week. The announcement of President considering
administrative changes in Sindh, approval of PkR202bn PSDP and Pak-India
holding talks in June brought some consolidation in the market on
Wednesday. Cement companies maintained their dominance as most of the
stocks registered gains due to the expectation of increased construction
activity in next FY and a possible reduction in CED in the forthcoming
budget. Rumors about SECP's proposal for qualifying capital gains tax
exemption with a minimum holding period requirement shattered investors'
confidence on Thursday pushing down the benchmark index by nearly 3.35%.
The last trading session of the week witnessed a strong reversal in the
negative trend with market recovering about 40% of the losses it has
incurred during the week. The gain would have been higher if market
management would not go for a cancellation of Friday's second trading
session owing to strike called by religious hardliners.
OUTLOOK FOR THE FUTURE
The pre-budget rally appears to us losing its
momentum in between the political uncertainty and capital gain tax
fears. Though government will try to push forward all the political
changes in the province of Sindh to get a consensus on the national
budget, we feel that budget may lose its sanity owing to (I) most of the
numbers and initiatives have already been made public and (II) any
change in the Sindh government may be considered as the starting point
of political changes in the centre. Though cement sector may keep
getting favorable waves, the broader market may not see much change in
the upcoming week. At the same time we also expect SECP to come up with
a clear-cut assurance on capital gains tax exemption to regain
investors' confidence. On a net basis, the continuation of neutral to
positive consolidation in the market is likely next week.
The major developments this week were:
•SBP allowed market forces to raise yields on PIBs
by about 66bp, 47bp and 88bp for 3-yr, 5-yr and 10-yr PIBs respectively
at its auction.
•Musharraf will chair NFC meeting next week due to
which Budget will now be announced on June 12.
•PTA received 95 Applications for LDI/LL License,
out of which about 30 applications were for LDI and remaining 65 were
for LL operations.
•Cement prices rose by 125% in a month to Dh27 per
50-kg bag (US$145 per ton) from Dh12 per bag in UAE due to severe supply
•PTCL's board of directors met on Tuesday to
discuss: (I) the company's position with reference to the ongoing
de-regulation, (II) corporate split within PTCL, and (III) status of WLL
•According to CBR, Revenue collection was PkR435bn
in 11-months. A below target performance for revenue collection during
May is likely to make it almost impossible for the government to achieve
its full year target.
•For the second consecutive fortnight in a row, oil
prices have remained unchanged as the government once again absorbed the
impact of rising international oil prices.
•Pakistan and India will be holding two different
sets of talks in June. The expert level talks are scheduled for June
19th & 20th, whereas the foreign secretaries will be meeting on June
27th & 28th.
•Car production during first ten months of FY04
registered 61.8% growth to 79,656units, the production of jeeps rose
145% to 725units.
•Oil prices continue their rising trend as fears of
supply disruption further dented the investor confidence as oil prices
moved up to US$42/barrel, their highest level in 21 years.
•PSF manufacturers raised PSF prices by PkR2.00/kg
in their recent meeting.
•As per APCMA, Local Cement sales have risen by 18%
in 11months(July-May). Reportedly, Attock, DGK and Lucky Cement have
received import queries from UAE Cement Dealers.
•The Federal Cabinet held a meeting on Wednesday,
which was mainly focused at discussing the situation in Karachi.
Reportedly, President Musharraf is expected to call an important meeting
in a few days, in which important decisions regarding administrative
changes in the Sindh government are likely to be made.
•Assurances from OPEC Kingpin Saudi Arabia on
increased output led to a drop in international oil prices to below
•US Congress approved non-Nato status for Pakistan.
•The Exploration Wing of Ministry of Petroleum and
Natural Resources has invited bids from interested parties for
exploration rights over a total of 4 blocks in Punjab and Sindh.
•Reportedly, Hubco is entering into an agreement
with KESC to create a linkage with the latter. This will provide extra
electricity to KESC which can partially meet its existing shortfall in
•Chaudhary Shujaat proposed the formation of a
national government in Sindh.
•SECP chief came up with an idea of linking capital
gain tax exemption with a minimum holding period. Later on, the chief
regulator termed this as his "personal view".
THIS WEEK'S TOP STORIES
TEXTILE SECTOR — BUDGET EXPECTATIONS
Probably textile is the only sector which has made
significant preparations for the budget; yet it is unlikely to have any
major impact from the budget. Various textile associations, in
consultation with the Ministry of Industries and Production, have
prepared a number of proposals for the upcoming budget. These include
demand for reduction in tariffs and sales taxes, enhanced duty drawbacks
on certain items, duty free import of machinery and amendments in the
DTRE. We feel that some of the demands made by these associations are
founded on sound logic. However, given the aggressive revenue targets
set by the government for the coming fiscal year, we do not expect that
all such demands will be met. We expect government to announce broad
measures, which may not yield much to the textile sector, though these
will provide them qualitative incentives. We advise a Neutral stance on
the sector, while Nishat Mills continues to be our favorite pick.
•Various textile associations, in consultation with
the Ministry of Industries and Production, have prepared a number of
proposals for the upcoming budget. These include demand for reduction in
tariffs and sales taxes, enhanced duty drawbacks on certain items and
amendments in the DTRE. In addition, some associations have asked the
government to allow duty free import of machinery.
•We feel that some of the demands made by these
associations are founded on sound logic. For example, the denim sector
has asked the government to increase rebate on denim manufacturing to 20
percent based on the fact that both gray fabric manufacturing and denim
manufacturing are currently subject to the same 10% rebate under SRO
490(1)/2003, despite the fact that the latter involves significantly
higher value-addition. However, given the aggressive revenue targets set
by the government for the coming fiscal year, we do not expect that all
such demands will be met. Moreover, the government will also need to
ensure that any increases in rebates that it gives, based on measures
such as value-addition, will be inline with the WTO regulations.
•Newspaper articles have also indicated that the
government is considering abolishing 15 percent general sales tax on
ginned cotton. Given that a substantial portion of local cotton is
exported in one form or another, the government incurs a large cost in
administering refunds to exporters each year. The elimination of this
tax should prove beneficial for both the government and exporters who
face the inconvenience of waiting long periods for their rebate.
•Talking about other incentives demanded by the
textile millers, we do not expect government to listen to most of these.
However, government may come up with broad measures for the sector,
which will set some policy guideline in the post quota scenario. This
policy guideline will bring in qualitative positive impacts.
•On overall basis, this year's budget should thus
bring in positive news for the textile industry. We advise a Neutral
stance on the sector, while Nishat Mills continues to be our favorite
PETROCHEMICAL SECTOR — BUDGET EXPECTATIONS
The issue of tariff rationalization has once again
gained momentum before the presentation of the FY04-05 budget. However,
there appears to be a split between the PSF manufacturers on the
reduction of import duty on Polyester Staple Fibre. A reduction in
import duty on PTA is likely to be opposed on grounds of delayed rebates
and drawbacks from the government. Consequently, import tariffs on PSF
are likely to be maintained at current levels as any reduction in import
duty on PSF would not be possible without a commensurate decrease in
import tariffs on PTA. While reduction in import tariffs on PTA is
difficult on account of sovereign guarantees, we believe that the
government is likely to seriously consider a reduction in import tariffs
on Mono Ethylene Glycol (MEG) to 5% from the current level of 10%. While
this is likely to reduce PSF industry's cost of input, it is unlikely to
have any significant impact on the profitability of the companies. The
long-standing demand of PSF manufacturers to reduce GST from the current
level of 20% is also likely to be fulfilled. However, the market rumors
are currently split over GST coming down to either 15.0% or 12.5%. We
might see some further reduction in import tariffs on Soda Ash, which is
likely to affect ICI adversely. Import tariffs on Soda Ash currently
stand at 10% and they might be revised downwards to 5%. We recommend a
Neutral stance on the PSF sector as we believe that the gap in the
demand supply situation is likely to keep the profitability of the
sector capped. Pakistan PTA appears overvalued at current levels,
trading at almost 16.5x FY04E earnings.
POWER SECTOR - BUDGET EXPECTATIONS
The upcoming budget is unlikely to carry anything
significantly different from what we saw last year. WAPDA and KESC are
likely to remain the focus of the government as far as the power sector
reform program is concerned. Reportedly, the Ministry of Water and Power
had sought a total allocation of PkR82bn under the Public Sector
Development Program. However, the Ministry of Finance has indicated an
amount of PkR42bn for the development of the water and power sector in
the country. Out of this amount, a total of PkR35bn is likely to be
allocated for the power sector while the remaining amount is to be spent
on development of water resources in the country. The budget is likely
to touch upon the issue of construction of new dams. Since the last
couple of years, the government is clearly focused on promoting hydel
and gas based power plants. The reason for this clear tilt is to
increase the reliance on indigenous resources, while replacing the use
of imported fuel oil. The upcoming budget is also likely to talk about
the increased allocation of gas to the existing power plants. The two
gas distribution companies have already developed aggressive capex plans
to meet the growing requirement of the power sector.
OILS — BUDGET EXPECTATIONS
The upcoming budget is unlikely to have any
significant impact on the oil companies. The margins of oil marketing
companies are likely to remain at current levels of 3.5%, and we do not
expect these to rise in the near to medium term. For refineries, the
change in return formula a couple of years back has been good
development. The refineries have benefited as profitability has
increased manifold whereas the government is happy in ridding itself of
implicit return guarantees to the refineries. The upstream oil and gas
sector stands pretty much deregulated and we do not expect any
significant development in this sector apart from possible reduction in
import duties on machineries. The overall attractiveness of the sector
has increased owing to the rising trend in oil prices. While upstream
and to some extent, midstream companies are likely to be beneficiaries
of the rising oil prices, downstream companies are unlikely to see any
positive impact till the time the government maintains the oil prices at
CEMENT SECTOR — BUDGET EXPECTATIONS
The upcoming budget is likely to have a direct
positive impact on the Cement Sector. A PkR202bn PSDP allocation and
government's focus on building physical infrastructure is likely to
boost the construction industry. The government had announced a 25%
reduction in Central Excise Duty (CED) on the cement leading to its
gradual removal over the five years period, in last year's budget and we
expect a further 25% reduction in CED in the upcoming budget. Meanwhile,
the coal-based plants, though still more efficient compared to RFO based
plants, are facing exceptional cost increases owing to a 100% rise in
coal prices. Delay by the federal government in releasing funds for Thal
Coal fields and PSDP for Sindh province are the causative factors for
this. Cherat and Maple Leaf Cement are our top pick in the cement
BANKING SECTOR — BUDGET EXPECTATIONS
The existing operating environment in the banking
sector is completely different from the scenario that prevailed in the
corresponding period of last year. Rising interest rates and a shift in
banks' focus to core earnings instead of capital gains are the two
different variables this time. The upcoming budget is likely to provide
another positive shot in the arm for the banking sector in the form of
lower tax rates. We expect another 300bps reduction in the tax rate,
which will bring it down from 44 percent to 41 percent. While we agree
that capital gains are likely to play a smaller role this year as
compared to last year, we do not anticipate portfolio losses to pose a
significant threat to the bottom line, at least for the current year
owing to improving core earnings and lower tax rates. We do not like the
banking sector as a whole due to pricey valuations. Based on both a
Price-to-Earnings, and more importantly, a Price-to-Book multiple
analysis, the banking sector is currently trading at a premium to
historical measures. Having said that, exuberant market sentiment is
likely to keep valuations on the higher end, implying that individual
stocks are likely to continue to offer good value to the investor in the
short to medium term. National Bank is our favorite pick in this regard.
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