CAPITAL MARKET

Bearing with price inflation

By HARIS ZAMIR
Apr 24 - May 07, 2006

The Karachi Stock Exchange (KSE) after making a record received some battering from the profit hunters especially in banks, cement and some of the oil and gas scrips. The cement sector felt the burnt because of the government's recent decision to provide subsidy of 60 rupees per kilogram on the import of cement, resulting heavy casualties at the local domestic market. Several companies trading on their optimum level closed on the lower circuit breaker, which means, the share price in a single day session declined by as much as 5 percent.

According to a market expert, the government has failed to address the grievances of the general public and instead of strict vigilance on the stockholders or the suppliers, the authorities have no alternative and they simply allowed import of the products to stem local prices. Last year, the wheat crop failure and mismanaged supply, transportation of wheat from one province to another, created scarcity of flour and prices sky rocketed. When the prices are their optimum, suddenly the government woke up and allowed import of wheat.

Likewise, we see, sugar shortfall last year which continued this year too, and the government hence have no alternative allowed import of sugar even from India to arrest the rising trend. Sugar share prices succumbed to selling pressure and government lost valuable foreign exchange.

Suleman Amir Ali, research analyst at Investcapital Securities said that although the decision regarding the subsidy on cement import has been taken by the government, several important factors should be kept in mind that could potentially hamper the expected price decline in the domestic cement prices.

Firstly, no SRO has yet been issued by CBR regarding the specifics of the subsidy amount and procedure. It is only after issuance of SRO that the nitty gritty of the import and subsidy procedure and its feasibility could be gauged. According to major industry players, the actual procedure for availing subsidy could well prove to be very cumbersome for importers, considering the bureaucracy issues.

Secondly, the quality of cement from India and Iran are not as good as the locally manufactured one. Therefore, the preference for locally manufactured cement and its brands could well lead to inventory buildup of imported cement and consequently losses to importers.

Since the start of the calendar year, the benchmark KSE-100 index has risen by 26.74 percent or 2519 points, from 9,557 to 12,075 points (April 19). The current bull-run has continued for almost six months now with only one sharp and short-lived correction in early March when the index plunged almost 14 percent in a week only to recover the very next week. The market appears on the path to newer highs going forward, but in the current market scenario, careful stock-picking is advised. Invest in companies that are trading at relatively low forward PER multiples, and keep a portion of funds allocated to high dividend yielding stocks which are less prone to market volatility.

According to Arif Rahman, research analyst at Elixir Securities the rally that started towards the end of 2005 was primarily driven by the phenomenal rise in banking sector profits. The sector has clearly outperformed the market during the rally with some of the banks such as MCB and UBL still moving on to new highs without undergoing any sort of correction. Out of the five banks under our coverage we recommend a positive stance on NBP and Askari Commercial Bank both of which provides upside potential of 13% to our fair values.

CEMENT

Recently the cement sector has attracted considerable interest from the investors and punters alike. Cement plants are running at high capacity utilization levels and the commodity is being sold at a considerable premium to its ex-factory price. With the start of post winter season, the demand for cement has picked up momentum and the commodity's price in the market has touched record levels. However, caution must be adopted at this point as companies not undergoing capacity expansion will see a decline in earnings going forward as supply doubles over the next 24 months and capacity utilization levels drops.

E&P

The discoveries of well in Tal block injected life into the oil and gas exploration sector which until February was lagging the market. However, the production numbers from the recently discovered wells have not been finalized (only initial test numbers were released by the operator), the stock prices of OGDCL, POL and PPL have responded massively to this news. We await further news inflow and confirmation of the exact reserve size of the well before giving out any change in recommendation on these companies. POL trades at FY06E PER of 14.3x while PPL trades at FY06E PER of 14.1x.

OMCS AND GAS DISTRIBUTION COMPANIES:

Margins were cut for oil marketing companies (OMCs) from 3.5% to effectively 2.8% and this has reduced their attractiveness for investors, as indicated by the negative impact on their stock prices since the announcement of this decision. At current levels PSO looks fairly valued (our fair value PKR373/share), while APL- due to its aggressive capex plans and growth in market share- looks the most attractive BUY in the sector. APL trades at a discount of 19% to our DCF based fair value of PKR427. Gas distribution companies, namely SSGCL and SNGPL, are trading at high premiums to our fair values of PKR28 and PKR76. The primary reason for such high prices has been the privatization play and the interest shown by some globally reputable organizations in acquiring a strategic stake in these companies. Also there are rumors that before the privatization takes place the government with the consent of new owners will draft a new return formula which will provide better returns than the existing asset based formula.

However, with the information currently available to us on these companies we recommend investors to 'SELL' both SSGCL and SNGPL at current levels as they trade at a premium of 31% and 33% to our target price.

IPP's

Hubco and KAPCO have been ignored for quite some time now. For FY06 Hubco offers a dividend yield of 11% while KAPCO offers an impressive dividend yield of 19% at current price levels. Now, when the market is trading at an all time high and there is always the fear of a major shakeup, investors should be dedicating a larger percentage of their funds to these two fundamentally sound and high dividend paying scrips. We recommend both Hubco and Kapco as BUYs with target prices of PKR32 and PKR52 respectively.