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Elixir Securities Limited – Pakistan Equity Market: Weekly Review

Karachi, January 05, 2018 (PPI-OT): Strong Foreign Flows Lead to 5% Gains in KSE-100

KSE100 Index rose by 2,052pts WoW (5.1%) to 42,524pts led by January Effect on fresh foreign buying.

Index was driven by Banks, Cements, Exploration and Production (E and Ps) and Fertilizers contributing 787pts, 309pts, 253pts and 231pts, respectively.

Banks returned 7.0%WoW led by increase in PIBs yields and expectation of higher inflation owing to PKR depreciation and resultant increase in interest rates.

Cements gained 8.1%WoW on the back of delay in Maple Leaf Cement (MLCF) expansion allaying concerns regarding overcapacities.

E and Ps posted 4.2%WoW returns due to increase in oil prices during the week and expectations of another round of PKR depreciation, as the newly appointed Finance Advisor committed to maintaining flexibility on the currency.

Fertilizers returned 4.3%WoW on increase in retail level Urea and DAP prices.

Trading activity picked up during the last four days of the week where average traded volumes and average traded value grew by 10%WoW and 9%WoW to 237mn shares and USD86mn.

Foreign investors stood out as the largest category of buyers as they mopped up shares worth USD23mn, up 1.6x from last week. Most of their buying was concentrated in Banking and Cement stocks. Mutual Funds also bought shares worth USD9mn, as they deployed fresh inflows into the market. Domestic Companies, Individuals and Insurance Companies however resorted to profit-taking during the week.

Equity Market Outlook and Perspective

Fresh foreign buying is expected to continue its momentum at least during the month which may result in January Effect to continue. However given that KSE-100 has sharply gained 12% from its Dec-17 low of 37,919, we would eye some profit-taking and consolidation to take place in the coming week. Political risk can also dampen the sentiments as Pakistan Awami Tehreek’s (PAT) will decide on future course of action post expiry of their extended deadline (7th Jan) for their irrational demands of resignation of Punjab CM and Law Minister.

Key news this week

SBP move likely to cause dollar shortage in open market (Economy): The State Bank of Pakistan (SBP) has decided to cut the import requirement of cash dollars to 35 per cent against the export of foreign currencies, creating fears about a shortage of the greenback in the open market.

The central bank issued a circular on Monday that asked exchange companies to bring only 35pc cash dollars as opposed to 100pc against the export of foreign currencies to Dubai.

US confirms new Pakistan aid cuts (National): The White House has confirmed suspending $255 million of military aid to Pakistan, a move seen as the first step to implementing President Donald Trump’s pledge to tighten economic restrictions on Pakistan.

Hours after President Trump’s New Year tweet, White House spokesman Raj Shah told reporters in Washington that “the United States does not plan to spend the $255 million in … foreign military financing (FMF) for Pakistan at this time”.

Census 2017: notification of provisional summary results approved by cabinet (Politics): The federal cabinet Wednesday approved notification of provisional summary results of the 6th population and housing census, paving the way for timely 2018 election that put the country’s total population at 207.774 million.

America suspends entire security aid to Pakistan (National): The Trump administration announced on Thursday it is suspending its entire security assistance to Pakistan until it proves its commitment to fight all terrorist groups operating in the region.

Under the new approach, funds would be allocated to a particular purpose identified with the allocation and would be released only after that target is achieved. The targets identified with the allocation could be strategic as well as issue specific.

Also on Thursday, US Secretary of State Rex Tillerson placed Pakistan on a special watch list for severe violations of religious freedom. A brief announcement by the State Department said that for the first time it has created a ‘Special Watch List’ for countries that “engage in or tolerate severe violations of religious freedom but may not rise to the level of CPC (Countries of Particular Concern).

No need for IMF bailout package: Minister Rana Afzal (Economy): Minister of State for Finance Rana Muhammad Afzal on Thursday reiterated the government’s resolve that it won’t resort to the International Monetary Fund (IMF) to obtain funds. “Pakistan’s economy is on growth track and the government has sufficient resources to meet expenditures,” the newly-appointed state minister said, addressing a media briefing.

This week’s top stories

Pakistan E and P Sector – Altering Oil Price Assumption Leading to FY18F Earnings Growth of 37%YoY

International Oil Prices surged 39% to USD65/bbl in 2H2017 on the back of OPEC/Non-OPEC’s production cuts. We believe oil prices to likely to stay firm amidst extended production cuts deal in 2018.

With continued resilience seen in oil prices, we have revised our oil price assumption from USD50/bbl to USD60/bbl from FY18F and onwards. As such, our E and P universe’s FY18F/FY19F earnings are revised up by 11%/13%, whereas our rolled forward Dec-18 PT’s are increased by 9%.

We have an Overweight stance on E and Ps where valuations are expected to be driven by 37%YoY earnings growth in FY18F on the back of stronger oil prices and PKR depreciation. Our top picks in E and P Universe include OGDC and MARI, led by additional hydrocarbon flows development projects and unwinding of discounts on Mari field‘s gas pricing and incentive pricing over benchmark production, respectively.

Pakistan OMC Sector – Retail Fuel Sales Fail to Compensate for FO Declines

Overall industry sales volumes fell 11/2% YoY/MoM in Dec-17 led by rout in FO offtakes which declined 44% YoY but increased 7% MoM owing to lower hydel generation in winters.

Retail fuels continued their growth trajectory with HSD and MOGAS volumes rising 9/-11% and 12/6% YoY/MoM respectively in Dec-17. Resultantly volumetric growth for HSD/MOGAS clocked in at 11/14% over 1HFY18.

HASCOL outperformed the industry with overall sales growth of 12/45% YoY in Dec- 17/1HFY18 buoyed by strength in HSD and MOGAS sales which increased 20% and 44% YoY respectively in the outgoing month.

Looking ahead we expect FO volumes to decline at a CAGR of 38% over FY17-20, as more coal and LNG based power plants come online; however some of these declines will be negated by sharp growth in HSD and MOGAS.

Within the space we highlight APL as our top pick due to its i) limited exposure to FO sales and circular debt, ii) synergies emanating from group companies and iii) muted exchange losses due to high local procurement.

Lalpir Power Limited – Furnace Oil Demise is a Boon

We Initiate coverage with a Dec-18 PT of PKR35/share offering 72.6% total potential upside from last close (including 10.4% leading dividend yield) at a 14.5% cost of equity.

LPL has historically suffered fuel losses of 160% of reported earnings over 2013-16. This has resulted in 6.7% average ROE which is expected to rise to 15.5%.

We see reduction in utilization rate from the historical average of 58% over 2013-16 to 25% post 2023, with drastic reductions in utilization during 2017-2022. This could potentially reduce average fuel losses by 56%.

Due to a scheduled outage in October and industry wide furnace oil plant closure in November, we expect utilization rate for 4Q2017 to average 20% at best. This would result in 81%YoY increase in 4Q2017 earnings to PKR1.1/share.

Going forward dividends are expected to increase. The 1994 Power Policy guarantees fuel supply from PSO which reduces working capital constraints for the company.

Capacity payments remain an issue if utilization levels fall. We have conservatively assumed 30% of capacity payments each year get delayed till 2028 resulting in PKR15.6bn in additional receivables by 2028.

We have also assumed that the plant sells for 75% of its book value by 2028 due to technological obsolescence.