Market remained lackluster amid political turbulence

 

June 29, 2012 (JS Research)

 

 

The market continued with subdued activity amid the political turbulence. On the political front, Presidential Ordinance which was issued to provide constitutional cover to former Prime Minister’s decisions was challenged. Other major highlights during the week included: 1) Competition Commission of Pakistan (CCP) issuing show cause notices to fertilizer companies, 2) PSO starting additional supply of furnace oil to generate 1200MW of power and 3) Indus Motor and Honda raising car prices to compensate for Euro II compliance. Consequently, the KSE-100 index closed at 13,801, up 0.5%WoW with average daily volumes of 69mn shares, up 0.3%WoW. Foreigners were net sellers of US$5.6mn.

 

CCP issues notices to fertilizer producers

Post the enquiry report on ‘unreasonable increase in the price of urea fertilizer’, CCP initiated proceedings against the urea producers for abusing their dominant position in the market by issuing show cause notices to all the fertilizer producers. On the other hand, State Bank of Pakistan urged the GoP to eliminate price gap between locally produced and imported urea. As a result, the key fertilizer stocks namely FFC, FFBL, ENGRO and FATIMA all underperformed the market by 1.4%, 1.0%, 3.0% and 0.5%, respectively on WoW basis.

 

Additional furnace oil supply for power

New Prime Minister directed the finance ministry to collect outstanding dues from GoP bodies and provide funds to PSO so as to start additional supply of furnace oil to generate 1200MW of power.

 

Indus and Honda raises car prices

During the week, Indus Motor and Honda raised their car prices to compensate for the Euro II compliance. However, INDU and HCAR underperformed the market by 2.9% and 6.4%, respectively.

Market remained lackluster amid political turbulence

NCL: Not Much to Offer

 

          Robust dividend income from its stable and efficient running subsidiary NCPL will continue to remain a strong cushion against any deterioration in cotton-yarn margins

 

          The easing finance cost (lower by 6% YoY in 9MFY12) also provided a breather to NCL’s profitability. However, possibility of another round of monetary tightening remains the key downside risk to our estimates

 

          With persistent decline in PKR value during 4QFY12 (3% depreciation in just last one month), we believe the company to book notable uptick in exchange gains thus further strengthening the bottom-line

 

          The recent approval of the EU trade concessions will certainly bode well for the company as it is already well positioned in the EU market

 

          With no near term solution in sight to the prevailing energy crisis, the rise in fuel costs will keep the margins under pressure

 

          With Cotlook A index bottoming to its lowest (since Feb10) at USD0.78 during the first week of Jun12, the sentiments continue to remain weak. Average cotton prices in 4QFY12 stands at USD0.91/lbs, depicting a decline of 10% QoQ as against USD1.0/lbs in 3QFY12

 

          Healthy dividend income and trade concessions offered by EU parliament will remain the key triggers, going forward. Based on our downward revised target price of PKR19/share, the stock represents a total return of 14%, thus justifying our ‘ADD’ stance on the stock

NCL: Not Much to Offer

NBP: A Cyclical Play

With adequate coverage ratio, stagnant NPL ratio and highest dividend yield amongst top tier banks, we reinitiate our coverage on National bank of Pakistan (NBP) with a ‘Buy’    Although NPL coverage standing at 74% is lower to the tune of 5% provided by comparable peers, we believe it’s adequate enough and the bank will continue maintain this level. Hence, we deduce that concerns over asset quality of the banks have been overplayed    Recently introduced mandatory requirement of a minimum deposit rate of 6%, the cost of deposits are bound to increase    The cost to income ratio which is a measure of efficiency for the bank stands at 56% - although measures to control costs such as up gradation of IT infrastructure and introduction of mobile and internet banking facilities are on cards, a complete implementation of the same would take its due time    The bank fundamentals demand a PKR50/share target price for the stock, offering 16% upside and above average dividend yield of 17%

NBP: A Cyclical Play

Fertilizers – A tough year to go

Fertilizer offtake during 1HCY12 remained sporadic where 4MCY12 urea offtake registered at a 5-yr low of 1.3mn tons (down by 22%YoY) while we reckon that sales picked up in May'12 and subsequently surged in Jun'12. In this regard, expected spike in urea offtake in Jun'12 doesn't necessarily reflect the demand from end-consumers (farmers), as we attribute this spike to dealers' reaction to anticipated price arbitrage on expected rise in urea price where local manufacturers increased urea price by PkR50/bag on Jun 16'12 and another PkR95/bag rise is expected in Jul'12. Lower 4MCY12 urea offtake was primarily caused by i) water shortages (rabbi crop water availability decreased by 15%YoY) and ii) farmers' weak purchasing power, where the surge in input prices (fertilizer, fuel etc) and low output prices, particularly cotton, have combined to weaken farmer purchasing power, which is expected to remain subdued going into 2HCY12. For CY12, we forecast urea offtake at 5.64mn tons (-4.7%YoY) while available urea and closing urea inventory are estimated at 6.25mn tons and 0.6mn tons, respectively. We expect fertilizer sector fortunes to improve going into CY13 as we expect lower urea imports (Pakistan possibly re-entering the IMF program, which is likely to lead to reduction in subsidies including subsidy on urea imports) as well as recovery in urea demand once soil conditions in Sindh normalize.                     .

 

Farmers' declining purchasing power: We reckon that farmers' capacity to purchase fertilizer has been significantly decreased, following the surge in fertilizer prices and significant fall in cotton prices (-32% YoY), the main farmer cash crop. Furthermore, delay of sugar cane payment by factories also restrained the liquidity of farmers. The table above contains a comparison of number of kgs per crop required to buy 1 kg of fertilizer (urea and DAP) during 10MFY12 over preceding period. Moreover, a comparison drawn at current retail fertilizer prices (unlikely to sustain at this level) with 10MFY11 is also provided. The nitrogen to phosphate (N/P) ratio (ideal between the 2.0x-2.5x range) has further increased during FY12F to 4.92x (+21%YoY), as surge in DAP prices (+27%YoY) has led to reduced offtake. Furthermore, impact of lower DAP application is already visible on the wheat crop, where yields for FY12 are down by 4%YoY to 2,714kg/ha.

 

Looking forward: Urea offtake is estimated to be 5.6mn tons during CY12 (down 4.7%YoY) with anticipated production of 4.7mn tons, imports of 1.5mn tons and closing inventory of 0.6mn tons. We expect fertilizer sector fortunes to improve going into CY13 as we expect lower urea imports (Pakistan possibly re-entering the IMF program, which is likely to lead to reduction in subsidies including subsidy on urea imports) and recovery in urea demand, once soil in conditions in Sindh normalize.                        .

 

Investment perspective: Within our Fertilizer universe, FATIMA remains our top pick (CY12P/E of 7.44x) with a Dec'12 target price of PkR40.2/share, implying 66% upside from current price. Once fertilizer offtake of local manufactured urea manufacturers will gain momentum in CY13F, FATIMA will be able to offload its CY12 inventory, ending with CY13F EPS of PkR6.8, and a forward P/E of 3.6x. Among other players, FFC is trading at an attractive dividend yield of 12.5% even under our worst case scenario (closing inventory of 500k tons and urea price of PkR1,795 per bag from Jul'12), calling for an Overweight stance on the scrip. Key downside risks to our call include i) significant decline in int'l urea prices and ii) regulatory risk particularly related to Competition Commission of Pakistan (CCP), where the CCP has issued show cause notices to fertilizer manufacturers over unprecedented urea price hikes during CY11, which the CCP deemed as unreasonable and unjustifiable.

Fertilizers – A tough year to go

Fertilizer Numbers: GST reduction rumors cause May12 urea sales to fall 20% YoY

 

          As per the latest data released by NFDC, total urea offtake fell by 20% YoY to 377k tons in May12, whereas DAP sales fell by 13% YoY to 26k tons

 

          NFDC attributed hefty decline in sales to 1) rumors of GST reduction on fertilizer in budget FY13, which failed to materialize, and 2) delayed cotton sowing

 

          The numbers and reasons for sales decline are inline with our expectations which we have already communicated in our report titled “Fertilizer: Tightening Screws” dated June 6, 2012

 

          We reiterate that with these rumors finally laid to rest, we expect Jun12 urea sales to clock in at over 750k tons, representing over 50% increase YoY. Accordingly, we anticipate that the largest players FFC and Engro Fertilizer will be able to sell ~400k and ~250k tons of urea respectively

 

          For May12, FFC sold 204k tons of urea, representing 3% YoY decline. Urea sales for Engro Fertilizer clocked in 43% lower YoY to 64k tons. FFBL and FATIMA sold 52k tons (up 19% YoY) and 1.5k tons (down 96%) of urea respectively

 

          FFBL’s DAP sales clocked in at 17k tons, down 21% YoY. FATIMA sold 28k tons of CAN (down 22% YoY) and 19k tons of NP

 

          We maintain our preference for FATIMA in BMA Fertilizer Universe, which enjoys immunity from additional gas cess to be imposed from July12. The company trades at CY12E PER of 6.2x and offers 45% upside to its Dec12 TP of PKR35/sh

 

          We highlight that FFC is likely to exhibit a short term rally based on healthy Jun12 sales numbers and 2QCY12 results

Fertilizer Numbers: GST reduction rumors cause May12 urea sales to fall 20% YoY

LOTPTA: No relief in sight despite fall in oil prices!

 

June 26, 2012 (JS Research)

 

 

International PTA-Px margins have exacerbated further in 2Q2012 despite the sharp decline in Paraxylene (Px) prices. Since May, Px prices have plunged by 18% following the declining trend in international oil prices. However, PTA prices too plummeted by 20% in the same period, consequently leading to eroding margins. International PTA-Px margins have averaged around US$89/ton in June, below the breakeven level. Not surprisingly, LOTPTA in 2012 year to date has underperformed the market by 42%. We maintain our ‘Hold’ recommendation on the stock with a target price of Rs8.3. At current levels, the stock trades at a 2012E and 2013F PE of 14.52x and 8.34x respectively.

 

Resistance of Px prices finally broken!

Px prices which were fairly sticky in 1Q due to relatively tight supply in the region have taken a battering in 2Q. Initially the prices fell due to weak PTA demand but more recently falling international oil prices (WTI down 25% since May) has played a major role. Px which is extracted from Naptha (crude oil derivative), has tumbled 18% since May to US$1266/ton.

 

 

Considering lower world oil consumption owing to the gloomy global economic outlook, oil prices may stay relatively subdued. This may in turn keep Px prices relatively tame as well in the near term.

 

Fall in Px prices fails to propel margins

Declining price trend of Px should have come as a major relief to PTA producers as Px is used as feedstock for PTA.  Unfortunately, for PTA manufacturers, PTA prices have plummeted more sharply (down 20% since May) to US$930/ton. As a result international PTA-Px margins have averaged around a dismal level of US$89/ton in June. The decline in PTA prices has come on the back of falling PTA demand in China with the downstream polyester market worsening in tandem with fresh economic concerns in Europe and USA . Moreover unfavourable factors like depressed cotton prices have further aggravated the situation. With massive planned expansions expected to come online in the next couple of years in both China and India , PTA prices are likely to remain under check.

 

 

Recommendation: ‘Hold’

LOTPTA’s stock has underperformed the market by 42% in 2012 year to date as deteriorating core fundamentals of the company hampered its stock price. With the recent attrition in international PTA-Px margins, a reversal in the stock price trend remains unlikely. The recent budget too was disappointing for the company as the proposal to increase import duty on PTA was ignored. Hence, we maintain our ‘Hold’ stance on the stock with a target price of Rs8.3.  However, further deterioration in PTA-Px margins remains a downside risk to our investment thesis.

LOTPTA: No relief in sight despite fall in oil prices!

Spreads on declining trajectory, fall 15bpsMoM

                    Written as on June 26, 2012

 

Highlights

            •         Banking spread stood at 7.07% during May-12, down by 15bpsMoM

            •         Deposit rates increased by 12bpsMoM to 5.88% during May-12

            •         Rates on lending down by 3bpsMoM to 12.95% during May-12

            •         Outlook - Spreads remains in the range of 7.0% to 7.5% during CY12

 

In today’s Value Seeker, we present an insight on latest figures issued by State Bank of Pakistan (SBP) for Banking Spreads during the month of May-12 along with our outlook on the sector.

Banking spread stood at 7.07% during May-12, down by 15bpsMoM

According to the latest figures released by SBP, banking spreads (difference between lending and deposit rates) of the overall banking sector during the month of May-12 fell by 15bpsMoM to stand at 7.07% compared to 7.22% during previous month. However on YoY basis, considerable decline of 58bps is witnessed compared to spread of 7.65% during May-11. The average interest rate spread during 5MCY12 (Jan-May) stood at 7.25% as compared to 7.57% in the same period last year, showing a decline of 32bpsYoY. Furthermore, the spreads based on gross disbursement and fresh deposit appreciated by 52bpsCYTD to 6.7% in May-12 from 6.2% in Dec-11.

Deposit rates increased by 12bpsMoM to 5.88% during May-12

The weighted average deposit rates on outstanding deposits including zero percent markup increased by 12bpsMoM to 5.88% during May-12 compared to deposit rate of 5.76% last month. On CY12TD basis, the rate on outstanding deposit remained flat at 5.88%. Highest deposit rate witnessed in Public sector funds which stood at 6.10% (declined 4bpsMoM) followed by deposit rate on private sector funds which stood at  5.84% (up 16bpsMoM).

Rates on lending down by 3bpsMoM to 12.95% during May-12

Yields on outstanding loans including 0% markup fell by 3bpsMoM to 12.95% during May-12 compared to 12.98% witnessed last month. While during CY12TD the rate on outstanding loans fell by 51bps compared to 13.46% of Dec-11 rate. Highest lending rates witnessed in Public sector loans which stood at 13.53% (declined slightly by 1bpMoM) followed by lending rate on public sector loans which stood at  12.98% (declined by 4bpsMoM). However, the 6M KIBOR, which is the benchmark for almost 80% lending to private sector hovered in very low range of 11.95% to 12.0% during the last five months or so, therefore the spread on fresh lending are on consistent downward trajectory largely after the downward adjustment in lending rates. On the other hand, stagnant deposit rate is the result of the slower inflow of funds into the banking system that made deposit mobilization task harder resulting into the fall in raising the rate of deposits.

Outlook - Spreads remains in the range of 7.0% to 7.5% during CY12

We expect that the full year average spreads of CY12 will remain in same range and likely to hover in the range of 7.0% to 7.2%. SBP has increased minimum deposit rate on all PKR saving account deposits from 5% to 6% to spur savings in the economy and benefit small account holders. However, we expect the impact would be lower to the savings accounts as the profit payable on savings deposits is calculated on the minimum monthly balance and the aforementioned instructions would not apply on foreign currency savings deposits.

 

Spreads on declining trajectory, fall 15bpsMoM

Defensive FFC amid turbulent sector dynamics

 

June 25, 2012 (JS Research)

 

Gas related woes of the Sui network and the availability of imported urea by the GoP has taken its toll on the fertilizer sector in general, particularly on FFC. As a result the stock has underperformed the market by 8.6% in 2012 till date. The strategy of local urea manufacturers to reduce price by Rs145/bag from May, 2012 so as to get rid of record inventory has paid off for them. Their offtakes have since then showed an improvement. As per industry sources, FFC has been able to capitalize the most on higher urea demand and has recorded substantial growth in urea offtake in May and June with lower prices. We believe it is likely to report an EPS of Rs3.7 in 2Q2012, up 21%QoQ and we continue to maintain a ‘Buy’ call on the stock.

 

The major beneficiary of the price cut

According to some industry sources, urea offtake for May was recorded at ~330k tons and uptil the mid of June it has already crossed 500k tons. FFC has been the major beneficiary of the price cut strategy. It has been able to capitalize the most on higher urea demand and has recorded substantial growth in urea offtake in May and June. The pre announced rise in urea price of Rs50/bag from June16, 2012 may have induced farmers to procure urea at the lower price of Rs1,650/bag. The high urea sales has more than offsetted the lower urea price for FFC. Incorporating provisional offtake figure along with our own estimates, we believe FFC will be able to report an EPS of Rs3.7 in 2Q2012, up 21%QoQ despite the absence of any dividend income from FFBL.

 

Gas related woes of Sui network

Currently, the fertilizer plants on the Sui network (SNGP and SSGC) are all closed as the gas supply has been diverted for power generation. As per reports, now FFBL may also get gas on a rotational basis so as to cater to the electricity shortfall in the country. On contrary, the plants on Mari network are somewhat immune to the shortage of gas in the country. However, availability of imported urea remains a key concern for them.

 

Availability of imported urea

The GoP has been importing urea to fulfil the gap between demand and supply of urea due to gas related woes of the Sui network based fertilizer plants. The availability of imported urea at subsidized rates has been a cause of concern for the local manufacturers. To recall, the budgetary allocation and current international urea prices, GoP can import 1.2mn tons of urea in FY13. However, the demand for urea in the country has historically been ~6mn tons annually. Therefore, keeping in mind the import target set in the federal budget, the local manufacturers may gain the pricing power going forward with relatively reduced availability of imported urea.

 

 

Outlook

FFC is trading at 2012E PE of 7.2x and offers a dividend yield of 13.4%. Currently, we have a ‘Buy’ stance on the stock. Since it is on the Mari network, it is somewhat protected from the gas related woes faced by other fertilizer producers on the Sui network. However, the key risk to our investment thesis remains the quantum of pass through of incremental cost after the imposition of Gas Infrastructure Development Cess (GIDC).

 

naveed.tehsin@js.com

92 (21) 111-574-111 (ext. 3100)

 

Also in focus

Presidential order issued to provide legal cover

A Presidential Order has been issued to provide constitutional cover for all the decisions taken by the former Prime Minster during the period from April 26 to June 19, 2012. After the disqualification of the Prime Minster, question marks over the validity of the decisions taken had arisen, including the recently announced Federal Budget.

Defensive FFC amid turbulent sector dynamics