Dismal Performance of Pakistani Fertilizer Companies

Pakistan Stock Exchange enjoys substantial foreign investment. With the commencement of results season investors await earnings forecast/results anxiously. Listed fertilizer manufacturing companies have always remained in focus. Previews financial results of the two leading fertilizer manufacturing companies namely Fauji Fertilizer Bin Qasim (FFBL) and Engro Fertilizer (EFERT) for July-September 2016 quarter (3QCY16) exhibits a dismal picture.

FFBL is scheduled to announce its results on 24th October. According to a report by AKD Securities, the Company is forecast to post profit after tax of Rs127 million for 3QCY16 as compared to net profit of Rs181 million for 3QCY15, down 30%YoY. This decline in earnings is expected on the back of: 1) gross margin of company declining to 18% (including subsidy) on account of significant reduction in DAP prices. There has been a decline of 14%YoY due to depressed international price trends. There has also been a decline of 81%YoY in other income (excluding subsidy) in the absence of dividend from associated companies (AKBL & FCCL) and reduction in term deposit placements. The brokerage house expect the Company to post net profit of Rs127 million (EPS: Rs0.14) for 3QCY16 as against a net loss of R381 million (LPS: Rs0.41) on the back of 60%QoQ growth in topline to Rs11.91 billion caused by likely 50%QoQ/36%QoQ increase in DAP/Urea offtake to 143,000/164,000 tons post-subsidy announcement in budget FY17. On a cumulative basis, the brokerage house expects FFBL to post net loss of Rs768 million (LPS: Rs0.82) for 9MCY16 as against a net profit of Rs939 million (EPS: Rs1.01) for 9MCY15. While core business outlook remains bleak, FFBL's impressive diversification strategy and investment in dividend yielding group companies (AKBL & FCCL) is likely to drive earnings of the Company. 

EFERT is scheduled to announce its quarterly financial results on 25th October. The Company is expected to post profit after tax of Rs2.98 billion (EPS: Rs2.24) for 3QCY16 as against net profit of Rs2.79 billion (EPS: Rs2.10) for 3QCY15. The recovery in earnings is expected on the back of: 1) strong 51%YoY growth in topline to Rs21.01 billion caused by likely 39%YoY increase in Urea offtake to 502,000 tons post-subsidy in budget FY17 and 2) a 28%YoY decrease in finance cost on account of swift deleveraging and low interest rate environment. On a cumulative basis, projected earnings for 9MCY16F are to be around Rs5.77 billion (EPS: Rs4.34) as compared to Rs9.91 billion (EPS: Rs7.44) for 9MCY15, down 41%YoY on account of unprecedented adverse market conditions caused by weak farm economics (urea offtake: down 16%YoY in 8MCY16) and delayed implementation of subsidy on urea by the GoP. Moreover, on the arrival of Rabi season, manufacturers are offering hefty dealer discount to clear out high inventory levels.

Pakistan Stock Market Marred by Foreign Selling

he After recording gains for three successive weeks, the benchmark of Pakistan Stock exchange took a breather with the index closing almost flat at 41,282 points during the week ended 21^st October 2016. The correction was led by the continued rise in political tensions and foreign outflows (US$8.46 million as against an inflow of US$2.2 million during the earlier week).

Average daily trading volume rose by 16.8%WoW to 471.9 million shares, led by retail favorites: BOP, TRG, PACE and JPGL. Scrips leading the market were: EPCL, APL, SNGP, HASCOL and NML. The laggards included: ASTL, CHCC, LUCK, MLCF and DAWH.

News flows for the week included: 1) Current account deficit for September 2016 recorded at US$161 million as compared to US$612 million in July 2016 taking 1QFY17 cumulative deficit to US$1.36 billion, up 136%YoY, 2) all PIB bids were rejected in the latest auction amid weak participation as banks bid at higher yields, 3) expected approval of relief package worth Rs200 billion for exporters, particularly belonging to textile sector, 4) Atlas Honda Limited (AHL) announced expansion with a second production line at its Sheikhupura plant to double assembly capacity to 1.2 million units per annum and 5) MLCF planning to set up a 40MW coal‐fired power plant to fuel its cement manufacturing operations. The company will generate funds worth Rs5.5 billion for the project from its own resources.

Market performance is likely to be dominated by earnings announcement from major sectors next week, including Banks (MCB, NBP, BAFL), Cement (MLCF, PIOC, LUCK, DGKC, FCCL), Fertilizer (FFBL, EFERT, FFC, ENGRO) and Autos (PSMC, INDU). Additionally, the announcement of the anticipated textile package is likely to prop up performance in the sector. However, planned protests by PTI may escalate political noise and keep the market volatile. On the macro front, key events of interest include planned visit by Managing Director of International Monetary Fund and President of Asian Development Bank to the country next week.

IMF recently released its staff level review report on Pakistan at the conclusion of the last review under the 3-year EFF program. Commending GoP on sustained progress on targets, the report highlights significant improvements achieved on the economic front over program's duration. The Fund has shown optimism on the country sustaining recent gains supported by external factors, improving credit outlook and growth initiatives under CPEC. However, this remains underpinned on continued efforts to enhance fiscal management, control debt accumulation and develop business competitiveness. Going forward, analysts expect GoP to revert to populist measures as general elections draw near with further delays in privatization program and fiscal expansion likely outcomes. Moreover, deterioration in external metrics remains a key risk going forward amid a widening current count deficit and debt‐dependent foreign exchange reserve accumulation.

Earnings Forecast for Pakistani Commercial Banks

Commercial banks listed at Pakistan Stock Exchange (PSX) are scheduled to announce their quarterly financial results shortly, beginning with UBL (Oct 19), followed by HBL (Oct 20) and ABL (Oct 21). According to a report by Pakistan’s leading brokerage house, AKD Securities, the Big-6 banks are expected to post a combined profit after tax of Rs98.2 billion for 9MCY16F as compared to Rs96.9 billion for 9MCY15.

The top-line growth is likely to be constrained on account of lower yield on earning assets amid ongoing PIB substitution and lower banking spreads. Capital gains backlog is estimated at a whopping Rs94.8 billion for the B-6, where higher utilization of the same can cause earnings expectations to deviate particularly in case of banks like NBP and ABL that have sizeable equity portfolios in addition to the bonds portfolio.

This growth seems illusive, being a function of lower tax expenses (super tax expensed out in 2QCY16) as on a pre-tax basis profits are expected to go down by 14%QoQ. With expectations regarding interest rates bottoming out, the banking sector has gained 13% since July 2016. While 9MCY16F results are expected to depict weakness, price performance will remain hinged upon the following: 1) earlier than expected monetary tightening and 2) pick-up in economic activity amid CPEC related development.

Core income is expected to remain weak (flat YoY) as lower interest rates continue to squeeze margins. Non-core income is also expected to decline by 4%YoY as capital gains utilization is anticipated to remain lower in 9MCY16. However, in 3QCY16 alone, the brokerage house expect the B-6 banks to post combined profit of Rs33.7 billion, higher by 10%QoQ where growth is likely to be a function of lower tax expenses in the absence of super tax charge levied in 2QCY16.

Investment Perspective: With economic indicators and global commodity trends now directing towards a possible end to the monetary easing cycle, the banking sector is likely to remain in limelight. While fundamental pressures remain intact, analysts believe triggers in the form of faster than expected uptick in advances, both corporate and consumer, along with speedy pickup in CPEC related infrastructure projects can push price performance.             

Pak-India border tension keeps local bourse under pressure

Despite prevailing India-Pakistan conflict the benchmark of Pakistan Stock Exchange inched up to close at yet another all‐time high of 41,464. Though, average daily traded volumes declined 33%WoW to 404 million shares. Top slots in volume ranking continued to be occupied by second tier scrips like: BOP, TRG, ASL, JPGL and BAFL. Leaders during the outgoing week included: HASCOL, AKBL, SHEL, BAFL and ASTL, while laggards were: LOTCHEM, EPCL, FATIMA, PTC and DAWH.

Key developments during the week included: 1) new deadlines set by the government for privatizing Pakistan Steel Mills and Pakistan International Airlines, 2) Chinese investors expressed keen interest in investing in troubled businesses in Pakistan, 3) IMF Mission Chief to Pakistan said that country’s foreign currency reserves have not yet reached a comfortable level, 4) China will help Pakistan in rehabilitation and expansion of its railway system starting with 1,700km Karachi‐Peshawar track at a cost of US$8 billion that is expected to be completed in 5 years and 5) China Petroleum Pipeline Bureau agreed to construct LNG terminal at Gwadar on EPC basis envisaging 700km pipeline (42‐inches diameter) from Gwadar to Nawabshah.

The market is anticipated to remain under further pressure in upcoming weeks as PTI’s sit‐in (starting 30^th Oct) is planned to immobilize the government until accountability of Prime Minister, Nawaz Sharif begin for his alleged inclusion in Panama Leaks. Though the border tension with India has eased in recent days, the risk of escalation continues to persist. While the market was driven by E&P sector recently in the wake of OPEC’s nod to output deal, oil price volatility till finalizing the deal (on 30^th Nov) presents further risk to the market.

Deriving strength from the uptrend in oil prices, the global commodity index rose by 3.4% MoM in Sep'16. In this regard, oil prices remained volatile, firming ground by the month end on OPEC's decision to cut output. Following on, while coal prices went up by 8.9%MoM owing to persistent supply pressures in China, steel prices, coal prices remained volatile due to re‐stocking of inventories by Chines mills. FAO Food Price Index was also up 2.9%MoM/10%YoY, going up steadily since Jan'16 supported by increasing sugar and dairy prices. Prices of commodities like urea and cotton remained sluggish on abundant supplies. Going forward, oil prices are likely to determine the trend in commodity prices where seamless completion of the output deal by OPEC in its Nov'16 meet can contribute further gains.

In order to revive the country’s dwindling exports, the GoP is considering certain amendments in the Textile Policy. While in FY14‐19 Policy the GoP has already lowered ERF and LTFF rates to 3.0% and 6.0% respectively, further proposed incentives in the form of increasing rebate (encouraging value‐added), in the range of 4‐6%, are being deliberated. In case the proposed incentive package is approved, the potential impact of the policy on textile sector is likely to be material. Remaining depressed for the most part of the year on account of continuous decline in exports, analysts believe the said incentive package (if approved) can rejuvenate interest in the textile sector.

Is EIA reporting correct data about US oil stockpiles?

Ever since the talk about global oil glut has got louder, I have been trying real hard to find out the factors responsible for the prevailing oversupply. The recent stories published and aired suggest that OPEC, led by Saudi Arabia, is responsible for the steep fall in prices. The price per barrel has plunged to US$35 from its peak of US$147 and currently hovers around US$50. A question came to my mind, is Saudi Arabia the only culprit?

Having spent weeks on finding a plausible reason, I reached a very disturbing point. My conclusion is that the stories being published and aired by western media are based on a few premises, which are incorrect and misleading. The biggest factor that moves oil price is weekly US stockpile data released by the US Energy Information Administration (EIA). In the recent weeks, it has reported sudden rise and fall in US stockpiles, which resulted in high volatility in crude prices. Most of these spikes were reported at a time when the world was following OPEC-led effort to contain glut.

Today, I read shocking news that millions of barrels of oil produced in US remain unaccounted for. This raises a question, is EIA reporting correct data about US oil stockpiles? Ideally one should trust that EIA is not providing misleading information. However, keeping the track record of US intelligence agencies in mind; one has a reason to question the sanctity of the data disseminated by EIA.

The data released by EIA about crude oil inventories influences its price. If the increase in crude inventories is more than expected, it implies weaker demand and is bearish for crude prices. The same can be said if a decline in inventories is less than expected. If the increase in crude is less than expected, it implies greater demand and is bullish for crude prices. The same can be said if a decline in inventories is more than expected.

The reason for doubting the sanctity of data disseminated by EIA is little disclosure about shale oil production. The number of operating rigs reported by some service provider is still less than 500, as against an installed number of more than 1900 touched in 2014. This suggests that around one-fourth of installed rigs are operating for almost three years. What has the fate been of remaining three-fourth? How many of them have filed bankruptcy under Chapter 11? If no such report has been made public, one has all the reasons to doubt the authenticity of EIA data.

Morale of the story, EIA is diverting the attention of the world from US crude production to Saudi Arabia, Russia, Iran and Iraq to hold them responsible for the glut. One should also keep in mind that US has also been the biggest beneficiary of low crude oil prices, being the biggest consumer of energy.

Can oil prices continue upward trend?

One of the questions haunting exploration and production (E&P) companies is how soon and how much oil prices will go up by end of this year? Te reply is simple, hike in price is dependent on how much output producers are willing to relinquish.

Therefore the first point to explore is who will take the lead in cutting down output first.

The western media is still keeping the hype that Saudi Arabia has to cut its output but the biggest stumbling blocks are Iran and Iraq. It continues to spread disinformation that since Saudi Arabia and Iran continue to be the worst foes, any reduction in output by Saudi Arabia remains a remote possibility.

According to a Reuters report, "Oil rose to a one-year high on optimism regarding a future agreement between OPEC and major producers to restrict output"

It also said, "Significant doubts whether they (production cut targets) will actually be fulfilled due to the rivalry between OPEC members, who are fighting aggressively for global markets share, could prevent an effective deal.”

As per report, Goldman Sachs said in a note to clients on Tuesday that despite a production cut becoming a "greater possibility", markets were unlikely to rebalance in 2017. The rationale was, "Higher production from Libya, Nigeria and Iraq is reducing the odds of such a deal rebalancing the oil market in 2017 and even if OPEC producers and Russia implemented strict cuts, higher prices would allow U.S. shale drillers to raise output.

Initially, I had a point of view that most of the shale oil producers were unable to continue production below US$50 barrel due to accumulated losses. Now, believe that they have withstood the test, which is evident from the persistent increase in tnumber of active rigs. However, the number of operating rigs is still less than 25% of total installed rigs.

Moral of the story is that shale oil producers are more anxiously awaiting hike in price but out of desperation they want to increase the number of operating rigs and snatch Saudi share as early as possible. They have invested billions of dollars hoping that oil price would not fall below US$50/barrel. The crash that began in 2014 has shattered their dreams. Even geopolitical turmoil in MENA has failed in deterring OPEC members, mostly located in the region where proxy wars have been going on for more than last two years.