AKD Securities Limited Equity Research – Daily Report

Karachi, December 21, 2017 (PPI-OT): Regulatory environment remained conducive in CY17

Playing a prominent role in market’s performance during the year, regulatory developments in CY17 have been of key importance. Reviewing the same, key sectors benefitting from various policy actions taken in CY17 included: 1) Textiles – GoP announcing PM’s export package offering various incentives to the export sector, 2) Fertilizers – extension of the fertilizer subsidy along with allowance of urea exports, 3) Steel – duty imposition (AD of 19.04/24.04/19.15% on imported CRC/billets/re-bars) providing competitive edge to local players, 4) Oil and Gas Exploration – revision in wellhead gas prices under PP12 and 5) OMCs- increase in margins of MS and HSD deregulation was a positive.

While significant additions to generation capacity were made, operational sustainability of the power sector (particularly FO based plants) came under pressure with the GoP announcing abrupt closure of FO power plants towards end CY17. Spillover impact of the same was also seen in Refineries, OMCs and Exploration sectors in terms of lower offtake. Going forward, populism is likely to dictate GoP’s policy directives as elections draw nearer. In this regard, we can see extension of current subsidies to sectors like Fertilizers and Textiles while additional incentives to gain electoral ground cannot be ruled out.

Steel: CY17 turned out to be a good year for the domestic steel industry as the National Tariff Commission (NTC) imposed anti-dumping duty (AD) of 19.04/24.04/19.15% on imported CRC/billets/re-bars. For a flat steel industry, dumping levy came as a key reliever enabling domestic manufacturers to ward off competition from imported steel dumped by Chinese manufacturers.

While already operating under regulatory protection (30% RD on re-bars), long steel industry would further benefit from recently imposed AD on re-bars as the pricing spread between imported-local re-bars has gone up to ~PkR20-25k/ton. Additionally, the imposition of AD on billets extends competitive edge to players (i.e. ASTL), which own both melting and rolling shops. Furthermore, the GoP’s decision to increase RD on scrap steel to 5% (previously at 1%) has an incremental cost impact of PkR350-400/ton for ASTL, which we expect the company to pass on considering strong pricing power.

Textile: To contain declining exports (down 8%YoY in CY16), the GoP announced PM’s export package in early 2017, offering various incentives to the export sector. With the hefty ~60% share in total country’s exports, textile sector emerged as a key beneficiary from the said package with benefits including: 1) straight 4-7% rebate on FOB value of exports, 2) zero rated tax regime for all inputs and 3) withdrawal of duty and sales tax on imported cotton. These measures helped the textile sector to partially regain competitiveness, as evident from the recent pickup in exports (5MFY18 exports up by 12%YoY). Moreover, other regulatory developments including imposition of 10% sales tax levy on imported fabric and 5%RD on imported synthetic filament yarn have enhanced regulatory protection against imported products.

Fertilizer: Maintaining its focus on improving farm economics, the GoP decided to extend the fertilizer subsidy products in CY17. Consequently, the price of Urea/DAP was maintained at PkR1,400/2,500 per bag (incl. subsidy of PkR284/300 per bag). Moreover, in order to ease the mode of subsidy disbursement, GoP has allowed companies to adjust GST with amount equivalent to a cash subsidy of PkR300/bag.

Taking notice of the high inventory stock, ECC of cabinet also allowed export of 600k tons for urea (530k tons till Oct’17 out of the allocated quota of 600k tons). In light of above measures, we saw notable improvements in the Fertilizer space including: 1) significant +21%/+18%YoY growth in total fertilizer/urea offtake during 10MCY17 and 2) normalization of inventory level (urea inventory standing at 690k tons vs. 1.70mn tons in Oct’16) and 3) export of urea.

Oil and Gas Exploration: The year in consideration turned out to be an eventful year for the E and P companies. Sui was granted a D and P lease along with revision in its effective well-head gas prices by ~90% linking it to PP12 based formula. TAL block fields namely Mamekhel, Maramzai and Makori East were also converted to PP12 positively impacting PPL, POL and OGDC. Towards the end of the year, however oil production form northern region is witnessing a decline (~12%) as refinery throughput remains affected by GoP’s latest decision to shut FO based power plants.

Power: CY17 saw almost 6,100MW of dependable capacity coming online including ~3,600MW based on RLNG and ~1,300MW based on coal. While this is indicative of GoP’s focus towards mitigating electricity issues, Oct’17 remained the month of setbacks for this sector. NEPRA released its revised tariff for KEL, which was although higher by PkR0.67/KwH to PkR12.77/KwH, but still fell short of the company’s demand, consequently delaying Shanghai Electric’s deal to acquire KEL. Moreover, PM Abbasi order to abruptly close ~4,500MW FO based plants has clogged the entire energy chain raising concerns over operational sustainability of such plants.

Cement: Regulatory action during the year included increase in FED on cements PkR1/kg to PkR1.25/kg (25% increase in absolute terms) in budget FY18 requiring PkR12.5/bag increase in cement prices. However, cement manufacturers were unable to pass on the impact of FED increase amid emerging pricing concerns, adversely impacting margins.

Autos: Following approval of AIDP-II Policy in 2016 favouring new entrants, the domestic auto industry is seeing increased interest from international players, where KIA, Hyundai, Renault and Nissan have partnered with local players. Tariff-based measures from the GoP that included imposition of regulatory duty (50-60%) later being further increased to 80-90%, have enhanced dominance of the local OEM’s, giving them an edge over the imported vehicles. Moreover, budgetary measures seeking reduction in the registration fees and offering incentives to tax filers favour domestic industry while imposition of RD on steel scrap and auto-parts is detrimental to profitability.

OMCs: In a surprise move, ECC approved the rise in retail fuels’ margins in Oct’17 to PkR2.55/ltr vs. PkR2.41/ltr previously, an increase of 5.81%. This bodes well for the sector in general but provides more leverage to PSO giving it an option to offer discounts backed by its huge retail network. In another move, ECC also decided to deregulate HSD margins (for OMCs and dealers) in the first phase subject to an increase in storage capacity while prices will be monitored by OGRA initially (w.e.f Jan’18).

This will provide cushion to OMCs against inventory losses. On the contrary, OMCs were given a beating twice during the year following disruption of POL products supply and shut own of FO based plants. Supply remained disrupted on two occasions following strikes by the transporters’ association in connection with 1) OGRA’s strict stance on the implementation of new safety regulations following Ahmedpur incident and 2) delay in transportation fare hikes. This culminated in OGRA raising fares by 20-64%. The other hit came on account of closure of FO based plants by the GoP resulting in demurrage charges on vessels and a quicker than expected phasing out of FO consumption in the country.

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