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Updated on Dec 29, 2001

The KSE - Overview: Market Bounce?

The KSE-100 Index fell by almost 10% during the past week with an increase of 9.3% in the ADV from 76.85mn shares last week to 84mn shares. The overall sentiments remained negative, however on Friday after a dip of 40 points in the market in the first half, it did recover 33 points to close at 1269.

From a technical viewpoint we believe that investors should redeploy their funds into the market in the immediate term, as we believe that a rally is a bit overdue following this week's crash.

In our previous technical updates, ("Morning Shout" dated December 10 and 24) we did warn our clients about the expected downside correction, due to the narrow trading band of the market, with the risk extended to 1325 level. However, this sharp dip was a surprise for us also as we expected it to correct in a more gradual manner, than the behaviour actually exhibited by the market.

To add a little background on our reasons for initially expecting a correction. Over a five-week period, the Index was trading in a small trading band of 1340-1360. Historically, breakthrough from such a band leads the Index to correct itself several points, after which it consolidates to continue on its longer-term trend. However, the Index breached it upward to test the 1408 level and the correction was overdue with the risk extending to 1325.

Due to the war risk, investors panicked and started aggressive selling, which led the Index to 1269 on Friday. With the closing at 1269, the Index is now close, in our opinion, to its oversold zone, where PTCL and Hubco have already tested their all-time lows during the first session on Friday. We feel that the market has now bottomed out and a rally is overdue. On a historical basis, the Index, after such a sharp decline usually recovers with the same speed, giving investors a brief opportunity of 10-15 days to re-enter in an upward rally. The market is now on its very strong support band of 1260-1245, which in the current scenario is unlikely to be breached. We recommend aggressive buying at current levels with greater emphasis on PTCL, Hubco and MCB, which are likely to out-perform the market in the immediate term. Even if the market weakens further, only those scrips will drop which are still trading in neutral zone such as, Lucky, DGK, Fauji, and Engro. However the downside risk is limited at current levels, therefore on a technical basis the market, in our opinion, is a short term 'Buy.'

Consumer Sector: Focus on FY02 Earnings

Half-year Results

Since the year- end of the larger consumer goods companies is September and December, the most recent available actual results of the sector are those that report half-yearly performance in FY01. A focus on half-yearly performance reveals slower growth in the top-line. In our opinion, this may be explained as follows:

1) A slowdown in GDP and hence, consumption growth during this period, which subdued demand growth in the sector.

2) An increase in smuggling from Afghanistan and Iran of certain consumer goods. For instance, smuggling of tea during 1H01 increased to 12,770 tons as compared to 6,630 tons in 1H00.

3) A more stable general price level in an increasingly competitive industry curtailed any selling price increases, which would have otherwise compensated for reduced volumes sold. In fact, the price of some consumer goods declined. For instance, domestic cooking oil and fats brands reduced prices by about 8.5% during 1H01, relative to 1H00, following the decline in international prices.

However, net profits for the half-year have shown satisfactory growth. The bottom-line improvement is entirely attributable to improved core profitability. One of the most important determinants of margins and hence profitability for several companies in the sector, is the international price of commodities, for instance palm oil and tea. Palm oil prices averaged 18.4% lower in 1H01 relative to 1H00. However, import cost of tea was 4.4% higher. SG&A expenses were kept under a tight leash, but as most of these expenses, except marketing and selling costs, are of a semi-fixed/overhead nature, lack of sales growth translated into a narrower operating margin. However, the markedly improved gross cash margin in general for the industry flowed into the improved consolidated operating margins for the sector.

1H01 trends preview of full-year story

With regard to the top-line, 2H01 is largely expected to be a rerun of 1H01. Slower domestic economic growth since January 2001 has subdued sales growth. Though there are concerns over the impact of the global slowdown being further exacerbated after 9/11, we feel that this is unlikely to dampen domestic demand for tea, edible oil and other consumption goods. Hence, we do not think that sector sales are likely to be affected in 2H01, especially since political stability has been maintained. However, in the FY02 Budget, the government raised import duties on tea from 25% to 30%. The 20% decline in tea imports through legal channels between July and October, despite growing overall domestic demand, indicates that the impetus to smuggling is due to the rise in duties.

Hence, although we expect a decline in the profitability of tea related operations in the consumer sector we forecast that overall sales for the sector in FY01 will show an increase of 6.4%. This is based on:

1) Expected agricultural growth of 2.2% in the fiscal year 2002 (year-end 30 June) and hence higher sales volume in rural areas. Over the last few years, the larger players in the industry have begun to increasingly focus on the rural markets to expand their market share.

2) The virtual closure of the Pakistan-Afghan border, which is expected to have curbed smuggling from 3Q01 onwards.






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.Source: KSE, MSCI, KASB