Updated on Jan
The KSE - Overview: Upbeat Sentiment Continues ...
The KSE-100 Index opened on a positive note at 1374
level, a continuation of last weeks upbeat momentum. The market
spiraled up on the back of developments at the SAARC summit that led
to prospects of peace on the Pakistan - India issue. However, over the
week ADV declined by 28% to 94mn shares as compared to 131mn shares
last week, reflecting low investor appetite for long term commitments.
The scrips that managed to capture foreign investors' interest were
HUBCO and Fauji, technically a continuation of the previous weeks
On Monday the Index briefly touched the 1400 level,
which acted as a physiological barrier to the local investors and as a
result of unavailability of a support level, the local institutions
started offloating or what you may say as 'profit taking' at high
levels. Tuesday, the market bottomed to 1369 level reflecting a
decline of 29 points compared to the previous day. The downturn can be
attributed to the variation of the on-going tension between India and
Pakistan and Tony Blair's unsuccessful attempt to pacify the situation
between the two countries. There were mixed sentiments in the last
three trading days with a bear run on Wednesday and a rebound on
Thursday that continued to close the market positively on Friday.
There are two dimensions of the Pakistan-India
situation that we wish to note, because we do not believe that they
have been adequately addressed by other media.
1) The almost paranoid fixation of the
general public in Pakistan of the whole world being out to get them is
unrealistic. In our opinion, this world view is naive, and only wish
the world were that simple. Such a fixation has also been apparent
during Mr. Blair's visit to the subcontinent, where his proclamations
about terrorism have been taken to be aimed at us. The fact is that he
also made a significant concession to Pakistan, which has been
overlooked. His call for dialogue between Pakistan and India was
borrowed directly from the GoP's own stated position which in
"diplomatic-speak" is very significant.
2) It is important also to understand that
imposing war is not the only reason a state builds up troop
concentration with the border with another. The buildup is also used
to get the other country to agree to a proposal or move their position
closer to it.
President Musharraf has a track record now of being
well able to handle crisis such as these. So stay bullish. But be wary
of the greatly exaggerated hype...that is not the time to buy.
Shell FY02 Results...RIP
The word on the street recently about the OMC
sector is to keep away — as expected — especially after a 10%
decline in POL consumption during 1H02 as reported by the industry
sources. We have always maintained a very cautious approach towards
investing in the OMC sector over the last year due to the changing
industry profile going forward.
Industry Dynamics - A brief Overview
The government has been historically keen on
reducing Pakistan's reliance on imported crude oil and POL products
not only due to rising oil import bill and limited foreign exchange
reserves but also because of the price differential advantage (lower
cost) that could be gained by the local industry.
With almost declining crude oil reserves compared
to our energy needs and higher prospects of finding new natural gas
reserves, we believe the government in treading on the right track.
Over the last ten years, oil consumption in Pakistan has risen by a
CAGR of over 7% in 2000 to 18.03 mn TOE. Local crude oil production
has declined by a CAGR of over 2% whereas the import of crude oil has
seen a rise of 1% CAGR over the last ten years. POL import, on the
other hand, increased by a CAGR of over 12% for the ten-year period
Furthermore, there are certain developments, which
need to be monitored closely to ascertain their impact on the OMCs
viability in the future.
a) Conversion of cement plants to natural
gas and coal from furnace oil
b) Increased supply of natural gas to power plants for
substitution of furnace oil to reduce power generation costs
c) Deregulation of import-export of major POL products with
government allowing WAPDA and other users to import POL products
(furnace oil and diesel) for consumption
d) Complete deregulation of the oil sector by lH03 which could
increase price competition and thus reduce already squeezed profit
e) Government's drive to enhance Pakistan's hydel power
generation capacity through increased investment in building various
dams and reservoirs
Natural Gas Sector - OMC's Dilemma
The developments that took place during the last
year within the Ministry of Petroleum and Natural Resources were aimed
at enhancing the role of the natural gas sector to meet the future
energy needs of Pakistan. In our opinion, these developments,
mentioned below, are certainly going to impact the consumption
patterns of the OMC sector going forward. a) Replacement of FO at
Power Plants b) Substitution of Motor Spirit and Diesel in the
Transport Sector c) Replacement of Kerosene in Domestic and Commercial
This would, according to industry sources, increase
the share of natural gas in primary energy mix from existing 41% to
47% by 2010. And with the increased probability of imported gas from
the Central Asian Republics from 2010 and beyond, the share of natural
gas would further improve by 11% to 57% going forward.
Volumes and Prices
As already mentioned above, the drop of over 10% in
POL consumption and falling international oil prices during lH02, have
already played havoc with the POL industry sales. Shell, as a result,
is bound to see a fall of over 11% in total POL sales during FY02.
However, due to a recent agreement signed last year between WAPDA and
Shell for the sale of furnace oil (FO) is likely to increase Shell's
FO volumes going forward.
The upturn in economic activity during FY03 would
enhance the total sales volume of Shell during FY03 in our opinion. We
have assumed a proportional jump in sales for various POL products
with furnace oil as an exception. Even though the total industrial FO
sales would go down going forward due to reasons discussed above,
Shell, in our opinion, would be able increase it's market share in FO
business by 4-5% from the existing 17.5% going forward.
The numbers for FY02 are evident of the fact that
demand/consumption and falling oil prices are bound to reduce the
bottom line of Shell tremendously. The revision in the distribution
margins by the GoP is only possible after a complete deregulation of
the OMC sector which, according to government sources, is planned
somewhere after June 2002.
This, in our opinion, limits possibility of any
relief to Shell during FY02 from GoP and it is left to the market
forces going forward to determine its bottom line. And this is where
the problem lies. Shrinking volumes and squeezing margins do not bode
well for Shell during FY02 and as a result could see a fall of over
50% in it's FY02 EAT.
And a continuous decline in margins (gross,
operating and net) from FYOOA to FY02F paints a rather negative
picture of Shell's operations going forward. However, due to its lower
exposure because of its smaller size and low market share, especially
in FO and HSD, makes it less vulnerable as compared to PSO going
What does it all mean especially to investors
interested in the OMC sector? In our opinion, FY02 is going to result
in a markedly lower bottom line not only for Shell but also other
OMC's as well (PSO and Caltex). For FY03, as we expect a turnaround in
economic activity, we believe Shell with less exposure due to its
smaller size and market share would find it easier to regroup and
turnaround than PSO. The rise in its market share, due to higher FO
sales, would to some extent support the declining bottom line. But in
our opinion, the changing industry dynamics will keep its sales
volumes almost flat and a five year CAGR EPS of -0.20% going forward.
We, thus, change our intermediate recommendation on
Shell to REDUCE and maintain a long-term NEUTRAL on the stock.
Mkt. Cap (US $ bn)
Total Turnover (mn shares)
Value Traded (US$ mn.)
No. of Trading Sessions
Avg. Dly T/O (mn. shares)
Avg. Dly T/O (US$ mn)
KSE 100 Index
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