ATTOCK CEMENT HALF YEARLY RESULTS: BELOW EXPECTATIONS

Attock Cement has posted it's half year result ended Dec 31,2010. The PAT is 235 million and EPS is 2.72 which is 62% lower than same period EPS of 7.2. The result is disappointing and company target price has now reached 72 which earlier was given around 80-90 range. Rising energy cost along with declining brand premium has caused this decline. The company is expected to perform better in 2nd half though as coal prices are now going down from it's peak of 130$/ton and given the fact the winter season is now ending further drop is possible in coal prices which will help cement manufacturues. Remember ACPL has the strongest balance sheet in cement sector i.e it has a lowest debt. Because of disappointing results share price has decreased but company is still worth investing and investors can get this share at lower prices. The expectation for FY 11 EPS is now revised, as now the company is expected to post an EPS of PKR 7 (previous expectation was PKR 13) along with dividend of PKR 5. With the current price of 65, dividend yield is 7.7% and P/E is 9.3, not that bad still.

FAUJI FERTILIZER: OFFERING 16% EXPECTED RETURN

Fauji Fertilizer (FFC) is one of the giants of KSE 100. The good thing about it that it belongs to a non-cyclical industry. However, even better thing is that it pays out all what it earns it the form of dividend. Yes, it usually has a 90% payout ratio. It is also the biggest company in this sector after ENGRO. However, it is not directly comparable to ENGRO because ENGRO is a conglomerate which predominant business is fertilizer.

Like it peers, FFC is also facing a gas curtailment issue. However, manufacturers are responding this issue by raising urea prices so no one is expecting any great impact on its earnings.

The company is expected to post its results for annual year 2010 (the companies in this sector present their financial statements on calendar year basis) somewhere between Feb-March. The expected EPS is PKR 16 with the cumulative dividend is expected to reach PKR 15. With the current price of around PKR 150, the company is trading at a P/E of 9.4 and a dividend yield of 10%. As you can see in the graph, the company has performed well in the last few days, it is due to this sudden upsurge the dividend yield and P/E is not looking as attractive (market is trading at a P/E of 8 – 8.5). However, investors should watch this share carefully and once they got an opportunity to buy it somewhere in the range of 130-140, they should buy it. The analysts are giving a target price of around PKR 160, which means an upside of 6.6% is achievable from current levels. 10% dividend yield and 6.6% upside means total expected return of 16.6%. Not that bad even at current levels. However, many analysts are expecting a correction in the market so if the price of the share goes down in future investor can get an expected return of more than 16.6%.

MONETARY POLICY: NOT USEFUL BUT HARMFUL

The CPI inflation for the month of Dec 2010 is recorded as 15.46%YOY slightly decreased from 15.48%YOY recorded on November 2010. Analysts are now eying on monetary policy statement to be announced on 29 Jan, 2011. The expectations are that central bank will keep its restrictive monetary stance by increasing the discount rate by further 50bps, which means discount rate will reach 14.5%.

However, what I want to say is that in every monetary policy statement, the reason of restrictive monetary stance is mainly attributed to heavy government borrowing. However, we know very well that government has not responded at all, in fact, government borrowing has now reached PKR 459bn for this year, which is 100% higher than a previous year. The purpose for which restrictive monetary stance was adopted has not been fulfilled so why keep raising interest rates and slowing growth of “efficient private sector”? Surely, central bank needs to understand that discount rate as a tool has not been effective in curtailing government borrowing but it is certainly very effective in slowing economic growth so why keep using it and slowing our already weak economic growth. Central bank’s current stance is aggravating our economy.

In short, discount rate as a tool for curtailing government borrowing has not proved to be “useful” but it is certainly proving to be “harmful”.

There is one more way for central bank that if it really wants to make it hard for government to borrow than it should now increase the discount rate by 100-200bps. This will give a much stronger message to government. Increasing the discount rate by mere 50bps in every monetary is just not working and this is something that we all have seen, government is just not taking it seriously. So, if central bank is again thinking to increase discount rate in next monetary policy than it should increase it by 100-200 bps or either not increase it all because increase of 50bps will not serve anything as I have discussed above.

HOLDINGS AS OF JAN 14, 2011

My Holdings as of January 14, 2011 are as follows:

Stock	Proportion
APL	10%
BAFL	4%
DGKC	8%
ENGRO	8%
FAUJI CEMENT	2%
HUBCO	10%
ICI	10%
KAPCO	11%
PACE	27%
PSO	8%
SHELL	1%
SILK BANK	1%

You may be wondering why do the small cap stock like "Pace Pakistan" is the heavy weight item of my portfolio. The reason is that I am a young investor and can afford to invest in small cap stocks which if invested after due and dilligence can provide a huge returns over a long term. Secondly, I shared my portfolio holdings with you just to give you some idea. I am not suggesting at all that you should have a portfolio like mine since it depends on many factors like your age, income etc.

REDUCTION IN PETROLEUM PRICES: POOR ECONOMIC DECISION

Politicians are happy that they forced the government to withdraw its decision to increase petroleum prices and government is happy that they get their majority back.

The fact is, it might be a “popular decision” but it is a very poor economic decision and will have negative consequences on the economy. To understand this point we need to see the 2008 crisis. Musharaf’s popularity was decreasing, elections were near and oil prices were recording new highs once reached around 147$ per barrel and Musharaf’s regime decided not to pass on the increase to consumers just to save their deteriorating reputation. Fx reserves depleted and this was the time when rupee started to depreciate from 60Rs/dollar, fiscal deficit rose, inflation rose and stock market crashed. What happened was that government just did not pass on the oil prices to consumers and it did not have enough finances to back this decision.

Now consider the current scenario, the popularity of PPP (and its allies) is decreasing, and when MQM decided to quit government mainly because of current increase in oil prices government lost its majority in the parliament. So far, government is not able to increase taxes, inflation is increasing so does the interest rates, fiscal deficit is increasing, and the last but not the least government borrowing is increasing at an alarming rate and it is the government borrowing which is the root cause of all issues. One thing is quite clear here, government is almost in the same scenario and ironically, government decided exactly what a Musharaf’s regime decided just to retain their majority in parliament. The question is how will government finance this subsidy? International oil prices are hovering around 90$ (at their 26 month high) and government had to pass on this increase in prices to consumers but they decided not to do so. Now they will need to borrow more (as they are already borrowing more causing high inflation and high interest rates) from SBP, which will increase already high inflation (around 15.8%) and we could see what we have seen in 2008. As per Mr. Naveed Qamar (Petroleum Minister) if oil prices remain at current level then government will now have to suffer a loss of PKR 5 billion per month. Given the fact that government has already borrowed 250 billion so far (increasing at an alarming rate of 100% YOY) this decision will now compel to borrow for this “Petroleum Subsidy”. I think this will also hurt Pakistan’s reputation in the eyes of foreign donors and foreign investors (especially sovereign debt investors) as well. Remember government has not been able to bring any tax reforms, this subsidy is just not bearable. SBP will now print more money because of increased borrowing from government, which will be more inflationary than the impact of increase in oil prices. Remember, our fiscal deficit is now expected to be around 6% for FY 11 but some analysts expect that it might end up much higher.

The only thing that is different from 2008 crisis is strong exports, low imports, increasing remittances and IMF support. In other, words our current account is not as bad as it was in 2008 because of above mentioned issue.

I believe this decision in just not sustainable and government will not be able to keep this subsidy and will pass on it to consumers in future in a more efficient manner i.e. it will not remove it suddenly but incrementally.

KAPCO: IT IS DEFENSIVE, HAVIING A GOOD DIVIDEND YIELD AND FUNDAMENTALLY STRONG

KAPCO (Kot Addu Power Company), the electricity generation company, certainly belongs to a very stable, non-cyclical industry. Even though it is now facing a problem of circular debt but given the fact that its trade debts are secured by Government of Pakistan this problem does not look very worrisome right now.

The company payout all what it earns, however due to circular debt issue, it is not expected to continue this 100% payout for the next year but still the payout is expected to be much better than most of the stocks in KSE 100. Its next year expected EPS is 7.5 - 8, and dividend is expected to be PKR 5.5 - 6 which means payout of around 75%. The current price of share is around PKR 44 and the target price is expected to be PKR 52, so the P/E of share is 5.9 (market has a P/E of around 8), dividend yield is around 12.5% and an upside of 20%. I think it is a good share to buy right now.

MARKET OUTLOOK FOR 2011: MARKET RANGE 10,600 -13,700

Market is just not looking behind, now heading towards 12,500 mainly led by rally in oil and to some extent fertilizer stocks. As you, all know this year-end target was expected to be around 11,200 but market closed this year 600-800 points higher than this target. The main reason for this is that market just did not take a breather and it is not clear exactly when it will take that breather. Let me emphasize one very important point, the market and its constituent stocks have now reached a position where stocks picking has become more important than index level. This is because many heavy weight stocks are overvalued and offering a very low dividend yield. For example, OGDC which is the largest heavy weight of KSE 100 and has a weight of around 25% is now trading at a P/E of 12 and dividend yield of just 3%. The case of POL (another heavy weight) is also not very different although still not as overvalued as OGDC.

POTENTIAL OF MARKET:

If one considers a FY 12 earnings then P/E of market is just around 7-8 range and if you exclude OGDC from index it comes in 5-6 range whereas regional level is around 12-13. However, economy of Pakistan has some fundamental problems like low tax to GDP ratio, high fiscal deficit that causes high inflation, high interest rates, poor law and order situation, and political instability. Because of these reasons, Pakistani market is expected to be trading at a discount from regional P/E. However, given the low interest rates environment in West, and flooding of this “cheap money” to emerging and frontier markets and given the profitability growth of main blue chip companies, there is still a lot of upside. This year market range is expected to be 10,600-13,700, which means an upside of around 15% is still present from current level. That off course excludes dividends. Therefore, you can certainly make more than 15% if you choose your stocks carefully and pick dividend-yielding stocks, the point that I am going to discuss below.

What are the stocks to be picked? Make it simple; just pick good dividend yielding and fundamental stocks. Are there any? Yes, there are and I will be informing about them very soon. I have already discussed two stocks in my previous posts namely ENGRO and Attock Cement, both although don’t have a high dividend yield but are fundamentally strong and I expect them to provide more than 15% (Please read my previous post for further detail about them).

RISKS OF MARKET:

The biggest threat is tightening monetary stance. With expected GDP of just 2-3%, tightening monetary stance of State Bank is just looking as horrible as it can be. CPI inflation is now hovering around 15% and there is a very strong change of further upsurge if Government is not able to reduce its borrowing (fiscal deficit is now expected to reach 6% of GDP, and this is with tax to GDP ration of just 8%), and it also needs to improve the supply side to manage food prices. Our import bill is around 40% composed of oil and if oil maintains its upsurge (currently at 26-month high of 92-94$) we would be facing an “imported inflation” in future as well. The rise in interest rates in response of rising inflation is by far the greatest threat to market since it can hurt corporate sector profitability and growth through its effect on Finance Cost.

Another threat is law and order. Recently, Governor of Punjab Salman Taseer was assassinated and this assassination has created a tense situation not only in Pakistan but also in International community as this assassination is linked to ‘religious matter” (regarding blasphemy laws).

As I stated many times political instability is a rule than an exception here in Pakistan, however one needs to cautious of what is happening out there.

CONCLUSION:

The market range for CY 2011 is expected to be 10,600-13,700. It is important now to concentrate more on individual stocks rather than an Index level. I would be discussing more individual stocks very soon.

CORRECTION: POLITICAL INSTABILITY FINALLY ENFORCE IT

Analysts were expecting a technical correction but that was just not coming but finally it seems that political instability might enforce that awaited correction. Currently, at the time of this writing market is down to 11,814 from 12,022 closing on Friday, which counts to a correction of around 200 points. However, we might see some more correction in the coming days as uncertainty regarding politics might continue for few more days. Those who have booked their profits will now be in a position to buy back stocks. However, there should not be any “huge correction” because this is a pure “Cash Market”.

ATTOCK CEMENT: HEALTHY CAPITAL GAIN

Cement sector hasn’t performed well in the recent rally. The impact of floods has also dwindled it’s demand. Coal prices are also showing a higher trend as 2QFY 11 price averaged 97.4$ per ton which is 10% higher on QoQ basis. However, remember there is also a seasonal effect here as we know cement sector usually face low demand in winter. Despite this, the expectation of post flood construction activities and rising cement prices are two positives of this sector.

Our current focus in cement sector is on Attock Cement (ACPL). It is the most unleveraged company in company sector. Secondly, the company is installing waste heat recovery plant of 12MW which will help it to reduce energy cost which subsequently will improve gross margins. The plant is expected to come online by July 2011. Given the fact that company is unleveraged and there are many companies in cement sector not able to earn profits, there is a chance that company will go for expansion. Remember company was considering the acquisition of Al-Abbas Cement in FY2010 but the deal did not materialize.

The company is expected to post an EPS of PKR 13.5 with dividend of PKR 5 in FY 2011. Company is currently trading at around 62-63 range so the P/E is just 4.6. Therefore, as you can see the company is trading at a very low multiple. Since the market is trading in a 8-10 range, this unleveraged and strong company should not trade at this discount for too long. However it can be expected to trade at a discount because of its low dividend yield and cyclical nature but we believe that current discount is just too high. Brokerage houses are quoting a target prices of PKR of 80-90. The capital gain of 30-45% is expected.

ENGRO: STILL GOOD INVESTMENT

ENGRO has started a trial production of its 1.3mn urea plant from Dec 29, 2010. The plant is expected to start formal production from end February 2011. Since its debt level is very high and facing a gas curtailment issue, many analysts are having a hold stance on it and quoting target prices of 200-225. However, this is for short-medium term only and for long-term most of the analysts have a positive view on ENGRO. Its expected EPS for 2010 is around PKR 18 with a cash dividend of PKR 2 making an accumulated dividend to PKR 6 for year 2010.

Given the fact that foreigners are now leading the market, they usually have a long-term view, and they usually invest in blue chips like ENGRO, I believe ENGRO can give you much more return than expected in the market. It is currently trading at around PKR 192 with P/E of around 10.6. I would recommend a buy.