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%	-

US war mongers flaring Sunni-Shia conflict

I really don’t know how many readers of this post will agree with me, but I consider it my ardent duty to keep on reminding the readers that US is the biggest war monger on this planet. Its sole purpose of creating conflicts and/or initiating wars is to sell armaments, US is the largest arms supplier that include both conventional and non-conventional.

At the recent elections it was hoped that newly elected US president will try to pull its troops posted in many countries. However, now It seems people were hoping against hopes as President Donald Trump is also surrounded by war mongers. His thinking is being influenced to the extent that it is becoming evident that soon the world may see opening up of US-China, US-Russia, Saudi-Iran and India-Pakistan fronts.

Some of the readers may wonder how the US could open so many fronts. Since World War II, it is evident that the US has been fighting proxy wars. However, over the last five decades it has become evident that it is ‘war of crusades’, all the fronts have been opened against Muslims. This includes Iraq attacking Iran, US attacking Iraq, Afghanistan and Syria. All these are proxy wars.

Ironically this time the US is planning to initiate war between two oil rich Muslim countries Saudi Arabia and Iran in the name of Sunni-Shia conflict. The US has already installed is touts and the hype is being created has some of the glimpses:

• The US has imposed new sanctions on Iran on the pretext that Iran remains both a major source of terrorism and a threat to the US interests.
• President Donald Trump has declared his intention of crushing the Islamic State (IS).
• The US strategy in Iraq prior to the 2007 was to oppose both Shia and Sunni factions but both have drawn strength from outside Iraq – the Sunnis from Saudi Arabia and the Shia from Iran.
• The US considers the Iranian-supported Shia as the greater threat and tried to counterbalance them by reaching a financial and political understanding with the Sunni leadership.
• IS has emerged as the champion of the Sunni Arab population.
• The US has remained powerless in crafting the Iraq it wanted.
• After 15 years of ineffective fighting the US must accept its defeat in the region, withdraw its troops and allow the region to evolve as it will.
• The US could face an increasingly powerful Sunni world and even more powerful Shia Iran.
• The US-led forces have failed in isolating therefore it has to be engaged in some form of military action, possibly directed at its nuclear program.
• The US does not have a military force large enough to wage war at Iran.
• The U.S. has limited forces, reluctant or discordant allies, and cannot win a war. Since the Islamic world is deeply divided along religious and ethnic lines. The option is allying with one faction to defeat the other.
• It is being portrayed that Sunnis are weaker than the Iranians. But there are far more Sunnis, they cover a vast swath of ground and they are far more energized. Iran may be more powerful but Sunnis are more ruthless.
• Some factions even go to the extent of saying that a US-Iran alignment may be more probable because they are the convenient option as they hate and fear the Sunnis.

I am of the opinion that the US cannot afford simultaneous conflicts with Sunnis and Shia, Arabs and Persians. Therefore, it is likely to opt for time tested strategy ‘divide and rule’. Muslims should be ready to face further fragmentation. If they (Muslims) want to survive they have to stand united despite being Sunni or Shia.

Pakistan stock market witnesses 12 percent increase in daily trading volume

Exhibiting signs of investor weariness and mixed responses to earnings releases, the benchmark index of Pakistan Exchange (PSX) closed the week ended 10^th February 2017 at 49,925 points. Market participants’ response to earnings announcements swayed greatly, with investors continuing to favor higher payouts over earnings growth, and corporate action, particularly in cements kept the sector in the limelight. Average traded volumes rose to 414 million shares, up 12%WoW. Key news flows were: 1) PSMC launched imported luxury sedan Suzuki Ciaz at competitive price, 2) International Steel Limited (ISL) stated in a filing that the National Tariff Commission (NTC) has decided to impose definitive anti‐ dumping duties on galvanized steel coils/sheets for a period of five years, 3) PSO's receivables from different enterprises, particularly power companies, have swelled to Rs277 billion, and 4) As per State bank of Pakistan foreign exchange reserves of the country declined by US$413 million to US$22.03 billion by 3^rd February and the external sector faces increased pressure as its trade deficit widened by 29%YoY to US$17.4 billion during 7MFY17 due to paltry exports and double digit growth in imports. Top performers at the bourse were: LOTCHEM, NBP, ASTL, NML, whereas laggards were: PTC, HUBC, AGTL and ABL. Volume leaders for the week were LOTCHEM, KEL, POWER and TRG. Oil is set to grab the spotlight in the coming week, where crude benchmarks are beginning to inch upwards on positive reviews of the OPEC and non‐OPEC output freeze. Results will remain the center of gravity, where companies reporting in the coming week include AGTL, HBL, FCCL, MLCF, DGKC, UBL, ENGRO and OGDC.

Commencing this week, commercial banks are scheduled to declare their CY16F/4QCY16F results. The first was MCB (8^th Feb), followed by ABL (9^th Feb) HBL (15^th Feb). As a group, the Big‐6 banks are likely to post cumulative profit after tax of Rs127.5 billion for CY16 as compared to Rs129.7 billion for CY15, a decline of 2%YoY. Top‐line growth is likely to be constrained on account of lower yield on earning assets amid ongoing PIB substitution and lower banking spreads (4QCY16 spreads lower by 26bps YoY). However, improvement in credit quality has restricted the earnings decline with provisioning charges for the Big‐6 down by a sizable 81%YoY for CY16. That said, revaluation surplus likely to improve by a significant Rs176 billion, where higher utilization of the same can cause earnings expectations to deviate particularly in case of banks like MCB, NBP and ABL that have sizeable equity portfolios in addition to the bonds portfolio. While CY16 results are expected to remain flattish, price performance should remain hinged upon the following: 1) higher than expected payouts, 2) earlier than expected monetary tightening, 3) formal inclusion into MSCI EM with HBL, UBL and MCB likely to make it to the list.

Latest APCMA data showed that cement dispatches during January'17 remained relatively flat at around 3 million tons, while it fell 12.86%MoM due to heavy rainfall/snowfall impacting local construction activity (domestic demand, a decline of 14.56%MoM to 2.722 million tons in January'17). Exports also remained subdued during the month and declined by 2.71%YoY/+1.85%MoM) due to rising fuel prices/other input costs and import/anti‐dumping duties making it more difficult for Pakistan's exported cement to compete against the indigenous cement. Greater intensity of seasonal effect has slowed down the cumulative domestic demand growth was 9.52% in 7MFY17 as compared to 15.66% in 7MFY16. Though, analysts expect exports growth to remain flat due to prevalence of aforementioned issues, they also believe that domestic demand growth will likely resume double digits growth as construction activity is expected to pick pace due to relatively greater proportion of PSDP releases in second half of fiscal year and record level growth in private sector credit related to construction activity, up 25.25%YoY.

Two of the largest IPPs of Pakistan HUBC and KAPCO are also scheduled to announce their half yearly financial results. HUBC is anticipated to post profit after tax of Rs5.25 billion for 1HFY17 (down marginally) on the back of muted generation, Pak Rupee remaining firm against greenback and picking up of RFO prices. Expensing of higher O&M charges, inflated admin expenses and investment in associate related expenses are expected to taper profitability, while the higher receivables burden is expected to raise financial costs. KAPCO is forecast to post 1HFY17 net profit of Rs4.67 billion up 8%YoY, from lower generation, slight improvements in generation on gas and below the line expenses remaining in check. Devoid of major movement on the expansion front (financial close of CPHGC, TEL, KAPCO Energy) IPPs are expected to remain in the sidelines, for the time being.

Engro fertilizers posts 40 percent decline in profit fir CY16

Engro Fertilizers Limited (EFERT) has posted profit after tax of Rs9.02 billion (EPS: Rs6.78) for CY16 as against net profit of Rs15.03 billion (EPS: Rs11.30) for CY15, a massive decline of 40%YoY. The results were anticipated but decline is more than expected. Despite the decline in profit the Board of Directors has approved distribution of final dividend of Rs2.50/share, taking the full year payout to Rs7/share. The major takeaways are: 1) topline declined to Rs69.51 billion from Rs85.00 billion, a fall of 18 percent, 2) reduction in urea prices (down 9%YoY) due to depressed farm economics and low international price trends (down 28%YoY) to an average of US$213/ton during the year under review, 3) there was a 32%YoY decrease in finance cost on account of swift deleveraging and low interest rate environment, 4) other income increased to Rs8.13 billion for CY16 from Rs4.31 billion a year ago, an increase of 88 percent.

Pakistan State Oil Company disappoints shareholders

Pakistan’s largest oil marketing company, Pakistan State Oil Company Limited (PSO) has disappointed its shareholders by not announce any interim dividend at the time of release of its financial results for July-December 2016 period. This comes as a shock as PSO has posted an EPS of Rs36.86 as compared to an EPS of Rs24.75 for the corresponding period of 2015. This raises apprehensions that the Company suffers from serious liquidity crunch, circular debt being the most notorious.

The suspicion gets credence because PSO is the largest energy supplier to power generation companies as well as the state owned enterprises. The other apprehend is that if crude oil prices continue upward trend, it may yield substantial inventory gains but maintaining high profitability  would not be possible without asking the government to raise POL prices substantially.

Net sales of the company for the period under review increased to Rs411 billion from Rs353 billion, posting an increase of 16 percent. Further impetus was provided by 20 percent increase in Other Income and 21 percent reduction in financial charges. As a result profit after tax for six months period increased by 49 percent to Rs10.015 billion, from Rs6.726 billion.