capex, would have the option of choosing only those projects that could overall enhance the return to its shareholders. Even if the GoP chooses to keep the ROA formula, we expect that, as was in the case of Mari Gas Company, we would see a shift from the current 17% ROA to a much higher ROA ranging between 21%-25% ROA for SSGC going forward. And we believe this to materialize before the GoP goes through its privatization of SSGC in order to attract international investor's interest.






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.Source: KSE, MSCI, KASB