First week of this year brought bullish sentiments to the investors, who led the KSE-100 Index to gain 93 point during the week after a fall of 139 points. ADV also showed a massive improvement of 56.31% from last week's of 84mn shares to 131.3mn shares this week. The scrip under the spotlight were Hubco, PTCL, PSO, FFCJ and ICI which gained by 16.5%, 11.4%, 4.65%, 25.76%, and 7.44% respectively.

The Market was relatively dull on Monday where it only gained 3 points to close at 1273 level. However, after a positive development on the political front capture the interest of not only domestic but the foreign investors which led the market to gain almost 50 points on Tuesday with high volumes and the Index closed at 1322. Hubco was the investors' favorite and held around 50% of the total market volume during theweek.

Technical Viewpoint

The Index remained choppy within the range of 1265 - 1360 in a positive direction where after gaining 7%, it closed at 1362 for the week. Technically the Index is again on the point from which it started two weeks back. It is now again in the caging region of 1360-1380 where it was captured for 4-5 weeks and the break led it to shed 139 points in one pace. This week is likely to be very important in terms of that if the Index succeeds in breaching this strong band of resistance and support in the coming week we may witness a strong rally leading it to test its next strong resistance of 1425 in a hurry. However, in our opinion the potential for such is very low at least for the coming week. We expect the market to remain choppy in the near term, within the band of 1340-80. We expect a short term correction in the following stocks: Hub Power, Fauji Fertilizers, Fauji Jordan, Askari Commercial Bank and TriPak.

Strategist's Note

India continues to flex its muscles on the border, while the government of Pakistan attempts to continue its crackdown on extremists groups without losing face. While President Musharraf has reiterated his invitation to India to meet at any time and any place, the Indian government continues to prefer to do its talking at the barrel of a gun. This inevitably led to another visit to China where the Chinese government acceded and made even stronger statements in support of Pakistan to give India pause. All in all though, barring an "accident," we feel we can continue to rule out war with India. This a view that the market seems to have taken in the past week as well.

Regarding the cement sector, we reiterate that we do not believe that any major windfall will come for the sector through the Afghan reconstruction effort, in our view. An explanation for this is the focus of our political discussion this week. However, we are bullish on the sector for two reasons. 1) Development projects in Pakistan are likely to take off by 2Q02 and the sector will benefit from the enhanced domestic demand, with some residual demand coming from Afghanistan. 2) The sector has responded strongly to calls for conversion to gas or coal, and we are expecting a significant shift to coal in the current year and almost a complete shift by the next calendar year. This will have significant cost advantages for the companies. In that context we believe that D G Khan cement will probably benefit most as a result of location advantage and due to the already working supply chain for provision of coal. While the Afghan residual demand advantage will most likely flow to Lucky Cement.

Its asset allocation season for global fund managers, where there is reportedly already one at work where a rumoured 27-28 million shares of Hub Power (US$5mn) were picked up. Asia will most likely continue to be index or under weight, hence we do not expect any major fund flows into Pakistan. Most of the entrants are likely to be taking out-of-Index bets, and hence will be fickle about any event risk.

Telecom Sector

Seriously speaking, does no one care about what's good for the country anymore???

Over the next 12 months, two deadlines have emerged as most important for PTCL: May 30, 2002 by which date the company must be privatized as per IMF guidelines for the PRGF and December 30, 2002 after which PTCL loses its monopoly over fixed line telephony. Hence 2002 is an important year for PTCL.

Much too important, in our opinion to not be taken seriously by the regulators, management and indeed, the government!

Tariff Disbalancing?

PTCL has been rebalancing its tariffs since 1997. This is an exercise that is important for the company since it is to lose its monopoly status by the end of this year. Before the market opens up to competition, PTCL must rebalance its tariffs by reducing prices on nation wide dialing (NWD), corporate leased lines and international calls. Better technology and higher competition have led to falling inter-connect charges in the region.

Consequently, to maintain profitability the company must phase out existing subsidies particularly on local calls and monthly rent. Although the company also subsidizes installation, this is to encourage new subscribers in a fixed line telephony, and since it is one-time revenue from subscribers, it works out better to maintain this subsidy.

However, the company must operate under certain regulations when adjusting its tariff structure. The overall guiding principle mandates that PTCL may adjust tariffs such that the collective weighted average price change of its basket of basic services is CPI-x%. The x% which is to be determined on a tri-annual basis by the Pakistan Telecommunication Authority (PTA) has been fixed at 7.5% for the next three years.

Accordingly, keeping the existing tariff structure in mind, PTCL had put forward its proposal for the revised tariffs from January 1, 2002. In fact the company proposed to lower its prices beyond the mandated amount on installation charges, NWD and international outgoing calls. According to the proposed tariffs PTCL would have changed its prices by CPI-14.2%.

However, the PTA appears to have yielded, in response to the hue and cry of the domestic industry and disallowed the increase in local call tariffs, while agreeing to the reduction in tariffs proposed by PTA for the other services. Monthly rental is the only service to register an increase. This has in effect meant that the overall change in tariff is over CPI-17.0%.

Discussing the PTA Decision

Was the PTA justified in spurning the request for a raise in local call charges? We think not. First of all the proposal by PTCL for tariff rebalancing was a very clear-cut document. It highlighted the reasons for tariff rebalancing and then declared that for the company to be able to continue to operate profitably, it is imperative that local call charges be raised such that erstwhile granted subsidies be done away with and hence the exposure to international calls, whose tariffs are rapidly falling, be reduced for the company.

The company's net profit breakup reveals that in fact, it is at existing tariffs currently incurring a net loss on installation and in particular on local calls. Furthermore, let us not be misguided by the large component of profitability from incoming international calls. In dollar terms, these revenues are declining and declining very fast. Over the last two years the international settlement rate has fallen by as much as 45%. It is only because of massive rupee depreciation that these numbers are what they are in local currency terms. A strategic investor will be looking at dollar based numbers and they won't be growing for international incoming revenues over the coming years, especially since we forecast a more stable rupee over the next year or so.

We should also touch upon the fact that it is important for PTCL to be profitable not only because the public entity has become one of the largest tax paying entities since FY00, but also since the company will hence be able to recycle its cash flows for capital expansion and upgradation. The company estimates that if the change in tariffs had been implemented following the proposal, it would have earned revenue of PkR67bn during the year. Consequently, of the PkR16.5bn that PTCL plans to invest over the next twelve months, the majority would have been raised from its own cash flows.

The PTA's decision, according to the company, could cause a shortfall of almost PkR1bn to PTCL's top line. These 12 months are particularly consequential for PTCL and the PTA's crumbling under public pressure is just not what the doctor ordered.

Regional Lessons

We took a look at the regional tariff structure of local call charges and found that as far as local call tariffs are concerned, countries continue to price them based on domestic considerations as opposed to international or regional benchmarks. To illustrate, local call charges in Australia are US$0.28 per 3 minutes, while the local call tariff in South Korea is US$0.03 per 3 minutes.

Further our study of the region has also revealed that PTCL local call tariff is well within the average for the region, excluding Australia, Japan and Thailand, at US$0.02 per 3 minutes. Even if the PTA had allowed local call charges to be raised, in terms of USD local call tariff would remain US$0.02 per 3 minutes. In view of the above factual comparison, we believe that domestic industry's competitiveness would not diminish due to the company's proposed tariff rebalancing. Thus the industry's hue and cry in this context seems to be misguided or intended to misguide the regulators. In our view, the domestic industry's sources of lack of competitiveness stem from more fundamental causes rather than telephone charges in any case.

Effect on Strategic value

With the IMF laid deadline for the privatization of PTCL before May 30, 2002, the strategic value of the company becomes of paramount importance. At this point we need to give serious thought to whether the GoP is serious about privatizing the company or is this just the bureaucracy's way of pushing back the privatization deadline? Further, we also need to examine the management's role pre-privatization and whether it is fulfilling its responsibility.