Declining fertilizer sale in Pakistan

Fertilizer sales continued downward trend during first two months of calendar year 2016. Reportedly offtake during these months was exceptionally low. While urea sales plunged to 656,000 tons (down 40%YoY), total fertilizer offtake was 982,000 tons (down 228%YoY). The declining trend in sales is attributable to lower crop prices (depressed agricultural commodity cycle) and weather-related crop shortfalls resulting in low farmer income.

According to the latest figures released by NFDC, cumulative fertilizer offtake during the Feb'16 was recorded at 491,000 tons as compared 606,000 tons in Feb'15, a decline of 19%YoY. Specifically, urea sales during Feb'16 have declined to 315,000 tons from 340,000 tons in Jan'16, down by 7%MoM/31%YoY.

On the other hand, DAP sales showed strength, registering an increase of 12%YoY to 71,000 tons and 9%YoY to 148,000 tons in Feb'16 and 2MCY16 respectively, however remaining lower by 7%MoM.

Imported urea sales went down by 98%YoY/87%MoM to only 1,533 tons in Feb'16 on account of weak demand and increase in production from the local players particularly EFERT and FFC that enhanced their production levels by 16%YoY to 172,000 tons and 70%YoY to 209,000 tons respectively.

Near-term checkpoints for the fertilizer industry remain: 1) international pricing dynamics where urea prices are down 26%FYTD to currently stand at US$236/tons, 2) Upcoming kharif season to drive demand and 3) increase in local gas prices (expected in Jun'16). In this regard, with no major volumetric growth in CY16, depressed farmer income and weak pricing power does not bode well for the sector.

Urea market share FFC (26%), EFERT (41%) and FATIMA (5%) in Feb'16. FFC sold 146,000 tons (down 21%YoY0, EFERT sold 128,000 tons (down 13%YoY) and FATIMA sold 15,000 tons (down 50%YoY) of urea. With the month under review remaining slightly better for DAP offtake, FFBL sold 24,900 tons of DAP (up109%MoM) while imported DAP sales rose by 33%YoY to 46,400 tons, however, declined by 28%YoY. After a sluggish start in CY16, NP and CAN sales improved to 36,700 tons and 52,400 tons respectively in Feb'16. 

Weak demand on account of poor farm incomes and increase in production from local players has led to high inventory levels in the system. In Feb'16 inventory levels for Urea (800,00 tons), DAP (269,000 tons), CAN (306,000 tons) and NP (180,000) tons. Consequently, end of Feb'16 inventory levels were relatively high for all four basic types of chemical fertilizers. In this backdrop, fertilizer producers are offering hefty dealer discount to clear out huge stockpile of inventory, affecting their margins.

In line with market volatility and depressed fertilizer outlook, the sector shed 14.2% CYTD. With little respite in sight for global commodity prices along with depressed farmer incomes, analysts believe the country's urea demand in CY16 is likely to fall to as low as 5.2 million tons. This alongwith inability to pass on any sharp increase in cost from further gas tariff rationalization (expected in Jun'16) given the continuously narrowing gap between local and international prices is likely to keep price under pressure.

Poor commodity prices, rising gas price, declining urea international prices, high carryover stock

Pakistan Stock Market Witnesses out flow of US$9.5 million

Pakistan market regained some momentum after the PXE-100 index crossed 33,000 level during the week ended 1^st April 2016, up 1.74%WoW despite volatility from global crude trends. Activity at the market showed sharp recovery, where average traded volumes for the week rose to 140 million shares as compared to 113 million shares a week ago. Key news flows guiding the market during the week included: 1) MARI announced crude oil discovery at exploratory well Halini Deep-1 in Karak block, 2) OGRA determined price of the LNG delivered on ex-ship (DES) basis at US$8.99/MMBTU exclusive GST and allowed increase in PSO margin to 2.5% on DES price from the previous 1.98 level, 3) CDWP approved Rs218.2 billion worth of development projects including Rs129.7 billion worth of motorway construction from Halka-Burhan on M-1 to Dera Ismail Khan as part of CPEC, 4) IMF's Executive Board approved disbursement of US$502.6 million after the completion of the tenth review under the EFF arrangement, 5) MSCI released its reclassification proposal with regard to migration of Pakistan index from frontier to emerging markets, where formal is expected to take place in May’17 and 6) GoP increased the price of petroleum products taking refuge behind the recent hike in global crude oil price. Performance leaders during the week were MTL, AGTL, ABL, HCAR and DAWH, while laggards included NCL, OGDC, HASCOL, UBL and ICI. Lack of foreign interest persisted during the week with net outflows of US$9.56 million, higher than US$2.31 million recorded in the previous week.

MSCI has released its reclassification proposal with regards to migration of Pakistan index from frontier to emerging markets. While consultation with market participants will be carried out in May'16 to be followed by a decision in Jun'16, formal inclusion is likely to take place in May'17. As per the proposal, the MSCI Pakistan Index would have a potential weight of 0.19% in Emerging Markets (significantly lower than the current 9% weight in the Frontier space) with nine companies making the cut. Out of the total, three companies (OGDC, HBL and MCB) will be placed in the large cap index whereas the rest (UBL, LUCK, FFC, ENGRO, HUBCO and PSO) are likely to be placed in the Mid-cap index. Broadly meeting the set graduation criteria, minor problem areas particularly with reference to market accessibility highlighted in the document include: 1) inability of foreign investors to undertake short selling/stock lending or borrowing and 2) stability of institutional framework. Moreover, continuous shrinking of volumes during the year (1QCY16 average volumes at 134 million shares as compared to 236 million shares during 1QCY15) can potentially raise concerns on meeting the size and liquidity criteria, altering the number of constituents and weights accordingly. Hopeful for an inclusion, the market is eyeing increased visibility on the global front as a key benefit especially in the backdrop of continuous foreign selling (CYTD FIPI outflow registered at US$98 million). Also, precedence (recent entrants of other markets) indicates that market multiples can sharply expand once graduated in the Emerging Markets category.

According to the latest provisional dispatches data, cement demand remained less than impressive. Contrary to the prevailing trend, export dispatches posted the best month of the year so far with domestic demand remaining flat. On a cumulative basis, dispatches reached a record high level of +9.0%YoY in 9MFY16 as compared to +8.6%YoY in 8MFY16. Companies outperforming the industry during the month included DGKC, ACPL, MLCF and PIOC, while KOHC, FCCL, FECTC and LUCK were underperformers. On cumulative basis, KOHC, PIOC, FCCL, DGKC and MLCF continued to outpace the industry while LUCK, ACPL, CHCC and FECTC were laggards on account of loss of exports to some markets (South Africa/Iraq). While March'16 failed to keep up with the momentum, analysts expect domestic demand to pick up pace going forward on the back of higher construction activity in summers where additional positive surprise can come from any aggressive utilization of remaining PSDP funds (unutilized FY16 federal PSDP: 50%). While exports continue to decline, experts believe the recent uptick in dispatches during March'16 is encouraging. With demand expected to remain robust alongwith lower operating costs, brokerage houses maintain an Overweight stance on the sector where their top picks include LUCK and DGKC due to their ability to catch up with anticipated rising domestic demand.

Following below expected CY15 financial results and adjustment in NIMs, there is a need to revisit Bank Alfalah (BAFL). While CY15 earnings depicted the swiftest pace of growth for BAFL (earnings grew by 33% YoY), analysts do not expect such momentum to sustain as pressure on NIMs from its investment portfolio (upcoming PIB maturities worth Rs50 billion) is likely to take a toll on earnings considering lending rates are already at their multi-yearr lows.  That said, BAFL's focus on attracting current accounts (37% of deposit mix in CY16F), efficient management of its staff cost (employee/branch to go down to 15.5 in CY16 as compared to 17 in CY14) and improvement in asset quality (credit cost to come down by 21bps to 0.45% in CY16) are key factors restricting earnings decline to some extent. Additionally BAFL's push towards expanding the high margin consumer segment business (5% of loan book in CY15) can also come in handy. While dividend curtailment in CY15 was not received too well by investors, strengthening of CAR by 60bps to 13.4%, as a consequence, is encouraging making room available for BAFL to participate in the credit up-cycle. BAFL's valuation can catch up with peers through: 1) sustainable and visible improvement in the cost structure, 2) an adequate CAR buffer and 3) higher payouts.

Pakistan announces new automotive manufacturing policy

The much awaited Automotive Development Policy 2016‐21 proves to be good for new entrants offering them lucrative incentives. Salient features includes: 1) a 10% customs duty reduction will be offered on CBUs and auto‐parts after for (CY18‐19) ‑ two years 2) restraining the definition of Greenfield investments, now defined to include on "an investor for the production of vehicles of make not already being manufactured in Pakistan" and 3) for existing investors, the duty on spare parts will be slashed by 2.5% to 30% from fiscal year FY17 and import duty of localized parts will be brought down to 45% from 50% currently.

Significant reduction in barriers to entry is envisioned through: 1) a 25% Customs Duty for FY16‐21 on localized parts as aginst 50% now and 45% in the policy for incumbents, 2) a 10% Customs Duty for FY16‐21 on non‐localized parts as compared to 32.5% now and 30% in the policy for incumbents and, 3) Duty free, one‐time import of plant and machinery, including import duty of 100 vehicles at 50% customs duty for test marketing. Additionally, room for new entrants may be furthered by JVs with non‐operational entities that may require fresh equity. 

Apart from this, financially defunct entities (DFML, GHNL) may also benefit from restructured financial arrangements allowing for higher financial leverage. While detrimental impact to cost structure will be there, pricing power and market segmentation are likely. Analysts retain their bullish outlook on INDU, citing: 1) presence of strong after sales service network, dealers, service areas, 2) strong brand equity and product mix with demand for locally produced Corolla, Vigo variants expected to remain buoyant and 3) entry into new segments may be threatened, while lead time of 18 to 24 months for establishing greenfield investments by new entrants offers opportunity to capitalize on reduced duties FY18‐19.

Pakistan must address structural issues on top priority

Historically Pakistan and International Monetary Fund (IMF) has lived with each other, at times with comfort and at tome with some unease. While the IMF role as ‘lender of last resort’ has helped Pakistan in overcoming economic malice, the loan covenants are often seen by Pakistani’s rather stringent.

Ideally the ruling regime in Pakistan should be more careful in formulation of policies and implementing these in letter and spirit but the overall impression is that the successive governments sooner or later suffer from complacency. It may also be said that political agenda pushes economic agenda in the back ground. Many analysts strongly believe that condoning deviation may not be difficult had appropriate efforts were made. In other words these deviations are the result of not following the ‘IMF Recipe’.

A team of AKD Securities, Pakistan’s leading brokerage house, recently met the IMF Regional Representative for a discussion on Pakistan’s progress on the macro front in the context of the ongoing EFF program. After the meeting it has also released a report that has many takeaways.

While progress on reform agenda so far remains commendable, continued reform implementation post completion of the program was stressed, where energy crisis and low revenue collection continue to rank as high priority issue areas.

The IMF, though cognizant of likely delays, sees room for steady structural changes even post completion of the program based on higher GoP resolve. Benefits of low oil prices and earlier reforms have placed Pakistan in a macro sweet spot with economic indicators marking record levels.

Agreeing with the IMF, AKD team believes this opens room for addressing deeper structural issues that can help Pakistan sustain recent economic gains where key reform areas highlighted were: 1) exports sector revival, 2) tax base expansion and 3) efficient expenditure and resource allocation between federal and provincial governments.      

Key takeaways

Priority on energy and revenue: Key issue areas for reforms that retain the highest priority were Energy and Revenues expansion – both resonated by all participants. Resolution to the country’s energy problems was highlighted, particularly in the context of its impact on industrial growth. Also, revenue collection remains equally crucial where considerable focus should be directed towards structural changes both through a) regulatory/legislative action and b) operational changes in FBR/tax collection mechanisms.

Privatization to slowdown: The privatization program remains on agenda, however it is likely to stretch beyond the current program as political opposition in PIA’s strategic divestment and labor union concerns in case of DISCOs continue to be major hurdles. That said, recent road shows for DISCOs’ sell-off were regarded as a key positive. Analysts expect revision of current timeline in the upcoming IMF review report for December 2015. Moreover, with the current government resorting to populist decisions in the run up to next general elections (expected 2018), the brokerage house highlight heightened risks to PSE sell-offs.

Another program unlikely: With the current program effectively concluding in June 2016, rollover to another program remains unlikely on account of Pakistan’s stable Balance of Position position. However the Fund is likely to remain engaged in a consultative process with the GoP to monitor current program objectives, though without imposition of conditions/targets.

CPEC – lack of clarity lingers: The Fund views the landmark China Pakistan Economic Corridor (CPEC) agreement as largely positive, though details on nature of agreements remain sketchy and are yet to be factored in fiscal expectations/targets. Alongside, infrastructure projects need for investment in export oriented sectors was also noted. 

Putian has all the reasons to visit Pakistan

Reportedly Russian Ambassador, Alexey Dedov said there was no reason the Russian President should visit Pakistan. His statement not only sounds amateurish but also shows his lack of understanding of the geopolitical scenario of the region. It may be an irony that the Russian diplomat is not only unaware of the history but also lack vision.

While delivering a lecture on Pak-Russia relations at the Institute of Strategic Studies, Islamabad he said, “The problem is that usually the purpose of the visit is not participation in ceremonies. The visit should have some substance.”

Ambassador Dedov defined the substance as “signing of documents” for cooperation, “preparation of plans” for expanding ties, and “declarations”.

The point to ponder is that no Russian or even Soviet president has ever visited Pakistan. President Putin had planned a visit to Islamabad in October 2012 for attending a quadrilateral summit between Pakistan, Russia, Tajikistan and Afghanistan, but cancelled it at the eleventh hour.

Former USSR and now Russia had a grudge that Pakistan remained in the lap of United States and also fought a proxy war in Afghanistan for a decade but have they ever bothered to review their own attitude? India, arch rival of Pakistan has always remained a darling of USSR/Russia.

The situation changed a bit during the regime of Prime Minister Zulfikar Ali Bhutto, only because of a bad patch of Pak-US relationship. This was because many Pakistanis strongly believed that the US played a key role in the creation of Bangladesh.

I would even go to the extent of saying that at that time USSR failed in exploiting the situation. It may also be said that assault on Afghanistan was considered a serious threat for Pakistan. That is the reason when USSR attacked Afghanistan, the US once again convinced Pakistan to fight its proxy war.

It is also on record that China, despite being a communist country, succeeded in maintaining the most cordial relationship with Pakistan. China was also fully aware of the US influence on Pakistan but never dragged it in Indo-China conflict.

The latest evidence of Pak-China strong relationship is agreement on development of China Pakistan Economic Corridor (CPEC), as against this Russia has not focused on developing economic relationship with Pakistan.

Russia played a major role in convincing the west to stop proxy war in Syria. If Russia is serious in expanding its influence in the region, it has to play a role in resolving Kashmir issue that has led to three wars between India and Pakistan.