The KSE — Overview: Suffering from PTCL Syndrome

Updated on Jan 29, 2001

Last week, in our weekly piece entitled, "Dances of the Wolves" we warned investors to beware of artificial rallies and keep to the sidelines. Just as well — because the KSE-100 Index fell from 1452.32 on previous Friday to 1417.54 last Friday, losing 34.78 points for the week. The Index is now down a full 100 points (or 6.5%) since the start of 2001. Can it fall further? We believe there is potential for the Index to test 1380's level, if foreign selling is triggered by PTCL's poor 1H01 results.

At the same time, with a FY01 PER of 6.5x for the Index and forecast earnings growth of 35% (including Hubco) 19% (excluding Hubco) we believe that near term downside is limited to another few percentage points. The psychological barrier of 1400 is important but from a technical viewpoint the support of 1380 is the one to watch.

A review of last weeks activity indicates that the market remained in our expected range of +/- 25 points until Thursday's morning session with a weekly high of 1478. Then, by the second session... PTCL happened!

Consensus forecast had ranged from Rs 7.5 — Rs 8.3 billion for half year after tax profits. In the event, the company disclosed a net profit of Rs. 7.1 billion, down 17% YOY. That spooked the market. This was the second consecutive negative earnings surprise by this market behemoth.

The problem, as seen by market participants was not just the fall in NPAT but the lack of sales revenue (top line) growth. The risk, which the market had perceived — sharp fall in international revenues, loss to Internet telephony and continued pressure on tariffs — was now becoming real. As a result, PTCL promptly lost 3% in price terms during Friday with the weekly loss extending beyond 6%. Large selling in PTCL since Wednesday flooded the market and overflowed into other counters. The fall in the index was accompanied by a very large expansion in trading volumes, which rose by 25% to almost 750 million shares for the week compared 603 million in the previous week. A positive aspect of this last point is that weak holders have likely liquidated their position in PTCL for now. The fall in badla rates to an average of 15.5% this week reinforcement our view that in the short term, downside of the market is likely limited to 25 — 30 points.

Over the last two weeks, ICI, PTCL, MCB and Nishat Mills have been the major under performers with fertilizer stocks leading the pack of outperformers. As long as the market remains under pressure this trend will likely persist. A new dynamic has also become visible in the present downside and this Hubco. It is interesting to observe that this stock is now beginning to behave increasingly as a 'normal' utility stock should behave — i.e. provide a safe haven during turbulence in the market. We believe that going forward this defensive characteristic of Hubco is likely to become more pronounced.

Going into next week, we feel that the market will behave in a volatile manner with bouts of weakness and then some consolidations. We therefore recommend that cash is still king and should be deployed gradually as the market moves in to its support zone, first 1400 levels and then 1380 levels.

Our recommended entry point for PTCL is below Rs 20, ideally in the low Rs 19 levels. We also feel that worldcall and Telecard may now be viewed as potentially more interesting plays in the telecom sector despite relatively tiny market caps. Further weakness would also provide good entry opportunities into Ibrahim Fibres, Dewan Salman, ICI and MCB as trading plays. However, accumulation should be gradual with an averaging down strategy and discipline needs to be maintained in exiting on the upside with predetermined profit levels.

Sector outlook

Telecom

In our December 2000 comment on PTCL, we had expounded on the positives for the company: In the right sector, at the right time, facing the right opportunity to grow successfully and add to shareholder wealth. We had also highlighted certain risk factors and concerns that faced investors. A key factor was non-privatization — i.e. the company remaining in the public sector.

After seeing the 1H01 (June — December 2000) results of PTCL announced, we are now convinced that our concerns were fully justified and the bureaucracy appears ready to run this company into the ground so deeply, that no private sector investor/operator would be interested in buying the company. And that would suit the bureaucracy perfectly, as it would continue to destroy the potential of a very valuable national asset. We therefore believe that this matter is not just a concern of the investor but also of the public at large. Ultimately, a piddly little value is what the citizens are going to be left with if matters in PTCL continue on their current course.

We had warned the management of the company in mid-2000 of what would happen to PTCL's earnings going forward if the company continued to be run as it was being run. Unfortunately, the warnings appeared to have fallen on deaf ears.

In our view, there is only ONE single problem with PTCL. And that is: the management or the lack of it.

Consider the following:

1) Incoming international call minutes are estimated to have increased by approximately 19% YOY, touching almost 73 million minutes in December 2000.

2) Outgoing international call minutes are estimated to have increased by almost 14% YOY to over 8.3 million minutes in December 2000.

3) Based on average exchange rates between Jun-Dec 1999 and Jun-Dec 2000, there is a currency depreciation of around 8% during 1H01 that should translate into higher rupee revenues on incoming calls.

4) PTCL raised local call tariffs, line rentals and installation charges last summer, which, in our estimate, should have added up to Rs. 1.5 billion to the top line. The reduction in NWD rates should also have been a plus due to the positive elasticity factor.

We have highlighted before that going forward, the most critical earnings driver for the telecom is volume growth via capacity utilization and higher net additions (more lines). With telephony tariffs declining rapidly and technology now being able to provide international access at between 30% to 10% of PTCL's present international call charge per minute, accelerated volume growth is the only way to make the best use of its limited monopoly time and beyond.

And line increase is exactly what is not happening at PTCL. Worse, the present state of the company resembles a headless chicken running around in circles without direction and rapidly losing precious blood (read cash flow) through unnecessary dividend payouts because the bureaucracy is unwilling to stop the cash drain elsewhere in public sector corporations and ministries.

This is the political aspect of PTCL's story, which can no longer be ignored. It appears that the free riders wish to destroy the future earnings capacity of the company so that no serious international buyer would find PTCL of interest. What will then happen is that offer price for the company will be so far below what the government wants that no privatization can ever take place. And this is just what the bureaucracy hopes for. After all, the rent-seekers in the economy have less and less places which are making money and can be fleeced to the detriment of investors and taxpayers.

Stock Market Synopsis:

MARKET ROUNDUP
..	LAST WEEK	THIS WEEK	% CHANGE
Mkt. Cap (US $ bn)	6.26	6.12	-2.24
KSE 100 Index	1452.32	1417.54	-2.39
Total Turnover (mn shares)	603.04	747.99	24.04
Value Traded (US$ mn.)	338.86	380.92	12.41
No. of Trading Sessions	5	5	.
Avg. Dly T/O (mn. shares)	120.61	149.60	24.04
Avg. Dly T/O (US$ mn)	67.77	76.18	12.41
MSCI Pakistan Index:
Pak Rs.	95.24	93.19	-2.16
US $	41.62	40.60	-2.45

.Source: KSE, MSCI, KASB

ASIA PACIFIC & AUSTRALIA EXCHANGE INDEX LEVEL CHANGE EXCHANGE Bombay BSE 4330.22 +3.80 0.09% Hong Kong Hang Seng 16044.21 -55.06 -0.34% Singapore Straits Times 1905.89 -8.31 -0.43% Sydney S&P ASX 200 3321.4 +24.20 0.73% Tokyo Nikkei 13696.06 -107.32 -0.78%

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EUROPE & UNITED STATE OF AMERICA EXCHANGE INDEX LEVEL CHANGE EXCHANGE Frankfurt DAX 6673.96 -53.53 -0.80% London FTSE 6228.3 -27.30 -0.44% Paris CAC 5879.85 -54.83 -0.92% Dow Jones Industrial 10659.98 -69.54 NASDAQ Composite 2781.30 27.02