Updated June 05, 2004


Poor law and order situation in Karachi and an increase in PIB yields kept the market under pressure and pulled the index down by 2.6% WoW. Major pre-budget speculation has been observed in Cement sector where a bullish run was created in second-tier cement stocks including Pakland, ZealPak, Dandot and Gharibwal Cement. The deteriorating law & order situation in Karachi influenced the market to see a nearly one percent decline during first two trading days of the 



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.


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 shortage.

•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 project.

•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$40/barrel mark.

•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 Karachi.

•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".



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 pick.


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.


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.




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 current levels.


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 sector.


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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