Pakistan Stock Market remains laclkuster

Due to political uncertainty and regulatory pressures the benchmark of Pakistan Stock Exchange index remained unexciting. The week ending 17^th March 2017 closed at 48,409 points, down 1.6% WoW. Soft global oil prices, SECP’s action to curtail in-house badla financing and political uncertainty kept the market under pressure. Key news flows during the week were: 1) SBP raised Rs284 billion through short‐ term government papers, 2) in line with expectations, the US Fed raised interest rates, 3) in addition to independent power producers’ claims of over Rs414 billion, non‐payments to oil companies were reported at more than Rs300 billion, 4) Ministry of Finance approved payment of Rs6 billion on Thursday for the state owned PSO to avoid an international default, and 5) HUBC and FFC announced in separate notices the offer and receipt of an equity divestment plan relating to Thar Energy Limited. (TEL), a 330MW mine mouth coal fired project in Thar Block II. Stocks leading the bourse were: MEBL, ASTL, FATIMA, and ICI. On the other hand, laggards were: HMB, PPL, and FFBL. Volume leaders were: KEL, BOP, TRG and ASL. Subdued global oil prices, strengthening US$ and global trade related developments over the upcoming G‐ 20 summit may impact the domestic markets. At home, any clarity on the political front could trigger bullish sentiment, while policies and budgetary developments for the Finance Bill FY18 can be expected to sway markets.

The PRK has remained stable over the last year, weathering the worsening external account position. While current account deficit is up 90%YoY during 7MFY17 and reserve position (down US$1.75 billion from its peak) has deteriorated, PkR/US$ has remained stable at PKR104.8/US$, which is reflective of GoP's resolve to keep exchange rate stable. Going forward, analysts see little pressure on the PRK over the short term, primarily supported by an expected recovery in forex reserve position. In this regard, analysts see support from expected inflows including: 1) up to US$1.0 billion from planned Eurobond/Sukuk issue, 2) US$550 million under CSF disbursement and 3) likely US$4.0 billion from project lending and commercial loans budgeted for the year along with room for greater accretion from CPEC related inflows. Incorporating this,

AKD Securities has recently revisited its investment case for PIOC, incorporating recent cement price increase and expected continuation of clinker sales. While rally in coal price is expected to shrink gross margins (GM) and dampen earnings, recently installed 12MW WHR is expected to partially make up for the above. In this regard, the brokerage house expects an after‐tax operational savings of PKR1.11/PKR1.82 in 2HFY17/FY18. Besides, the company revealed its plans of: 1) revising up its cement expansion capacity from 2.21 million tpa to 2.52 million tpa, 2) installing separate line of 12MW WHR for the expansion and (3) setting up 24MW coal CPP. The total capex associated with the projects is expected to be around PKR25 billion. Though, the brokerage house has not incorporated the aforementioned projects due to awaited details, it expects the expansion to result in increase in FY20‐23 average earnings. Moreover, the new line of WHR and coal CPP are together expected to result in incremental earnings.

OGDC discovers hydrocarbon in District Hyderababd

Pakistan’s largest exploration and production (E&P) enterprise, Oil and Gas Development Company (OGDC) has discovered a new oil and gas reserve in Hyderabad District. The OGDC is the operator of joint venture of Nim Block having 95% share along with 5% shareholding of the Federal Government through Government Holdings.

The discovery at exploratory well Chhutto-1 is the first hydrocarbon reserve in Bulri Shah Karim, Tando Muhammad Khan in District Hyderabad. Initial results encouraged the company to drill two more wells in this licensed areas, of which one well has already been marked for immediate drilling.

The structure of Chhutto-1 was delineated, drilled and tested using OGDCL’s in-house expertise. The well was drilled down to the depth of 3,820 meters. The well has tested 8.66 million standard cubic feet per day (mmscfd) of gas and 285 barrels per day (bpd) of condensate through 32/64-inch choke at wellhead flowing pressure of 2,100 per square inch.

As declared by the Company, the discovery is the result of aggressive exploration strategy adopted by the OGDC. It has opened a new avenue and would add to the hydrocarbon reserves base of the country in general and OGDC in particular.

The OGDC has the largest acreage, production and hydrocarbon reserves in the country. It is listed at Pakistan and London Stock Exchanges with a debt-free robust balance sheet and cash reserves, although its huge financials are stuck up in the country’s chronic energy sector circular debt.

Pakistan meets around 12% of its oil requirement from indigenous resources. Historically, the OGDCL’s production has hovered between 35,000 and 45,000 bpd. The company has embarked upon an aggressive exploration and development program in the last few years to take advantage of a slowdown in drilling activities in the Middle East and around the world.

Only recently, the company launched four fresh seismic crews started operations in Kharan, Pasni, Gwadar, Zhob and Musakhel in Balochistan which remained inaccessible due to security situation for a long time. It was for the first time that its nine seismic crews were simultaneously working in various parts of the country. The number of such crews never went beyond five in the past, he claimed.

US the biggest beneficiary of output cut by Saudi-led OPEC

I posted a blog ‘US producers gulping Saudi share’ on 4th February 2017. In this blog I had expressed my apprehension that Saudi Arabia was most likely lose its market share by cutting down output. I also warned that with the improvement in oil prices, US producers would be prompt in increasing their production to gulp Saudi share.

In the recent past various reports have been released that supports my point. The reports indicate that the US production has risen to around 9 million barrels/day. These reports also confirm that the compliance by OPEC members is as high as 95 percent; Russia has not made the corresponding cut in its output.

According to EIA data, US crude inventories hit record highs last week, after eight straight weeks of build ups. This was because of increase in number of active rigs as production topped 9 million barrels per day for a second week in a row, the most since April 2016. Increase in US crude stockpiles undermine efforts by Saudi-led OPEC to contain global oil glut.

I am obliged to share a report published by Reuters ‘U.S. drillers add oil rigs for seventh week in a row: Baker Hughes’ indicating that with the improvement in crude oil price the US drillers have added a total of 293 oil rigs in 36 of the past 40 weeks. This is the biggest addition since a global oil glut crushed the market in mid 2014. The US drillers added seven oil rigs during the week ended 3rd March 2017, taking the total count up to 609, the most since October 2015. During the same week a year ago, there were 392 active oil rigs only.

According to Baker Hughes, oil rig count plunged from a record 1,609 in October 2014 to a six-year low of 316 in May 2016. This fall has been attributed to the collapse of US crude oil prices to near US$26 in February 2016, from over US$107 a barrel in June 2014.

Yet another sign of warning is a report by the US financial services firm, Cowen & Co that said its capital expenditure tracking showed 52 exploration and production (E&P) companies planned to increase spending by an average of 50 percent in 2017 over 2016.

One of the likely OPEC decisions could be to declare that the agreement reached last year is no longer binding for its members. Increasing output may not pose any problem for OPEC members but could certainly put US producers in trouble. Only price could determine who can withstand the completion.   

Pakistan stock market witnesses 6% decline in daily traded volume

The benchmark index of Pakistan Stock Exchange continued to experience volatility during the week on account of reported action by SECP against in‐house financing and uncertainty with regards to Panama‐gate case. Though market fell initially to one‐month low on first day of the week, it recovered thereafter closing at 49,624 points (+1.26%WoW) on rumors of a new leveraged product and SECP clarification on measures/regulatory oversight over brokerage firms. Average daily traded volumes fell by 6%WoW to 322 million shares where volume rankings were occupied by: LOTCHEM, ASL, KEL, ANL and TRG. Leaders during the outgoing week included: LOTCHEM, EPCL, AGTL, SNGP and ICI while laggards included: NCL, HMB, PIOC, DAWH and PPL. Key developments during the week included: 1) Pak Suzuki Motor Company (PSMC) sent an investment plan of US$660 million to the government, requesting same benefits/incentives for 2 years from the start of mass production of new models instead of 5 years granted to new entrants in the Auto Policy 2016‐21, 2) MUGHAL announced to set up 6 additional lines of 3.1MW gas CPP taking total CPP capacity to 27.9MW and spend Rs1.00 billion on these lines and BMR of existing re‐rolling mill, 3) SBP issued Rs387.4 billion worth of T‐Bills against the participation of Rs473 billion, 4) SNGP’s BoD approved a capital intensive project for development of 1,200mmcfd LNG pipeline from Karachi to Lahore at an estimated cost of Rs111 billion with expected COD of October 2018, and 5) CPI inflation hit a 3‐month high of 4.2%YoY in February  2017. The market is likely to remain volatile in the upcoming week due to lingering regulatory and political risks. Inflationary pressures on account of rising food and fuel prices are expected to strengthen hawkish monetary policy stance. In this backdrop, banks are expected to perform well.

Continuing to climb albeit at a slower pace than the tail end of CY16 bullish sentiment prevailed in global commodities market during February 2017. This sentiments were driven by hike in prices of commodities actively traded that included oil, Cotton, Steel and food commodity prices. Whereas, commodities witnessing decline in prices were Coal and Urea on the back of policies and capacities raising global production. Going forward factors driving commodity prices are: 1) divergence in global monetary policy, where any tightening in US rates could strengthen the greenback, softening commodity prices, 2) global economic activity picking up pace as global manufacturing PMI remain expansionary and 3) continued tightening of supply dynamics for energy prices expected to keep supply constrained. Lastly, political factors including expansionary fiscal policies by the US government and China's meeting of the Politburo Standing Committee are expected to renew commitments to infrastructure development, providing support to metals, energy and hard commodity prices.

After a fitting end to CY16 (promising rabi season), CY17 got off to a sluggish start with not only urea but cumulative fertilizer sales remaining depressed during January 2017 primarily in response to low crop prices (depressed agricultural commodity cycle) and crop shortfalls lowering farmer's income. According to latest figures released by NFDC, cumulative fertilizer offtake during the aforementioned month was recorded at 595,000 tons as compared to 1,278,000 tons in December 2016, declining significantly by 53%MoM, while it rose 21% on yearly basis. Specifically, urea sales during January 2017 were recorded at 406,000 tons as compared to 898,000 tons in December 2016, lower by 55% MoM, while it grew 19%YoY. On the contrary, imported urea sales went up to 15,000 tons in January 2017 on account of the discount offering with imported urea prices at 10% discount to its local counterpart. Following the trend, DAP sales also remained depressed, declining to 61,000 tons in January 2017. Post Rabi season, near‐term expectations are: 1) export of excess urea inventory and 2) change in international pricing dynamics.

CPI based inflation for February 2017 is projected at 4.1%YoY, considerably higher than 3.66%YoY registered in January 2017. While food prices are likely to see a dip on seasonal trend, this should be countered by the recent hike in petroleum prices. Consequently, 8MFY17 CPI average is expected to rise stand to 3.9%YoY compared to 2.5%YoY in the corresponding period. Going forward, analysts expect inflation levels to post a steady increase buoyed by higher price levels for food items and rising global oil prices.

HUBCO More than just an Independent Power Producer

The Hub Power Company Limited (HUBCO) is Pakistan's largest multi-project power producer (1200MW RFO powered base plant, 214MW RFO powered Narowal, 84MW hydel based Laraib) and a stalwart of the IPP space in Pakistan.  Continuing with its pedigree of developing diverse capacity additions, expansion into coal fired power through its 46% stake in China Power Hub Generation Company Limited (CPHGCL) is now likely. Inclusion of the 2x660MW project in the priority list for CPEC projects confirms the market’s bullish expectations and allows us (AKD Securities) a firm basis to include dividend income from the project in our valuation set. We await the financial close of Thar Electric Power, to incorporate upside. Furthermore, the COD of SECMC (expected Dec'18) may also be achieved offering additional upsides. Moreover the company has also approached relevant authorities for developing a mine mouth power project of, 330MW in Thar. Having had a strong bull run (FY14-16 return of 102%), on the back heightened investor expectations of value addition post expansion plans, the stock trades at attractive price.

Going forward, earnings are expected to be driven by: 1) movement past the trough of the U-shaped tariff for the base plant, 2) improved efficiency in the base plant from continuing overhauls (boiler overhaul completed) and 3) termination of O&M contract with O&M services at the base plant (and planned coal expansion) to be managed internally, reducing consolidated O&M costs (halving of annual O&M expense). The separation of O&M services subsidiary Hub Power Services Limited as an in-house O&M provider in a technical agreement with GE and its stake in SECMC are value accretive. The absence of these companies in the consensus valuation method (DDM using income paid through tariffs post indexation), may be undervaluing the company and missing value additions from these segments of HUBC's business.

CPHGCL (2X660MW) coal fired plant with accompanying jetty adjacent to its base plant site, with an expected cost of US$2.4 billion (in an 80/20 debt to equity) through a JV with China Power International  Holdings, and HUBC holding minority stake in the project (recently notified at 46%). To recall, coal based power plants have a lucrative upfront 27.2% ROE (imported coal) during the four year construction period, with a guaranteed 17% US$ indexed IRR. Thus, the planned project, with expected COD by FY19-20 (staggered COD is planned, with each 660MW unit brought online in a span of 2-3 quarters of each other), is expected to be a major contributor to payouts from FY20 (Rs5.73/share in annual dividend income from CPHGCL).

HUBCO’s base plant with 1,200MW net generation capacity forms the foundation of the current valuations as it makes up for 80% of units generated by the company. These factors allow the base plant to add Rs63.2/share to DDM based valuation in the form of dividend income (at 100% ownership). Having a U-Shaped tariff (unique in the Power Sector) the plant's tariff peaks towards the end of its tariff period, expiring in FY27. Additionally, the recent completion of boiler overhauls and incorporation of a wholly owned subsidiary to carry out plant O&M significantly reduces O&M costs for the consolidated entity.

A number of catalysts continue to fuel investor expectations including: 1) demerger of Narowal into a separate IPP, with potential listing to raise additional funds for sizeable CPHGCL equity drawdown, 2) Pak Rupee depreciation and increase in US CPI provide upside to indexations built into the tariff and adjusted quarterly, and 3) additional income from the acquisition of 6% stake for US$20 million in Sindh Engro Coal Mining Company (SECMC) tasked with mining for coal in Thar Block II (COD expected Dec'18). Lastly, headway on additional projects, including 330MW Thar Electric (TEL) could be value accretive (26.5% ROE on local coal vs. 24.5% on imported coal).

Under the scheme of arrangement for asset desegregation approved in the EOGM on Feb'15, the newly formed Narowal Company Ltd will have 392.2 million shares. Post demerger, 100% ownership of Narowal Company Ltd will remain with HUBCO; the company may put up a minority stake for listing through Offer for Sale.

Valuation & Investment Perspective: Having had a strong run (FY14-16 return of 102%), on the back heightened investor expectations of value addition post expansion plans, the stock trades at a premium. The financial close of TEL also offers additional upside. Between now and the commencement of operations in the 1320MW coal fired extension project, the COD of SECMC (expected Dec'18) may also be achieved offering additional upsides. That said, both projects will be a drain on liquidity, which the company may balance by offloading Narowal post demerger. Despite this, management has recently stated its aim to implement quarterly payout regime.

Regulatory impediments with pending approvals on 1,320MW coal fired power plants having the potential to delay the project in a material manner. In the backdrop of additional burden of upcoming projects and investments, liquidity crunch may ensue if circular debt resurges. Any surge in debt build up may impede FO supply, particularly at the base plant, where PSO (with whom a Fuel Supply Agreement governs payments) is exposed to a liquidity crunch and may face problems opening LC's/ facilitating shipments.

HUBCO, Pakistan, energy crisis, circular debt

Pakistan Stock Market Comes Under Extensive Pressure

After starting the week on a shaky foot, market remained volatile as investors preferred realizing profits due to uncertainty around Panama hearing, law and order concerns and stories about unethical conduct of some of the brokers. During the week ended on 24th February, the benchmark index of Pakistan Stock Exchange (PSX) closed almost flat at 49,008 levels. Average daily trading volume at the bourse tapered to 322 million shares, down by 11.6%WoW. Foreign flows also declined with net outflows for the week rising to US$4.8 million as compared to inflow of US$4.2 million a week ago. Major news flows during the week included: 1) current account deficit for January’17 rose by 16%YoY to US$1.19 billion taking 7MFY17 cumulative deficit to US$4.71 billion, up 90%YoY, 2) GoP raised Rs59.7 billion through PIB auction with banks’ biding for Rs115.2 billion but cut off yields remained largely flat, 3) National Assembly Standing Committee was informed that the GoP is considering a subsidy package for farmers in the FY18 Budget, 4) Chairman of the PSX’s Divestment Committee stated that the exchange would be listed through an IPO by the end of June this year, 5) PSMC announced expansion plans for producing 100,000 units, with total planned outlay of US$460 million and 6) KPMG Taseer Hadi – Independent Consultants for SNGPL and SSGC – released their report suggesting UFG benchmarks for the utilities at 5%. Top performers at the bourse were: HMB, MTL, PIOC and SSGC, whereas laggards included: HASCOL, DAWH, AGTL, and ASTL. As the result season approaches its end, the market is likely to retain focus on developments around Panama‐gate case. Uncertainty around the time frame for the announcement of the decision can keep investors on edge, inducing greater volatility in the market. Additionally, February’17 CPI inflation to be announced next week is expected to be higher than last month and will help to firm expectations of a higher interest rate trajectory going forward.

External trade trend witnessed improvement during January'17 with exports rising to US$1.78 billion (up 3.0%MoM/0.7%YoY), marking reversal from the consistent monthly downward trend seen this year. Textile sector, which constitutes more than 60% of country's exports picked some pace and rose by 2.7%MoM to US$1.06 billion during the period under review driven by broad‐based recovery in both low value (+7.8%MoM) and value‐added segments (+1.0%MoM). However, on a cumulative basis, 7MFY17 textile exports are still 1.5%YoY lower as compared to that of US$7.23 billion for the corresponding period last year. Going forward, analyst at AKD Securities expects textile exports to largely remain under pressure due to: 1) demand side bottlenecks with weak Chinese demand outlook and concerns of an economic slowdown in the EU following Brexit and 2) lower currency competitiveness amid sharp depreciation in regional currencies against US$. That said, the recently announced export incentive package worth Rs180 billion with the textile sector having the lion's share is expected to enhance export competitiveness over regional countries remains a key near‐term trigger for the sector. Moreover, encouraging cotton arrivals to date (up 10.63%YoY) to 10.634 million bales) is expected to reduce cotton shortfall this year.

Large Scale Manufacturing (LSM) during 1HFY17 grew by 3.90%YoY buoyed by a jump in December'16 by 7.04%YoY on seasonal trends. However, this remained slightly lower as compared to 1HFY16 owing to slower than earlier growth in the Auto sector. However, recovery in the Food sector lent support to the LSM index. While some upwards push is expected in the coming months on periodical trends, analyst expects the trend to normalize over FY17. However, ongoing expansion plans can lift the index higher than previous year. This remains inadequate for achieving FY17 GDP target of 5.7%.

Pressures on rupee seems more imminent due to 7.3%MoM increase in trade deficit emanating from a 6%MoM decline in remittance inflows during January’17. Consequently, analysts expect sharper deterioration with CAD rounding off at 1.85% of GDP in FY17 on rising trade deficit and declining remittance. This adds to already worsening foreign exchange reserve position as foreign debt flows (net of repayments) in 7MFY17 at US1 billion have been lower than US$1.3 billion in the corresponding period. Resultantly, import cover on SBP held reserves now stands at 4.6 month compared to 5.4 month at end FY16.

OGDC half yearly profit declines by 12 percent

Pakistan’s largest exploration and production (E&P) company, Oil & Gas Development Company Limited (OGDC) has announced its half yearly (1HFY17) financial results. The Board of Directors also approved payment of one Rupee per share interim dividend. Both the financial results and dividend payout are below expectations.

OGDC has posted net profit of R15.38 billion (EPS: Rs3.58), down 4%YoY while up 5%QoQ. The earnings are lower than with major deviation coming from lower topline, higher operating expenses and exploration costs partially compensated by lower effective tax rate. While the 1HFY17 earnings are down 12%YoY to Rs30.01 billion (EPS: Rs6.98) owing to lower realized gas prices (result of lagged oil price linkage). The earnings are expected to increase onwards due to improvement in realized gas prices and significant addition in flows from KPD-TAY, Sinjhoro and TAL Block.

The major takeaways are:  1) Topline remained flat on quarterly basis at Rs41.52 billion, however, it improved by 5%QoQ owing to improved oil production and higher oil price, 2) operating expenses increased to Rs15.28 billion in 2QFY17, 3) exploration expense increased 33%YoY due to relative differential in dry wells’ expenses, 4) though other income was relatively flat at Rs4.25 billion and 5) tax expenses declined by 27% to Rs4.29 billion due to lower effective tax rate.

OGDC: Income Statement
(Rs million)	2QFY17	2QFY16	YoY	1HFY17	1HFY16	YoY
Net Sales	41,516	41,673	0.0%	81,081	86,186	-6.0%
Royalty	-4,521	-4,680	-3.0%	-8,828	-9,694	-9.0%
Operating expenses	-15,277	-13,934	10.0%	-28,356	-26,568	7.0%
Transportation charges	-426	-401	6.0%	-836	-869	-4.0%
Gross profit	21,291	22,659	-6.0%	43,061	49,055	-12.0%
Other Income	4,248	4,305	-1.0%	9,309	8,295	12.0%
Share of profit	369	246	50.0%	922	615	50.0%
Exploration expense	-3,868	-2,906	33.0%	-8,189	-4,713	74.0%
Admin expense	-925	-897	3.0%	-1,653	-1,812	-9.0%
Finance cost	-412	-408	1.0%	-815	-833	-2.0%
WPPF	-1,035	-1,150	-10.0%	-2,132	-2530.32	-16.0%
PBT	19,668	21,848	-10.0%	40,503	48,076	-16.0%
Tax	-4,291	-5,902	-27.0%	-10,494	-13,870	-24.0%
NPAT	15,377	15,946	-4.0%	30,008	34,206	-12.0%
EPS	3.58	3.71	-4.0%	6.98	7.95	-12.0%
DPS	1.0	1.2	-17.0%	2.5	2.7	-7.0%
ETR	-22.0%	-27.0%	-	-26.0%	-29.0%	-