The KSE - Overview: Up, Up and Away?

The market has been giving clear indications of an upward rally by consistently rising over the last four weeks, from the 1269 closing on December 28, 2001. This week certainly confirmed the overwhelmingly positive sentiments when the market rose by over 47 points to close at 1527 relative to a week ago when it closed at 1479. The average daily volume (ADV) during the current week rose to 176.50 million shares, which showed 7% higher turnover than last week's ADV of 165 million shares, reflecting an entry of institutional buyers. The turnover on Friday was as high as 200 million shares.

The daily action

The market opened on Monday with the news that Canada has decided upon conversion of its Pakistan's entire debt of 447mn Canadian Dollars into a grant for Pakistan and that the ADB would provide assistance of up to US$2bn over the next two years. However, the threat of an escalation in the India-Pakistan tension accompanied the news that Pakistan had shot down an unmanned Indian spy plane along with the fact that the Index was due for a correction resulted in a decline in nine points on Monday and sixteen on Tuesday.

On Wednesday and Thursday, the rejuvenated market gained 30 and 9 points respectively with first the news of the SBP reduction in discount rates by another 100bps to 9%, and then a reduction in T-bill rates by between 134bps to 148bps in sync. On Friday, the market notched up 11 points before the news of India's testing of its 'Agni' nuclear missile sidelining the bulls temporarily, when the market fell 12 points. Not for long though, however, as the bulls made their return in style bringing the market up to close 16 points higher than the day before at 1527.

Who gained, who lost?

The granting of a quota-free status by the WTO to Pakistan on Saturday, with relevance to several textile export products, resulted in positive interest in textile stocks during the entire week. Other sectors that remained positive during the week were cement and banks, as the news of allocation for development expenditure came into the market, and in expectation of upcoming results from the commercial banks.

Hubco remained the most active stock this week as well and its price increased 7.0%, closing at PkR22.90 at the end of the week. The second most active scrip, PTCL disclosed its half yearly results on Monday. The half yearly results were well within the range of market expectations, however, the price slipped on account of the negation of speculation regarding an interim dividend. Over the rest of the week, however, the stock price increased and the scrip closed 1.2% higher at 17.10. The other active stocks during the week were SNGPL, Engro and FFC Jordan.

The market came to hear more bad news regarding PSO during the week. WAPDA declared that it would import furnace oil directly, instead of purchasing it at a margin from PSO.

That's the question...so what's the answer?

The question being, let us remind you: up, up and away? The answer is no and yes and in that order. In the short term, the market will take a dip for correction purposes and the risk, according to our technical analyst, could extend to 1425- 1440 levels where investors should start buying for the longer term. We maintained that ceteris paribus, the market should not technically be able to maintain itself above the 1500 levels. But the cut in the discount rate (which we admit we did not expect) has shifted the equilibrium market level. Our market model (driven primarily by liquidity and corporate earnings) indicates that 1540- 1565 is the next equilibrium level. We feel the long term KSE-Index target (8-12 months) is 1720-1750.

Engro Chemicals: Neutral All the Way

It has been a long time since we have covered Engro Chemicals in our publications. After the announcement of fertilizer policy the outlook of the fertilizer sector has become clearer while the company also has announced its results for 3Q01. On the basis of our assumptions and current developments we are forecasting a net profit of PkR392mn in the 4Q01, which results in a 2.5% decline in net profits of FY01. We maintain our NEUTRAL stance for the scrip in the Intermediate/Long term.

Result Review for 1 H01

The result for 1H01 looks quite impressive where the company succeeded in posting a net profit of PkR287.3mn, up 294.6% from PkR72.8mn in 1H00. With marginal growth of 0.7% in net sales and decline of 0.3% in COGS gross profit improved by 2.7% to PkR865.9mn in 1H01 from PkR843.2mn in 1H00. The company managed to reduce its administration cost by 23%, which basically came from lower marketing allowances and decline in transportation costs. This allowed operating profits to increase by 29.2% YoY in 1H01 and improved operating margins to 21% versus 16% in the previous half year. The major boost came from "Other Income" account, which increased by almost 129% in 1H01 due to the dividend payments from the sister concern Engro Vopak, in our opinion. Along with the above, reduction of 8.6% in financial charges enabled Profits after tax to increase by 237.6%.

And in the end, the overall reduction of 56% in the tax rate from 23% to 10% helped net profits to increase by 294.6% to PkR287.3mn versus PkR72mn in 1H00. As a result, NPAT margin came out at 11% versus 3% in 1H01.

Now to clarify the picture luckily we have quarterly results, announced by the company along with recently announced third quarter results.

In 1Q01, the overall demand and prices of urea were almost 18% higher as compared to the corresponding period last year. Revenue collection hence increased by 42% from PkRl,193mn in lQ00 to PkR1,698mn and posted a net profit of PkR339mn. The financial year 2000 was one of the worst years for the fertilizer sector, where the demand and prices were depressed, while on the other hand the cost of production also increased drastically in the same year. Due to the reason Engro posted such despondent results in lH00. Therefore, an increase of 653% in net profit in lQ01 was not a big surprise however; a net loss of PkR52mn in 2Q01 was a shock.

The production of the urea plant was down by 14% in 2Q01 as compared to the corresponding period last year. According to company sources, they installed a new redesigned rotor in April and due to other equipment limitations, the same production level was not achievable. This resulted in a decline of 37% in sales from PkR1,312mn in 2Q00 to PkR825mri and hence the net loss was of PkR52mn in 2Q01.

In the third quarter, plant capacity utilization normalized to 98%. However, the revenue declined by 12% due to the lower demand. The company managed to improve its net margins where NPAT improved by almost 18% on YoY to PkR419mn.

The company is expected to announce its final results for FY01 on January 30th. On the whole company's production declined by 3% in the 4Q01, imports of other fertilizers were also down by almost 20% during the year. This is likely to reduce the revenue receipts and also the net profit. We expect a decline of 3% in EPS to PkR7.9/share in FY01 from PkR8.10/share in FY00. Engro has already paid a dividend of PkR4/share, where we expect the company to pay PkR2/share more as final dividend.

Investment Perspective

Engro is currently trading at a premium of 11 % from our fair value of PkR55.8/share based on our DCF valuation with the discount rate of 18% and long-term growth rate of 6%. With a forward (FY02) PER of 7.6x, the stock is at a 20% premium to the market PER, but it has historically traded at such premiums. Based on our forecast of around 8% CAGR in earnings, we recommend an Intermediate Term NEUTRAL and Long Term NEUTRAL rating on Engro

Technical viewpoint

From the level of 51.40 Engro has increased massively by 22% to close at 62.40 on Friday. The scrip has confirmed its long term positive trend, where currently it is trading above its 40-DMA and 40-WMA. However, with 14-days RSI near 69-70 the scrip is now very close to its short-term overbought zone. Correction is anticipated in the near term before which the scrip may test 63 levels, where profit taking is recommended.