KARACHI, PAKISTAN: The bottom-line profitability of Pakistan Stock Exchange (PSX) benchmark KSE-100 index grew by 12% YoY in 1HFY23 to Rs522 billion. Index heavyweight, E&Ps and Banking, drove the bulk of the growth during the period as their profits rose by 42% YoY and 35% YoY, respectively.

These two sectors alone were responsible for nearly 70% of the index’s bottom-line profitability.

Barring the two sector, the KSE-100’s profits fell by 21% YoY because of the general economic slowdown and restrictions on imports, limiting industrial activity. Moreover, rising interest rates further dented profitability amidst rising debt levels.

For the remainder of the fiscal year, analysts at KASB Research think the two index-heavyweights will keep the KSE100’s profitability afloat. E&Ps will likely benefit from the Pak Rupee depreciation on its USD-hedged revenues and the banking industry will benefit from increased NIMs because of higher lending rates and treasury yields. Other sectors, however, are expected to see their profitability erode.

Commercial Banks

Banking sector underperformed the benchmark index by 18ppts during the past 12 months. This is on account of fears of domestic restructuring and adverse taxation measures. However, the profits exhibited a strong growth of 48% YoY in 4QCY22.

This is a combination of sharp uptick in NII amidst hike in policy rate by 100bps and growth in fee income. However, the profits were somewhat contained by recognition of higher provisioning expense amidst economic slowdown and higher taxes.

On a cumulative basis, the profits increased by 14% YoY in CY22. Bank wise, National Bank (NBP) and Allied Bank (ABL) were the outperformers recording a growth of 191% YoY and 109% YoY, respectively.

During CY22, PBT increased by 42% YoY driven by expansion in NII and NFI by 40% YoY and 27%, respectively. NII growth was led by hike in policy rate by 625bps to 16% to curb inflationary pressure in the outgoing year. This was further supported by higher CASA mix that kept a lid on cost of funds and robust yield on earnings assets amidst shift in investment mix to floaters from fixed in a timely fashion. Additionally, NFI rose because of growth in FX income and fee income.

Signs of economic slowdown have started to show under the weight of decade high inflation and climbing interest rates. This is evident from provisioning expense recorded in 4QCY22. Notably, Bank Al Falah (BAFL), Habib Bank Limited (HBL) and Meezan Bank (MEBL) prudently recognized provisioning worth Rs4.3bn, Rs4.9bn and Rs2.4bn, respectively in light of economic slowdown in CY23.

Oil and Gas Exploration

Profits of Pakistan oil & gas exploration industry surged by 42% YoY to Rs182bn. The sector benefitted from increased revenues on its oil & gas revenues and treasury income.

The Pak Rupee came under considerable pressure over the past year, depreciating to a low of Rs225/USD and increasing the sector’s revenues in PKR terms.

Global oil prices came under pressure in 1HFY23, declining from a high of USD 108/bbl to lows of around USD 70/bbl. Global recessionary concerns were expected to keep the demand for oil relatively low, causing the commodity’s prices to come down.

Going forward, analysts expect oil prices to remain at present levels despite subdued demand amidst the economic slowdown. Oil-exporting nations will likely adjust supply to ensure a demand-supply balance.

The recent weakness of the Pak Rupee to record-low levels of Rs280/USD will keep the sector’s profits elevated. Moreover, the government is taking structural steps to address the sector’s stuck receivables, which have crossed Rs1.0tn recently. Any development on this from will enhance the sector’s payout potential in the coming fiscal year.

Oil & Gas Marketing

The profitability of Pakistan’s Oil and Gas Marketing companies (OMCs) plummeted by 94% YoY to Rs2.2bn in 1HFY23 against Rs39bn in the same period last year.

The decline stemmed from a fall in ex-refinery prices, causing the sector to write-down its inventory and record losses. In contrast, 1HFY22 saw the sector record considerable inventory gains.

The sector’s working capital needs grew substantially amidst the sharp rise in oil prices. PSO, particularly, was affected by stuck cash on its RLNG sales, further enhancing its working capital needs. As interest rates rose, the sector’s debt servicing burden grew in tandem.

OMC sales came under considerable pressure amidst record-high product prices and the economic slowdown. Moreover, the demand for furnace oil also fell on account of seasonal factors reducing demand for electricity. Onwards, the economic slowdown will keep OMC sales under pressure.

The recent currency weakness may cause considerable losses to OMCs through exchange losses as existing ex-refinery prices do not fully reflect the prevalent Pak Rupee rates. Moreover, this development will further increase the sector’s working capital requirements amidst rising interest rates, leading to a sharp increase in debt servicing costs.

Refineries

Refinery sector’s profitability sustained amidst the financial performance of Attock Refinery (ATRL), whose bottom-line rose by 9.1x, causing the refinery sector’s profits to rise by 54%. Other refineries, however, incurred losses on account of a combination of factor.

Refinery margins came off considerably over the past half from record-high levels seen during 1HCY22. Most notably, Furnace Oil (FO) margins turned negative while MS margins touched break-even levels on the international front.

ATRL’s margins, however, sustained on account of its product mix which was tilted towards the relatively higher margin high speed diesel (HSD) and motor spirit (MS).

The refinery industry also has high working needs and the rise in interest rates substantially increase the debt servicing costs. Moreover, the sector was also subject to inventory write-down as global oil prices came off considerably from over USD 100/bbl to around USD 75/bbl.

In a bid to attract Saudi Aramco’s USD 10.0bn investments for a deep-conversion refinery, the government of Pakistan is expected to finalize the refinery policy, which offers tariff protection to existing refiners. Increase revenues resulting from the policy’s implementation will be used to finance the refinery upgrades.

Fertilizers

Fertilizer sector outperformed the benchmark index by 4ppts during the past 12 months. This is because the sector remains relatively insulated from macroeconomic headwinds and offers strong dividend yield.

The industry witnessed profitability growth of 19% YoY in 4QCY22 accredited to higher gross margins amidst strong pricing power and stable offtakes.

Urea and DAP prices averaged around Rs2,450/bag and Rs11,372/bag, respectively in 4QCY22. Company wise, Fauji Fertilizer Bin Qasim (FFBL) was the outperformer as the profits increased by 155% YoY accredited to higher DAP volumes and strong prices.

On a cumulative basis, sector profit decreased by 20% YoY as a result of one-time super tax that was recognized in 2QCY22. The sector maintained decent payout amidst stable cash-flow generation.

Farm economics in CY22 significantly improved that provided support to the fertilizer offtakes. Urea offtakes increased by 4% YoY in CY22 closing at 6.6mn tons. This growth is attributed to i) urea export through informal channels amidst widened gap between international and local urea prices and ii) substitution to cheaper nitrogen based fertilizer as DAP prices crossed the 12k mark.

This is in-line with international prices and currency depreciation. Recall that international DAP prices increased to USD 856/ton in CY22 vs. USD 603/ton last year.

Company wise, FFBL was the outperformer as the profits increased by 155% YoY followed by ENGRO with a profit growth of 87% YoY in 4QCY22. FFBL’s profits increased as the DAP prices increased 42% YOY in 4Q. On the other hand, Fauji Fertilizer Company (FFC) and Engro Fertilizer (EFERT) were the laggards and recorded relatively lower gross margins.

Fertilizer industry has a strong pricing power as evident from complete pass on of recent hike in gas prices. Additionally, improved farm economics would support the demand and keep the topline elevated in CY23 as well. The sector also benefits from hike in policy rate because of availability of excess cash.

Cements

Despite record-high energy prices and falling demand, the profits of the cement industry grew by 28% YoY to Rs40.5bn. The industry was able to sustain its margins to a timely pass-on of cost pressures via price hikes.

Coal global prices came off considerably from highs of USD 400/ton to around USD 200/ton during the financial year. The industry, however, continued to utilize local and Afghan coal on account of its relatively cheaper costs, which hovers around Rs20k/ton cheaper than the imported counterpart. Utilization of cheaper coal allowed the industry to maintain margins.

The cement industry took on considerable debt to finance its 4^th expansion cycle, which is expected to take the industry’s capacity north of 100mn tons. Amidst rising interest rates, analysts foresee a sharp rise in the sector’s debt servicing costs.

Analysts expect cement demand to remain low for the remainder of the fiscal year as economic slowdown limits construction activity. Moreover, the shrinking fiscal space may reduce demand emanating from the public sector.

Additionally, many construction contractors a delaying construction activity amidst the record-high rise in construction costs.

Given the recent decline in coal prices, the cement prices are expected to come down as industry demand remains low. Moreover, many expansions are expected to come online in the coming months, further reducing the industry’s pricing power and profitability potential.

Textile Composite

Textile sector has underperformed the benchmark index by 14ppts in the last 12 months. This is driven by i) global economic slowdown, ii) high energy prices, and iii) elevated cotton prices. The sector’s profits decreased by 73% YoY in 2QFY23 led by lower margins and higher finance cost as LTFF and ERF rates were increased in-line with policy rate.

Company wise, Interloop Limited (ILP) and Nishat Chunian (NCL) were the worst performers as the recorded losses of Rs376 million and Rs1.706 billion, respectively.

Meanwhile, Nishat Mills (NML) was the outperformer as major support came from other income. Cumulatively, the sector’s profit decreased by 36% in 1HFY23.

The global inflation wave compelled central banks to slow down their economy to combat inflation. The impact has begun reflecting in consumer spending in key export markets, particularly the US and UK.

Therefore, textile exports declined by 7% YoY in 1HFY23 to USD 8.7bn. Moreover, Rupee slightly depreciated by 1% QoQ in 2QFY23. This is the reason that the topline remained flat during the quarter.

Company wise, NML was the outperformer as it reported a growth of 59% YoY in 2QFY23. This was driven by record high other income of Rs3.2bn as a result of i) dividend income, ii) interest income from loan to subsidiaries and iii) exchange gain.

The company’s margins stood at 14% in 2QFY23. On the other hand, NCL was the laggard during the quarter under review as the gross margins reduced to 2% from 11.2% in the preceding quarter and 22.7% last year.

Given the unstable domestic and global economic environment, analysts expect the sector to remain under pressure in 2HFY23. This would be a combination of higher energy prices, withdrawal of concessionary electricity rate, hike in finance cost amidst 300bps increase in policy rate and high cotton inventory. However, the sector dynamics are expected to improve in 2HFY24 as inflationary concerns ease off.

Automobile Assemblers

Auto sector has underperformed the Pakistan Stock Exchange (PSX) benchmark index by 29pts in the past 12 months. This is accredited to lower sales in the backdrop of deteriorating purchasing power, record high interest rates and extended plant shutdowns amidst supply chain constraints.

Additionally, higher input cost as a result of currency depreciation also impacted the sector’s margins. Therefore, the sector saw a severe drop in profitability by 53% YoY.

Company wise, Honda Cars (HCAR) was the outperformer in the sector led by expansion in gross margins to 7.7% in Dec22 supported by increase in car prices.

On the other hand, Millat Tractors (MTL) was the worst performer during the quarter because of low demand. Cumulatively, profits contracted by 65% YoY in 1HFY23.

Car sales declined 29% YoY in 2QFY23 because of non-availability of CKD parts amidst Letter of Credit (LC) restriction and higher interest rates. The highest decrease of 51% YoY and 47% YoY was posted by Indus Motor (INDU) and HCAR, respectively. This is because of plant shutdown in view of shortage of raw material amidst ban on imports. PSMC registered a decline of 7% YoY.

Company wise, HCAR was the outperformer as it reported a growth of 82% YoY in 2QFY23. This was driven by expansion in gross margins amidst increase in car prices. On the other hand, MTL was the laggard during the quarter under review because of low demand.

The sector is eying an overall slowdown in sales mainly due to supply side crunch and plant closures in 3QFY23. Furthermore, record high interest rate of 20% is expected to decrease consumer car financing demand. This coupled with currency depreciation would keep the input cost on the higher side, thereby negatively impacting auto sector this year.

Chemicals

Chemical sector witnessed a drop in profitability by 15% YoY and the major decline was posted by Engro Polymer & Chemicals (EPCL) and Archroma Pakistan (ARPL) as the profit reduced by 50% and 79% YoY, respectively in 2QFY23. However, profits of Lotte Chemicals (LOTCHEM) and Colgate (COLG) were up by 42% and 73% YoY, respectively. This is because of strong topline growth.

The sector saw a sharp increase in global PVC Ethylene core delta in Oct’21 as it reached to USD 1312/ton. This was due to shortage of PVC led by supply shocks in USA. However, core delta has decreased to USD 397/ton in 2QFY23 causing decrease in gross profit by 56% YoY and 35% QoQ despite increase in sales volume and depreciation of currency.

Topline of LOTCHEM decreased by 30% leading to drop in gross profit 37% QoQ. This is because of shrinkage in sales volume owing to downturn in textile activity. However, profit after tax has increased by 42% YoY as a consequence of surge in PTA-PX delta by 9%.

Central bank has raised interest rate by 750bps since January 2021. This has shot up finance cost of EPCL by 73% YoY basis which led to drop in profit after tax by 49% YoY. LOTCHEM also witnessed a rise in finance cost by 65% YoY. However, the bottom line was supported by decrease in finance cost by 80% QoQ.

The overall sector will face difficult times ahead due to increase in gas tariff amid reduce fiscal deficit. Chemical sector companies utilize gas-based power plant for production process. We estimate cost of production of EPCL and LOTCHEM will increase by 250mn and 600mn, respectively.

In addition to this, PTA-PX core delta is on declining trend leaving dry margins for chemical sector. Moreover, drop in construction activity will also decrease demand for PVC.