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STRATEGY
PAK FLOODS: IS THE ROPE BROKEN?
BMA RESEARCH TEAM Floods to date have ravaged approximately 20% of the country’s landmass with
Hamad Aslam, CFA flow rates toping over 1.1mn cusec. As much as 20mn people have been affected
haslam@bmacapital.com making it one of the world’s worst natural disasters in recent history. A
comprehensive damage assessment will have to wait till the floods recede however
Abdul Shakur encouragingly initial estimates do not hint towards a significant damage to urban
abdul.shakur@bmacapital.com infrastructure. Nonetheless one-off slowdown in GDP growth and upside risks on
inflation and fiscal deficit will haunt the overall economic momentum.
Nurali Barkatali
nurali.barkatali@bmacapital.com THE ECONOMIC STORY: FLOODS 2010 - NONE WORSE THAN
THIS
Sana I. Bawani
sana.iqbal@bmacapital.com We estimate GDP growth to clock in at 2.1% for FY11, compared to original
forecasts of 4.5% while CPI inflation is expected to peak at 17-18%. Further, we
Omar Rafiq estimate PKR60bn shortfall in tax collections and expect fiscal deficit to be recorded
omar.rafiq@bmacapital.com at 6.2% for the year. In this regard, final outcome of the ongoing meeting with IMF
is awaited where we expect 200bps relaxation in deficit target. Given the overall
Muhammad Ali Taufiq outlook and SBP’s vigilant stance, another hike of 50-100bps in the discount rate
Ali.taufiq@bmacapital.com can be expected during the fiscal year. On the bright side, pledged foreign inflows
have alleviated upside risks to our 4-5% PKR/USD depreciation target for the year.
Inflation Avg CPI of 20% for FY09 MoF and BMA Research CPI Crop/food shortage and higher
rationalized to 12% in FY10 estimates stood at 9% and 12%, govt borrowing poses upside
respectively for FY11 risks of 300-400 bps from initial
forecasts
Interest Rates Benchmark discount rate SBP’s unwarranted stringent Higher expected fiscal deficit
rationalized from a high of 15% stance through 50bps increase in and inflation, together with
in FY09 to 12.5% in FY10 discount rate had already paved SBP’s hawkish stance reflects
way for expectations of further the possibility of higher interest
upside rates over FY11
Interest rates will however play the centre stage in recovery. While tight monetary
policy may not be the solution to the current economic challenges, higher fiscal
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September 3, 2010
deficit and inflation may still allow SBP to further tighten the environment with
upside risks to discount rate being higher than downside risks at the moment.
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September 3, 2010
Our take on cement and fertilizer sectors is however contrarian when compared to
market consensus. We estimate reconstruction activities to add only 0.6-0.7mn tons
of additional cement demand and thus may not have an immediate turnaround
impact on the sector. For fertilizers, we maintain a positive outlook whereby
potential slowdown in offtakes is only likely to hit imported products.
The only upward revision in estimates, in the aftermath of floods, has come for APL
whereby we estimate reconstruction activity to translate into higher offtakes for
asphalt in the country (FY11 growth in volumetric offtakes taken at 10% against
initial forecasts of 2%). Moreover, given overall growth story and limited upside
risks on effective taxation, we take this opportunity to add APL amongst our High
Conviction Investment Ideas.
Sector
BMA BROADER INVESTMENT THEMES REMAIN INTACT; 2010 INDEX
Recommendation
TARGET UNLIKELY TO BE MET THOUGH
OMC OVERWEIGHT
Electricity OVERWEIGHT While most of the listed sector has remained secured from the ongoing floods, the
crop losses alone paint a bleak economic outlook for FY10. Needless to mention
Cement MARKETWEIGHT
however, that most of the downward revision in economic growth stems from one-
E&P MARKETWEIGHT
off crop losses while shrinkage in demand for other industries (eg autos) should
Commercial Banks MARKETWEIGHT start to recover in FY12.
Telecom and Tech. MARKETWEIGHT
We thus highlight that overall investment theme for Pakistan equities stay intact
Fertilizer MARKETWEIGHT
which is largely driven by domestic demand, favorable demographics and rich
Textile MARKETWEIGHT natural resources. We however reiterate that current situation warrants an even
Refineries UNDERWEIGHT closer adherence to screening criteria based on companies with pricing power,
Autos UNDERWEIGHT devaluation positive revenue stream and attractive dividend yields.
For the rest of the 2010 however, equity markets may continue to remain hostage
to negative news flow emanating from the situation. Moreover, concerns on rising
inflation and fiscal deficit and consequent risk of SBP further tightening the
monetary environment will continue to loom over investor sentiments. We thus
believe that our initially set KSE100 target of 11,500 may not be met during 2010
while upside risks to this thesis largely rest on introduction of a timely and effective
leverage tool i.e. Margin Trading System.
High Conviction Investment Ideas
Current Fair Pot
Company Ticker EPS (PKR) PER(x) EPS Growth Dividend Yield
Price Value Upside
PKR/share PKR/share FY10E FY11E FY10E FY11E FY10E FY11E FY10E FY11E
Pakistan Petroleum PPL 203 231 14% 23.4 28.0 8.7 7.3 -16% 20% 4% 6%
Attock Petroleum Ltd APL 307 522 70% 55.3 64.0 5.6 5.0 3.0 16% 11% 12%
MCB Bank MCB 186 216 16% 23.0 25.0 8.1 7.4 13% 9% 6% 7%
Lucky Cement LUCK 68 79 16% 9.7 12.5 7.0 5.0 -32% 29% 6% 3%
Fauji Fertilizer Bin
FFBL 28 33 17% 4.3 4.8 6.5 6.0 7% 11% 15% 15%
Qasim
BMA Universe Average 8.1 7.4 13% 8% 6% 8%
Source: BMA Research
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September 3, 2010
Textile exports constitute ~60% to total exports. Clothing exports from Pakistan
are likely to be down by around one-third as orders for the upcoming Christmas
season (which are normally placed in September) may not be met
With a weightage of 33% in large sector manufacturing (LSM) it may hinder the
expected LSM recovery going forward. Nonetheless, performance of cement,
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September 3, 2010
fertilizer and automobile sectors should provide some respite which together
hold 15% weightage in LSM.
Rice
Cotton
Sugar
Maize
Sowing
Growth
Harvest Flood begun in Jul10
and water starts
receding in Sep
Source: Pakistan Meteorological Department
On the brighter side, better water availability, improved crop yields and increasing
IMF to provide USD450mn in arable land (as water reaches Baluchistan) suggest upward revision in wheat and
Immediate Emergency Assistance to sugarcane crop next year. Therefore if boundary controls and admin issues are
Pakistan and seems committed to managed effectively, no substantial supply side issues should emerge for wheat.
work towards completion of Stand-by
Arrangement Program review FISCAL OUTLAYS SURPASSING TARGETS: HINGED ON
As the IFIs are conducting loss FINANCING
assessment, materialization of funds Floods have poured in further uncertainty to the fiscal position of the economy. A
for rehabilitation should taking place
significant portion of cropped area has been damaged, transportation means
in post Sep-Oct10. Therefore
disrupted and economic activities hampered. In pre-flood scenario, govt. estimated
government’s reliance on banking
system should support deficit fiscal deficit of PKR780bn for FY11 - 4% of GDP. However, potential shortfall in tax
financing. Emergency funding of collection and incremental fiscal outlays make FY11 challenging for fiscal account
USD450mn, however, is expected to management.
be disbursed in Sep10 and should
Imposition of one-time taxes in this regard is likely to offset the shortfall. Govt. plans
thus help mitigate liquidity issues to
some extent. to enhance revenue base by imposing a flood tax of 5% on imports and an
additional 5-10% on taxable income (above PKR300,000 for all taxpayers) for FY11
and FY12. These measures would help govt. generate additional ~PKR150bn
whereas the expected incremental 220bps of fiscal deficit allows additional outlays
of PKR377bn for FY11. However given the track record of tax receipts, we
anticipate a lukewarm response from the taxpayers this time round. Moreover, in
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September 3, 2010
the absence of any spark in local consumption and demand, corporate profitability
is also expected to decline and hence, a decline in tax receipts.
Therefore VAT imposition remains critical to enhance tax to GDP ratio. Moreover,
given IMF’s tough conditionalities, it would be challenging to keep the Budget FY11
on track – fiscal deficit is expected to reach 6.2% against pre-flood estimates of 4%
for FY11.
To stabilize the country’s fiscal position govt. plans to abandon all development
projects and reallocate funds to rehabilitation. Although a trend reversal in subsidies
is expected amidst higher import requirements for sugar and pesticide, subsidy
elimination from energy chain is likely to continue which would help save
~PKR109bn during FY11.
Considering 42% weight of food items in CPI basket, widening demand supply
gap for grains can fuel inflation
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September 3, 2010
Worst case estimates for inflation to reach 25% by FY11 against the initial
target of 9% by govt. We estimate inflation to settle in the range of 16-18% for
FY11
Carry forward stock of 4.4mn tons and production of 24mn tons of wheat suggest
sufficient supply. With higher than 8% weight in CPI basket, wheat is expected to
help consolidate the price index. However supply side issues for perishable food
items including damage to standing minor crops, disruption in transportation
network and lack of storage facilities can not be ruled out. Shortages necessitate
imports and a rising trend in international commodity prices may further intensify the
upsurge in price levels through imported inflation.
Jun-10
Jun-10
Jul-10
Aug-09
Jan-10
Aug-10
Sep-09
Oct-09
Oct-09
Dec-09
Feb-10
Feb-10
Apr-10
Nov-09
Mar-10
May-10
FY82
FY83
FY84
FY85
FY86
FY87
FY88
FY89
FY90
FY91
FY92
FY93
FY94
FY95
FY96
FY97
FY98
FY99
External account indicators Recent trend reversal in grain prices and fiscal indiscipline are the impediments to
the ongoing economic consolidation. In addition, borrowing from banking channels
(PKR mn) FY10 FY11F
seems indispensible (particularly from SBP which by itself is inflationary), till
Exports 19,636 20,618 materialization of foreign inflows takes place.
Imports 31,013 34,735
SBP had recently voiced its concerns against resurgence of inflation and fiscal
Trade deficit (11,377) (14,117) imbalances by raising policy rate by 50bps in Aug10. Considering economic
Remittances 8,906 10,509 consolidation to be of prime importance together with IMF conditions, upward
interest rate revision of 50-100 during FY11 remains on the cards.
CA deficit 3,507 5,557
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September 3, 2010
material, food, cotton and pesticides are likely to increase in the short term - at
present it contributes 35% to the import bill.
Although security concerns continue to hinder foreign direct investment (FDI),
equity portfolio is expected to add approx USD500-600mn during FY11. In addition,
materialization of external inflows is expected to keep overall balance in green zone
despite CA deficit surpassing USD5bn.
Higher inflows (aids, grants and soft loans) as well as additional IMF assistance
limit upside risks for PKR depreciation in the medium term and should keep USD
reserves intact. However, divergence of funds from current programs to
rehabilitation may cause lower than anticipated lending from ADB and WB.
Therefore, avg. annual 4-5% PKR depreciation can not be ruled out.
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September 3, 2010
Corporate SME
Consumer
SME
Corporate
Commodity
financing
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September 3, 2010
Money supply data also suggests that currency flows have started shifting from
banking channels to currency in circulation and have thus effectively kept deposit
growth in check. Therefore we believe that deposit cost for the banking sector is
likely to increase by 30-50bps during the next quarter. However, yields on Govt.
securities and KIBOR are also expected to increase amidst increasing monetization
and inflation. Therefore defying any major contraction in spreads, we expect them
to sustain 7-7.5% range during CY10.
Moody's rating for Pakistani banks MOODY’S TAKING IT SERIOUS: REVISED OUTLOOK TO NEGATIVE
Banks BFS LTDD LTDF Taking into account the recent economic challenges, Moody’s has revised its
NBP D Ba2 B3 outlook to negative from stable for domestic deposits and financial health of five
HBL D- Ba3 B3 major banks of Pakistan. However, ratings have remained unchanged as
UBL D- Ba3 B3 mentioned in the table on the left. Rationales for outlook revision are as follows:
MCB D Ba2 B3 Financial health is considered to be more vulnerable amidst weak loan
ABL D- Ba3 B3 growth and emerging NPL pressure which may consequently lower
BFS: Banks Financial Strength profitability
LTDD: Long Term Deposits - Domestic Rating agency linked higher exposure in government securities to event risk
LTDF: Long Term Deposits - Foreign at the sovereign level (sovereign rating stands at B3 with stable outlook).
STRONG ASSET QUALITY AND LOW COST IS THE KEY: BUY MCB
Considering the emerging liquidity and cost related issues, we reiterate our
recommendation bias for banks with relatively stable NIMs and stronger asset
quality. With these criteria in mind, MCB is expected to outperform the peers going
forward.
Comparative analysis for asset quality
NPLs to loan Loan loss coverage (RHS)
15% 100%
12% 80%
9% 60%
6% 40%
3% 20%
0% 0%
NBP BAFL HBL MCB UBL Industry Avg.
Although BAFL carries lowest infection ratio amongst BMA banking universe,
lowest loan loss coverage suggests incremental provision losses going forward.
Similarly NBP outperforms peers on valuation matrix due to low PBV multiple of
0.6x, yet we maintain a Neutral stance on the scrip (fair value: PKR60/share) due to
looming asset quality concerns and escalating deposit cost. MCB, on the other
hand, currently trades at PBV multiple of 1.8x, and offers upside potential of 14% to
our Dec10 based Target price of 216/sh. – recommend Buy!
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10
7
8
9
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4
5
3
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FO (Furnace Oil) sales for the industry are also expected to experience a 23%
decline for the month of Aug10 due to temporary closure of some RFO based
thermal power plants at Kot Addu Block, Muzaffargarh, Guddu Central Block and
Northern Block. FO is primarily supplied by PSO at these stations and therefore a
decline in FO sales will impact PSO’s earnings for the on-going quarter only.
FO based Power plants affected by floods
% of total FO
Stations affected consumed by Power Status
Sector
Guddu Central Block 3 0.3% Closed for 2 days
Northern Block 1 7.1% Closed for 8 days
Northern Block 2 4.2% Closed for 8 days
Northern Block 3 2.6% Closed for 8 days
Kot Addu Block 1 5.6% Average utilization level of 45.5%
Kot Addu Block 2 13.2% Average utilization level of 45.5%
AES Lalpir 5.7% Closed for 25 days
AES Pakgen 5.2% Closed for 25 days
Total 50.7%
JP (Jet-Fuel) sales, on the other hand, are expected to rise by 10% over the period
of Aug10 - Sep10 due to increased domestic demand driven by air-based flood
rescue operations carried out by the Pakistan Army.
In the non-energy segments, lubes sales are expected to witness a decline on the
back of reduced overall road transportation activity during the month of Aug10.
SHEL whose overall profitability is highly dependent on lubes sales is most likely to
witness a decline in 3QCY10 earnings.
Among the OMCs, Asphalt sales are currently controlled by APL alone. Due to a
massive slowdown in construction activity, Asphalt sales for Aug10 – Sep10 period
are expected to witness the sharpest decline. Floods have done major damage to
road network and bridges (approximately 400km of roads and 36 bridges have
been destroyed). Going forward however, we expect Asphalt sales to increase by
10% YoY for FY11 period on the back of infrastructure development required in
flood-hit areas. We believe APL will remain a major beneficiary of increased net
sales of Asphalt, hence there exists significant upside risks to its FY11 earnings.
Province-wise division of POL products sales
Province-wise % Khyber
Punjab Sindh Balochistan Azad Kashmir
volumetric sales Pakhtunkhawa
Mogas 7.1% 61.6% 27.7% 1.7% 1.9%
HSD 14.4% 57.1% 24.1% 2.5% 1.9%
FO 0.9% 60.1% 14.2% 24.7% 0.0%
JP 0.2% 27.8% 71.3% 0.6% 0.0%
Asphalt 4.4% 62.4% 29.1% 2.9% 1.3%
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September 3, 2010
Going forward we also expect FO, MoGas, HSD, JP and Lubes sales to return to
their normal levels by Oct10. It should be noted that most of the severely affected
regions are rural areas and do not constitute major portion of POL products sales.
As economic activity revives in adjoining urban areas, industry sales figure are
expected to return to their normal levels.
Company and Province-wise division POL Products sales
PSO SHEL APL Industry
Mogas
Sindh 26.9% 30.3% 9.4% 27.7%
Punjab 61.4% 59.4% 78.6% 61.6%
Khyber Pukhtunkhawa 8.0% 6.2% 8.2% 7.1%
Balochistan 1.7% 2.2% 0.0% 1.7%
Azad Kashmir 2.1% 2.1% 3.9% 1.9%
HSD
Sindh 23.2% 22.6% 11.7% 24.1%
Punjab 56.9% 59.2% 67.2% 57.1%
Khyber Pukhtunkhawa 15.4% 11.6% 17.8% 14.4%
Balochistan 2.4% 4.7% 0.0% 2.5%
Azad Kashmir 2.0% 1.9% 3.4% 1.9%
JP
Sindh 95.3% 42.5% 13.0% 71.3%
Punjab 4.3% 55.7% 87.0% 27.8%
Khyber Pukhtunkhawa 0.4% 0.0% 0.0% 0.2%
Balochistan 0.0% 1.8% 0.0% 0.6%
Azad Kashmir 0.0% 0.0% 0.0% 0.0%
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September 3, 2010
PEPCO-TPS
IPPs
Hydel Generation
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September 3, 2010
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September 3, 2010
Askari 1
Cherat
Kohat Askari 2
Mustehkam Dandot
Dewan Gharibwal
Bestway
Lucky 1
DG Khan 1 DG Khan 2
Bestway
Flying
Pioneer
Maple Leaf
AC Rohri
Al-Abbas
Dadaboy
Thatta
Dewan
Zeal Pak Javedan
Attock
Lucky 2
22
Source: BMA Research
September 3, 2010
25
20
15
10
-
FY91
FY92
FY93
FY94
FY95
FY96
FY97
FY98
FY99
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
Source: BMA Research
23
September 3, 2010
likely to further add to the seasonality effect witnessed for cement manufacturers
here in Pakistan. Farmers who rely on crop harvesting as a source of income will
now have to wait till the wheat crop harvest to see major inflows in income, thereby
postponing demand for cement to 4QFY11 or possibly later.
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September 3, 2010
AGL - HPF
AGL - PAL
PAFL
FFC
FATIMA
ENGRO
FFBL
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September 3, 2010
3.0
2.5
2.0
1.5
1.0
0.5
-
FY73
FY75
FY77
FY79
FY81
FY83
FY85
FY87
FY89
FY91
FY93
FY95
FY97
FY99
FY01
FY03
FY05
FY07
FY09
26
Source: BMA Research
September 3, 2010
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September 3, 2010
of 22% to our fair value of PKR208/share, without ruling out the possibility of a
delay in the urea plant we maintain our cautious stance on the stock as earnings
growth can be potentially delayed.
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September 3, 2010
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September 3, 2010
time. Additionally, JPY has currently surged to new levels against PKR crossing
PKR1/JPY mark which leads us to expect another round of price increases in the
coming months. We thus downgrade our sector stance from Marketweight to
Underweight.
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September 3, 2010
DISCLAIMER
This memorandum is produced by BMA Capital Management Limited and is only for
the use of their clients. While the information contained herein is from sources
believed reliable, we do not represent that it is accurate or complete and should not
be relied upon as such. Opinions expressed may be revised at any time. This
memorandum is for information only and is not an offer to buy or sell, or solicitation
of any offer to buy or sell the securities mentioned.
ANALYST CERTIFICATION
We, Hamad Aslam, Abdul Shakur, Nurali Barkatali, Sana I. Bawani, Omar Rafiq
and Ali Taufiq, hereby certify that this report represents our personal opinions and
analysis of information. All views are accurately expressed to the best of our
knowledge. We certify that no part of our remuneration is linked either directly or
indirectly to recommendations or analysis covered in this report
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