The KSE - Overview: Rumors Reign Again

Trading activity remained dull on the very first day of the week due to absence of any institutional demand and individual trader interest in the market. The KSE 100 Index closed only two points up from its previous close on Saturday on declining volumes. Textile shares experienced some renewed interest on the back of recent news flow of an increase in trade quotas and duty cuts by the European Union but the selective interest in textile shares failed to make any significant impact to provide the needed stimulus to take the Index any higher for the day.

However this all changed the very next day when the Index was overwhelmed by bullish sentiments - mainly based on a rumor regarding PSO. The Index moved 12 points up to close at 1372.76 for the day on a 40% jump in Average Daily Volume (ADV) as rumors regarding PSO took the market by surprise. This led to increased activity in the energy sector shares especially Hubco and PSO, which later spread to other sectors also. The share price of PSO was rumored to gain between PkR10-15 per share and as a result, this invoked buying interest in other large market cap stocks also.

According to market sources, the news of a Dubai based oil giant's interest in buying around 5.0mn shares of PSO had the day traders and small investors flocking to share profits from any ensuing speculative activity. The share price, as a result, jumped PkR1.20 to close at PkR102.65 per share after touching an intraday high of PkR104 but not as much as it was rumored in the market. This run up was supported by an increase of 40% in the ADV on the very next day and the Index touched its intraday high of 1380 on Wednesday. The profit taking by the weak holders around this level, however, pushed the market down to close at 1376.39 for the day.

On Thursday, the Index closed down 18.23 points at 1358.16 on profit taking — especially by weak holders due to the absence of any investor interest in the market. The rumor regarding PSO, which kept up the trading activity, finally died down, as not one source was able to confirm the authenticity of the rumor even after three full working days. The result was profit taking by all counters — especially in PSO shares which erased all the gains made earlier by the Index during the current week. The market finally closed at 1355.06 on Saturday — only 4 points down from its last week's close.

Strategist's Note

Over the past few weeks clients have noted that this market review's structure has changed from one with a strategic focus to one which reviews the trends in the past week's market, with a brief note on where we believe investors should be positioned. The reason for this change has been our view that the market was going nowhere in a hurry, and that investors should basically concentrate on consolidating their present portfolios.

This week, we shift the emphasis to you. We believe that it is time for investors to decide where they stand with respect to their view of future market direction. Or more fundamentally, will you manage your portfolios strategically or tactically? No, this is not a rehash of the age old "axiom" about the equity markets in Pakistan, wherein every Tom, Dick and Harry is an expert, and where all the "experts" have one view: that market valuations in Pakistan are not determined by fundamentals, but by the machinations of a secret elite society whose sole aim is to make Pakistan's bourses an insane investment proposition (of course this is funded by RAW and the CIA, is a more general conspiracy to undermine Pakistan!!). No seriously, that the market is solely determined by the whims of a few large brokers and market players, and that the only way to make money is to trade actively with the market. It does not matter that very few trading investors have actually beat the market.

So returning to our original question for non-trading investors, where do you stand with respect to market strategy? Strategic focus or Tactical? A strategic focus would compel investors to recognize that the present year is likely to be a depressed one for corporate earnings on the KSE. It would also indicate that given the strength of the global recession, it is unlikely that global investors will go emerging cyclical in the near future. Hence, the strategic investor would be looking to invest defensively. Meaning exposure to stocks with stable EPS and dividend payout history, like PTCL, Fauji Fertilisers or Levers Pakistan. On the other hand, you could be a tactical investor, where you believe that the liquidity induced in the country by the SBP and inflows of foreign assistance should force the market to take "low-quality" rallies on whose cycles the tactical investor would position him/herself in high-Beta scrips, ride the low-quality rallies to take profits. There are two important things to note here. 1) We are discounting investors taking a longer term focus, because the fluid environment in regional politics and global economics would make this an unwise decision and 2) that there is no right or wrong approach. We, of course, will continue to present to you a more long run view of the market and economy, but we feel that investors must decide in the current market environment which side of the fence they choose to sit. Why? Because that will determine the timing of adding/ reducing exposure, and where the exposure is taken.

Given that we have time to play with. Over the next two weeks, we will elucidate on how and where we feel investors on both sides of the fence should invest.

Sector outlook

DGK Cement FY01 Results: Nothing Unexpected

The DG Khan Cement Company Limited (DGK) announced its full year 2001 results. The company posted a Net Loss of PkR444mn, PkR342mn greater than last year's Loss of PkR101.2mn.

As the comparative numbers indicate, the problem was related to both top line growth as well as higher costs. Net sales slipped by 13% reflecting not only lower volume but also lack of pricing power due to the intensified price competition. At the same time, COGS depicted an increase of 1%, mainly caused by sharply higher fuel prices. As a result, gross profit fell by 94% as the gross margin shrunk to 1% in FY01 from 15% in FY00.

The company managed to control well, what it could control — selling and distribution expenses. The selling and distribution expenses were actually reduced by almost 72% but the hit at the gross level flowed through to operating margins, which were squeezed to -1% in FY01 versus 12% in FY00. Other income improved massively by 215% and was offset by the increase in other income and financial charges, which jumped up by 22% on compound bases. The net result was a net loss of PkR444mn with net margins falling to-17% from -3% a year ago.

Future Outlook

Current fiscal year FY01 proved itself to be one of the worst years for the cement industry where the industry faced insignificant demand, low pricing power and a sharp increase in production cost (mainly furnace oil). We expect a sharp enhancement in the profitability of the sector on the basis of improving pricing power, reduction in cost of production (lower fuel oil prices — conversion to coal), and increase in capacity utilization due to a potential increase in demand domestically and expected silver lining in export of cement to Afghanistan.

With the growing emphasis of the government on the construction and housing industry and development of new water reservoirs, a silver lining maybe discernable for the cement industry in the coming future, especially since 60-70% demand comes from the construction and housing industry. In this regard the GoP has recently increased Public Sector Development Programme (PSDP) by PkR13bn to PkR140bn for FY01-02, which should positively impact cement and construction industry in the coming years. This should improve the capacity utilization from the current 60% to 70%.

Apart from this, the recent shift in interest from furnace oil to coal is likely to improve the profitability margins of the sector. With cost of coal being 55% of the furnace oil cost, this conversion is likely to reduce overall cost of production by almost two-third. However according to the industry, this process is likely to take more than two years and require an additional investment of around PkR300-400mn. DGK is currently in the process of shifting its operations from Furnace oil to coal, which will be completed by June 2002 and is likely to reduce the cost of production in coming year.

Another factor, which cannot be ignored, is the international exercise to reconstruct Afghanistan. The cost of reconstruction is expected to be high although it will be premature to put the actual amount at the moment though sources indicate US$20bn could be allocated for this purpose. This is likely to provide a potential silver lining to the cement sector as this reconstruction will enhance the possibility of exporting cement to Afghanistan and hence will increase the profitability of the sector. At present, Pakistan has capability to export 5.95mtpa cement, after fulfilling the domestic demand.

Investment Perspective

We expect a recovery in the earnings of the company in FY02, driven by the conversion of DGK's production facility from furnace oil to coal, lower financial charges due to debt restructuring and other above given reasons. We maintain our stance of intermediate-long term NEUTRAL for the scrip. However, due to the brighter earning prospects in coming years, we give Overweight on the sector.

Technical Outlook

Currently the scrip is trading in its Intermediate term positive trend where after testing 7.20 level it corrected itself to close at 5.95 on Monday. We expect further weakness in the near term, which may lead the scrip to test its lower support at 5.30 where trading opportunities may exist. We will advise investors to take weakness as an opportunity to accumulate the scrip for long term investment.