PAKISTAN RESEARCH PAKISTAN FIGHTS TO STAY AFLOAT

STRATEGY
PAK FLOODS: IS THE ROPE BROKEN?
BMA RESEARCH TEAM Floods to date have ravaged approximately 20% of the country’s landmass with
Hamad Aslam, CFA flow rates toping over 1.1mn cusec. As much as 20mn people have been affected
haslam@bmacapital.com making it one of the world’s worst natural disasters in recent history. A
comprehensive damage assessment will have to wait till the floods recede however
Abdul Shakur encouragingly initial estimates do not hint towards a significant damage to urban
abdul.shakur@bmacapital.com infrastructure. Nonetheless one-off slowdown in GDP growth and upside risks on
inflation and fiscal deficit will haunt the overall economic momentum.
Nurali Barkatali
nurali.barkatali@bmacapital.com THE ECONOMIC STORY: FLOODS 2010 - NONE WORSE THAN
THIS
Sana I. Bawani
sana.iqbal@bmacapital.com We estimate GDP growth to clock in at 2.1% for FY11, compared to original
forecasts of 4.5% while CPI inflation is expected to peak at 17-18%. Further, we
Omar Rafiq estimate PKR60bn shortfall in tax collections and expect fiscal deficit to be recorded
omar.rafiq@bmacapital.com at 6.2% for the year. In this regard, final outcome of the ongoing meeting with IMF
is awaited where we expect 200bps relaxation in deficit target. Given the overall
Muhammad Ali Taufiq outlook and SBP’s vigilant stance, another hike of 50-100bps in the discount rate
Ali.taufiq@bmacapital.com can be expected during the fiscal year. On the bright side, pledged foreign inflows
have alleviated upside risks to our 4-5% PKR/USD depreciation target for the year.

LISTED SECTORS IN LIMELIGHT: BANKS, OMC AND AUTOS TO

TAKE THE MAJOR BRUNT
Weaker economic picture and risks of incremental NPL accumulation paint a
gloomy picture for the commercial banking sector, particularly HBL and NBP.
Similarly, automobile assemblers that drive a substantial portion of their sales from
rural economy i.e. INDU is likely to suffer from a decline in its offtakes for FY11.
The most severely hit, according to our estimates, will however be PSO for which
we recently revised down its FY11E EPS by 35% on the back of lost sales, product
losses and infrastructure damage.
APL, the sole OMC involved in Asphalt is however likely to benefit from road
reconstruction and has been added to our High Conviction Investment Ideas.

BROADER INVESTMENT THEME STAYS INTACT: 2010 INDEX

TARGET UNLIKELY TO BE MET THOUGH
Overall investment theme for Pakistan equities stays intact which is largely driven
by domestic demand, favorable demographics and rich natural resources. We
however reiterate that current situation warrants an even closer adherence to
screening criteria based on companies with pricing power, devaluation positive
revenue stream and attractive dividend yields.
However concerns on rising inflation, fiscal deficit and consequent risk of SBP
further tightening the monetary environment will continue to loom over investor
sentiments. We thus believe that our initially set KSE100 target of 11,500 may not
be met during 2010 while upside risks to this thesis largely rest on introduction of a
timely and effective leverage tool i.e. Margin Trading System.
TABLE OF CONTENTS

1 Strategy: Is the Rope Broken? 1

2 Economy: Floods 2010 - None Worse Than This 4

3 Banks: Did Anyone Say Recovering? 10

4 E&P: Temporary Production Halt But No Long Term

12
Concern

5 Refineries: Closure of PARCO 14

6 OMC: Sales Drowned In Floods 16

7 Electricity: Circular Debt to Linger 20

8 Construction & Materials: Do Not Expect Too Much! 22

9 Fertilizer: Not Much To Worry About 25

10 Auto: Rural/Agri Based Demand To Take A Hit 29

 September 3, 2010

STRATEGY PAK FLOODS; IS THE ROPE BROKEN?

Starting on July 29, 2010, floods to date have ravaged approximately 20% of the
country’s landmass with flow rates toping over 1.1mn cusec. As much as 20mn
people have been affected making it one of the world’s worst natural disasters
toping Tsunami 2004, Kashmir earthquake 2005 and Haiti earthquake 2010.
Hamad Aslam, CFA
Head of Research For a country like Pakistan, where economic recovery is still fragile, the devastation
has raised serious concerns on the agriculture productivity, rural demand and
communication activity. While we do not agree with the government’s recent
assessment of flood loss at USD43bn (~25% of GDP); yet USD2.8bn of crop loss
and PKR48bn in incremental NPLs alone is a concerning scenario.

Event Affected people

Pakistan flood 2010 20mn
Tsunami 2004 5mn
Kashmir earthquake 2005 3mn
Haiti earthquake 2010 3mn

URBAN ECONOMY LARGELY SAFE; ECONOMIC SLOWDOWN TO

HAVE ITS PERILS THOUGH
A comprehensive damage assessment will have to wait till the floods recede
however encouragingly initial estimates do not hint towards a significant damage to
urban infrastructure. Nonetheless one-off slowdown in GDP growth (to 2.1% from
earlier estimates of 4.5%) and upside risks on inflation and fiscal deficit will haunt
the overall economic momentum.
What did the Floods change; Economic slowdown imminent

Backdrop FY11 – Pre Flood Outlook FY11 – Post Flood Outlook

GDP Growth Recovered to 4.1% in FY10 on Continued revival was expected in Agriculture sector is expected
the back of a strong rebound in LSM while agriculture was to post negative growth while
LSM sector projected to post a growth of 3-4% overall GDP growth may settle
at 2.1%

Inflation Avg CPI of 20% for FY09
rationalized to 12% in FY10
Interest Rates Benchmark discount rate
rationalized from a high of 15%
in FY09 to 12.5% in FY10
MoF and BMA Research CPI
estimates stood at 9% and 12%,
respectively for FY11
SBP’s unwarranted stringent
stance through 50bps increase in
discount rate had already paved
way for expectations of further
upside
Crop/food shortage and higher
govt borrowing poses upside
risks of 300-400 bps from initial
forecasts
Higher expected fiscal deficit
and inflation, together with
SBP’s hawkish stance reflects
the possibility of higher interest
rates over FY11

Source: BMA Research

Interest rates will however play the centre stage in recovery. While tight monetary
policy may not be the solution to the current economic challenges, higher fiscal

1
 September 3, 2010

deficit and inflation may still allow SBP to further tighten the environment with
upside risks to discount rate being higher than downside risks at the moment.

ON THE BRIGHTER SIDE; FOREIGN FLOWS AND STABLE PKR

Pakistan has so far received pledges of around USD4bn (ADB: USD2bn, World
bank: USD1bn, IMF: USD450mn and Humanitarian pledges of ~USD500mn) in an
effort to allow the nation respond to the ongoing challenge. However it is important
to note that apart from the humanitarian pledges by other countries, other inflows
will only add to the external debt stock of the country. Moreover, a substantial
portion of the assistance from ADB and World Bank will be a diversion from their
ongoing/already announced commitments and will therefore add little to incremental
foreign inflows for the country.
We nonetheless believe that these pledges have capped upside risks for PKR/USD
depreciation whereby we foresee 4-5% annual depreciation during FY11.
WHAT’S THERE FOR LISTED SECTORS; BANKS, OMCS AND AUTOS
TO TAKE THE MAJOR BRUNT
Weaker economic picture, slowdown in farmer incomes and risks of incremental
NPL accumulation paint a gloomy picture for the commercial banking sector,
particularly HBL and NBP. Similarly, automobile assemblers that drive a substantial
portion of their sales from rural economy i.e. INDU is likely to suffer from a decline
in its offtakes for FY11 while we downgrade our stance on the auto sector from
Marketweight to Underweight. The most severely hit, according to our estimates,
will however be PSO whereby we recently revised down its FY11E EPS by 35% on
the back of lost sales, product losses and infrastructure damage.
What did the Floods change; listed sectors that feel the heat
Backdrop Flood Impact BMA Take
Banks Despite highest spreads in the Slowdown in farm incomes and PKR48bn of incremental agri
region; asset quality a concern crop losses related NPLs to take NPL to asset
for small and select public sector ratio to 15.5%
banks though
OMC Supplies disrupted along with One-off downward revision of 35%
Double digit POL offtake growth flood-led product losses in FY11 EPS for PSO
on the back of power deficit and
switching from CNG 10% YoY growth in Asphalt Upward revision of 3% in FY11
offtakes EPS for APL
Autos Agri/rural related demand to Up to 21% downward revision in
43% YoY increase in volumetric take a hit FY11 EPS for INDU
offtakes for FY10 – sharp
recovery after the slowdown in
FY09
Fertilizer 3Q offtakes deferred to 4Q Domestic production demand stays
Supply shortfall for both urea intact while imported fertilizer to
and DAP in the country – covered suffer from reduction in demand
by imports

Source: BMA Research

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 September 3, 2010

Our take on cement and fertilizer sectors is however contrarian when compared to
market consensus. We estimate reconstruction activities to add only 0.6-0.7mn tons
of additional cement demand and thus may not have an immediate turnaround
impact on the sector. For fertilizers, we maintain a positive outlook whereby
potential slowdown in offtakes is only likely to hit imported products.
The only upward revision in estimates, in the aftermath of floods, has come for APL
whereby we estimate reconstruction activity to translate into higher offtakes for
asphalt in the country (FY11 growth in volumetric offtakes taken at 10% against
initial forecasts of 2%). Moreover, given overall growth story and limited upside
risks on effective taxation, we take this opportunity to add APL amongst our High
Conviction Investment Ideas.

Sector
BMA BROADER INVESTMENT THEMES REMAIN INTACT; 2010 INDEX
Recommendation
TARGET UNLIKELY TO BE MET THOUGH
OMC OVERWEIGHT
Electricity OVERWEIGHT While most of the listed sector has remained secured from the ongoing floods, the
crop losses alone paint a bleak economic outlook for FY10. Needless to mention
Cement MARKETWEIGHT
however, that most of the downward revision in economic growth stems from one-
E&P MARKETWEIGHT
off crop losses while shrinkage in demand for other industries (eg autos) should
Commercial Banks MARKETWEIGHT start to recover in FY12.
Telecom and Tech. MARKETWEIGHT
We thus highlight that overall investment theme for Pakistan equities stay intact
Fertilizer MARKETWEIGHT
which is largely driven by domestic demand, favorable demographics and rich
Textile MARKETWEIGHT natural resources. We however reiterate that current situation warrants an even
Refineries UNDERWEIGHT closer adherence to screening criteria based on companies with pricing power,
Autos UNDERWEIGHT devaluation positive revenue stream and attractive dividend yields.
For the rest of the 2010 however, equity markets may continue to remain hostage
to negative news flow emanating from the situation. Moreover, concerns on rising
inflation and fiscal deficit and consequent risk of SBP further tightening the
monetary environment will continue to loom over investor sentiments. We thus
believe that our initially set KSE100 target of 11,500 may not be met during 2010
while upside risks to this thesis largely rest on introduction of a timely and effective
leverage tool i.e. Margin Trading System.
High Conviction Investment Ideas
Current Fair Pot
Company Ticker EPS (PKR) PER(x) EPS Growth Dividend Yield
Price Value Upside
PKR/share PKR/share FY10E FY11E FY10E FY11E FY10E FY11E FY10E FY11E
Pakistan Petroleum PPL 203 231 14% 23.4 28.0 8.7 7.3 -16% 20% 4% 6%

Attock Petroleum Ltd APL 307 522 70% 55.3 64.0 5.6 5.0 3.0 16% 11% 12%

MCB Bank MCB 186 216 16% 23.0 25.0 8.1 7.4 13% 9% 6% 7%

Attock Cement ACPL 66 84 27% 14.1 15.0 4.7 4.4 -18% 6% 4% 6%

Lucky Cement LUCK 68 79 16% 9.7 12.5 7.0 5.0 -32% 29% 6% 3%
Fauji Fertilizer Bin
FFBL 28 33 17% 4.3 4.8 6.5 6.0 7% 11% 15% 15%
Qasim
BMA Universe Average 8.1 7.4 13% 8% 6% 8%
Source: BMA Research

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 September 3, 2010

ECONOMY FLOODS 2010: NONE WORSE THAN THIS

Pakistan is currently facing the worst natural disaster in its history with the flood’s
tail still passing through the lower Sindh. Initial estimates show that 20mn people
have been affected and ~288 thousand houses have been damaged in this misery.
Abdul Shakur Floodwaters ravaged approximately one fifth area of Pakistan including 18% (0.58
Economist mn hectares) of planted cotton, and 27% & 14% of rice and cane respectively.
One fifth area affected

Super imposed blue area indicates flood affected region

Source: BMA Research

FY11 ECONOMIC IMPLICATIONS

Growth FY10 FY11F
Budgeted
Mass destruction to crops, house holds, road links and communication envisage
Agriculture 2.0% 3.8% -1.4%
sizeable revision to economic growth forecasts for FY11. According to recent
Manufacturing 4.9% 5.6% 2.1% estimates, economic managers are eying at a GDP growth of 2.5% and an inflation
Services 4.6% 4.7% 3.5% of 15-20% for the current year against previous targets of 4.5% and 9%
GDP 4.1% 4.5% 2.1% respectively. Our estimates however stand at 2.1% GDP growth with inflation to
Source: Budget estimates, BMA Research
peak at 17-18% for FY11.
Damage to the country’s overall wellbeing is massive; agriculture being the most
affected sector is expected to derail the economic recovery the most. According to
4
 September 3, 2010

estimates from Ministry of Agriculture, assessed loss may cross PKR240bn

(USD2.8bn). Value erosion from major crops alone sums to PKR180bn or 3% of
GDP (initially expected growth of 4.5% was to add PKR255bn to GDP during
FY11).

AGRICULTURE SECTOR: GROWTH TO COME DOWN TO -1.4%

Precedence shows that aftermaths of flood transmitted down to agriculture and
plunged GDP growth significantly. Post 1992 floods for instance, GDP growth
declined to 2.1% in 1993 followed by a healthy 7.5% growth while agriculture
declined by a whopping 5% in 1993.
Composition of agriculture sector is heavily skewed towards major crops (33%) and
livestock (53%) and the two cumulatively contribute 18% to GDP. Taking into
account the available loss estimates, we expect agriculture growth to decline to
negative 1.4% compared to 3.8% targeted for FY11.
Analysis of Agrculture losses – Major Crops
Mn tons Wheat Cotton* Rice Sugarcane
Est. production 23.8 14.0 5.9 54.8
Est. loss due to flood 0.6 2.4 1.6 7.6
Revised production 23.2 11.6 4.3 47.2
Last year production 24.0 12.7 6.8 49.3
YoY increase / (decline) -3% -8% -36% -4%
Contribution to Agri 16% 8% 5% 4%
Contribution to GDP 3% 2% 1% 1%
Price Per ton 23,750 29,848 45,000 3,000
Total loss (PKR Mn) 14,250 70,979 72,000 22,938
Area cropped (Mn hec) 3.20 2.53 1.05
Area damaged (Mn hec) 0.58 0.68 0.15
Damaged area 18% 27% 14%
per hec. Yield 2.6 4.1 2.4 52.4
Crop damage (Mn tons) 2.4 1.6 7.7
* bales
Source: KCA, MINFAL, BMA Research

COTTON DAMAGE ADDING TO ECONOMIC WOES

ƒ Amongst the major crops of Pakistan, cotton is severely affected - ~18% YoY
decline is expected which would in turn have a detrimental impact on the textile
sector

ƒ Textile exports constitute ~60% to total exports. Clothing exports from Pakistan
are likely to be down by around one-third as orders for the upcoming Christmas
season (which are normally placed in September) may not be met

ƒ With a weightage of 33% in large sector manufacturing (LSM) it may hinder the
expected LSM recovery going forward. Nonetheless, performance of cement,
5
 September 3, 2010

fertilizer and automobile sectors should provide some respite which together
hold 15% weightage in LSM.

LIGHT AT THE END OF THE TUNNEL: WHEAT CROP TO SUSTAIN

Fortunately, wheat crop largely remained immune to the floods. As the crop is
normally harvested in May-Jun, only the stored stock was exposed to deadly
waters. Furthermore, only 0.5-0.65mn tons of wheat have been reported to be
damaged while 28mn tons are presently available in stock.
Crop Calendar
JAN FEB MAR APR MAY JUN JUL AUG SEP OCT NOV DEC
Wheat

Rice

Cotton

Sugar

Maize
Sowing
Growth
Harvest Flood begun in Jul10
and water starts
receding in Sep
Source: Pakistan Meteorological Department

IMF to provide USD450mn in
Immediate Emergency Assistance to
Pakistan and seems committed to
work towards completion of Stand-by
Arrangement Program review
As the IFIs are conducting loss
assessment, materialization of funds
for rehabilitation should taking place
in post Sep-Oct10. Therefore
government’s reliance on banking
system should support deficit
financing. Emergency funding of
USD450mn, however, is expected to
be disbursed in Sep10 and should
thus help mitigate liquidity issues to
some extent.
On the brighter side, better water availability, improved crop yields and increasing
arable land (as water reaches Baluchistan) suggest upward revision in wheat and
sugarcane crop next year. Therefore if boundary controls and admin issues are
managed effectively, no substantial supply side issues should emerge for wheat.
FISCAL OUTLAYS SURPASSING TARGETS: HINGED ON
FINANCING
Floods have poured in further uncertainty to the fiscal position of the economy. A
significant portion of cropped area has been damaged, transportation means
disrupted and economic activities hampered. In pre-flood scenario, govt. estimated
fiscal deficit of PKR780bn for FY11 - 4% of GDP. However, potential shortfall in tax
collection and incremental fiscal outlays make FY11 challenging for fiscal account
management.
Imposition of one-time taxes in this regard is likely to offset the shortfall. Govt. plans
to enhance revenue base by imposing a flood tax of 5% on imports and an
additional 5-10% on taxable income (above PKR300,000 for all taxpayers) for FY11
and FY12. These measures would help govt. generate additional ~PKR150bn
whereas the expected incremental 220bps of fiscal deficit allows additional outlays
of PKR377bn for FY11. However given the track record of tax receipts, we
anticipate a lukewarm response from the taxpayers this time round. Moreover, in

6
 September 3, 2010

the absence of any spark in local consumption and demand, corporate profitability
is also expected to decline and hence, a decline in tax receipts.
Therefore VAT imposition remains critical to enhance tax to GDP ratio. Moreover,
given IMF’s tough conditionalities, it would be challenging to keep the Budget FY11
on track – fiscal deficit is expected to reach 6.2% against pre-flood estimates of 4%
for FY11.
To stabilize the country’s fiscal position govt. plans to abandon all development
projects and reallocate funds to rehabilitation. Although a trend reversal in subsidies
is expected amidst higher import requirements for sugar and pesticide, subsidy
elimination from energy chain is likely to continue which would help save
~PKR109bn during FY11.

Commitments form IFIs IMF UNVEALS EMERGENCY LOAN PLAN OF USD450MN

Funding agency Amount (USD mn) According to a press release issued yesterday, IMF is to provide USD450mn in
Humanitarian
459 Immediate Emergency Assistance to Pakistan and seems committed to work
pledges
World bank 900
towards completion of Stand-By Arrangement Program Review. We expect the
following to be the likely outcomes of the ongoing review:
ADB 2,000
IMF 450 ƒ A relaxation in condition for fiscal deficit by 200bps together with enhancing
borrowing limit for budgetary borrowing form SBP

ƒ Emergency loan of USD450mn for budgetary expenditures likely to be

disbursed in Sep10

ƒ As Pakistan authorities show willingness to adopt suggested economic stability

measures, the ongoing review is likely to end up with securing next tranche of
USD1.7bn

ƒ IMF disbursements (including emergency assistance) is expected to clock in at

USD2.2bn by Dec10
We believe materialization of external flows for budgetary spending would help
mitigate liquidity risks. Additionally, reallocation of funds from current programs to
rehabilitation suggests no additional funding in case of World Bank.
As the IFIs are conducting loss assessment, materialization of funds for
rehabilitation may have to wait till Oct10. Therefore, government’s reliance on
banking system may support deficit financing. Further, emergency funding of
USD450mn in Sep10 should help mitigate liquidity issues to some extent.

DOUBLE DIGIT INFLATION TO PERSIST: SBP LIKELY TO

TIGHTEN RATES
ƒ Average inflation growth of 2-4% YoY was observed in post-flood scenario from
1988-1997

ƒ Considering 42% weight of food items in CPI basket, widening demand supply
gap for grains can fuel inflation

7
 September 3, 2010

ƒ Worst case estimates for inflation to reach 25% by FY11 against the initial
target of 9% by govt. We estimate inflation to settle in the range of 16-18% for
FY11
Carry forward stock of 4.4mn tons and production of 24mn tons of wheat suggest
sufficient supply. With higher than 8% weight in CPI basket, wheat is expected to
help consolidate the price index. However supply side issues for perishable food
items including damage to standing minor crops, disruption in transportation
network and lack of storage facilities can not be ruled out. Shortages necessitate
imports and a rising trend in international commodity prices may further intensify the
upsurge in price levels through imported inflation.

Inflation trend – post flood situations Monetary aggregates

(%) Flood 1992: Flood 1997: 10 Yrs 12M
Revier Sutlag Revier Jhelum, (%) SBP discount rate CPI
14
& Ravi Chanab & Sutlag
Flood 1988: 15
12
Revier Indus 14
10
13
8
12
6 11
4 10
2 9
- 8
Jul-09
Jul-09

Jun-10
Jun-10
Jul-10
Aug-09

Jan-10

Aug-10
Sep-09
Oct-09
Oct-09

Dec-09

Feb-10
Feb-10

Apr-10
Nov-09

Mar-10

May-10
FY82
FY83
FY84
FY85
FY86
FY87
FY88
FY89
FY90
FY91
FY92
FY93
FY94
FY95
FY96
FY97
FY98
FY99

Source: BMA Research

External account indicators Recent trend reversal in grain prices and fiscal indiscipline are the impediments to
the ongoing economic consolidation. In addition, borrowing from banking channels
(PKR mn) FY10 FY11F
seems indispensible (particularly from SBP which by itself is inflationary), till
Exports 19,636 20,618 materialization of foreign inflows takes place.
Imports 31,013 34,735
SBP had recently voiced its concerns against resurgence of inflation and fiscal
Trade deficit (11,377) (14,117) imbalances by raising policy rate by 50bps in Aug10. Considering economic
Remittances 8,906 10,509 consolidation to be of prime importance together with IMF conditions, upward
interest rate revision of 50-100 during FY11 remains on the cards.
CA deficit 3,507 5,557

FDI 2,205 2,095 EXTERNAL ACCOUNT DELINQUENCIES: YET STABLE

Financial Account 4,930 11,023
RESERVES
Overall balance 1,253 5,731 With 60% of exports linked to cotton, potential for loss of Christmas opportunity has
compelled us to revise down export growth target from 8% to 4-5% for FY11;
however inflows through remittances are likely to improve by 15% YoY.
Prudent power generation mix (based on higher water availability) is the key to
contain oil import bill (34% of total imports) going forward. However, non resolution
of circular debt and low GRMs which restrict refineries’ capacity utilization levels
posses upward risk to import estimations. In addition, imports of construction

8
 September 3, 2010

material, food, cotton and pesticides are likely to increase in the short term - at
present it contributes 35% to the import bill.
Although security concerns continue to hinder foreign direct investment (FDI),
equity portfolio is expected to add approx USD500-600mn during FY11. In addition,
materialization of external inflows is expected to keep overall balance in green zone
despite CA deficit surpassing USD5bn.
Higher inflows (aids, grants and soft loans) as well as additional IMF assistance
limit upside risks for PKR depreciation in the medium term and should keep USD
reserves intact. However, divergence of funds from current programs to
rehabilitation may cause lower than anticipated lending from ADB and WB.
Therefore, avg. annual 4-5% PKR depreciation can not be ruled out.

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 September 3, 2010

BANKS BANKS: DID ANYONE SAY RECOVERING?

MARKETWEIGHT Aftermaths of flood 2010 does not paint a promising picture for the banking sector
which is yet to come out of the economic shock triggered in CY08. As per SBP’s
initial estimates, banks may face incremental NPL losses of up to PKR48bn –
depicting a sharp 10% increase from current levels of PKR460bn to over
PKR500bn. This would further aggravate banks’ NPL to loan ratio to 15.4% from
Abdul Shakur present 14.3%. However placing incremental NPLs under substandard categories,
Banking Analyst provision coverage is likely to ease amidst provision aging benefit; hence provision
losses should remain lower compared to last year.

AGRI-LOAN HITS ASSET QUALITY, DESPITE ITS LOW SHARE

Taking into account the current loan book details, share of agriculture loan stands
at a meager 5% however it carries second highest infection ratio of 17%. Moreover,
it should be noted that given the inter-linkages of agri economy with manufacturing
sector, supply shortages and cost escalation can potentially hurt the productive
capacity of SME and corporate sectors - which in turn share the highest amount in
banks’ loan book. SME being the riskiest element may hurt asset quality of majority
of the mid and small tier banks. Amongst our banking universe in specific, we flag
HBL and NBP as the ones with higher risk of incremental infection due to their hefty
textile and agri loan portfolio.
Classification of loan book Sector wise infection ratio Loan book of BMA universe

30% Textile Agri related

10% 25%
25% cement Transport. & const.
11% 17%
14% 25%
20%
5% 15% 20%
12%
10% 15%
10%
64% 5%
1% 10%
0%
5%
Agriculture

Corporate SME
Consumer
SME
Corporate

Commodity
financing

Agriculture Commodity financing

0%
Consumer
NBP BAFL HBL MCB UBL
Source: SBP, BMA Research Source: SBP, BMA Research Source: SBP, BMA Research

EMERGING LIQUIDITY CONCERNS: YET SPREADS TO REMAIN

STABLE
We believe that budget financing will remain the key impediment for credit growth in
FY11 – whereby initial target was set at PKR499bn (USD5.8bn) form domestic
sources. To put things into perspective, budgetary borrowing for banks has
surpassed the target by 111% in FY10. Although inflows form IFIs are expected to
materialize by Oct-Nov10, budgetary outlays for rehabiliation and Eid withdrawals
suggest looming liquidity risks in the short term.

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 September 3, 2010

Money supply data also suggests that currency flows have started shifting from
banking channels to currency in circulation and have thus effectively kept deposit
growth in check. Therefore we believe that deposit cost for the banking sector is
likely to increase by 30-50bps during the next quarter. However, yields on Govt.
securities and KIBOR are also expected to increase amidst increasing monetization
and inflation. Therefore defying any major contraction in spreads, we expect them
to sustain 7-7.5% range during CY10.

Moody's rating for Pakistani banks MOODY’S TAKING IT SERIOUS: REVISED OUTLOOK TO NEGATIVE
Banks BFS LTDD LTDF Taking into account the recent economic challenges, Moody’s has revised its
NBP D Ba2 B3 outlook to negative from stable for domestic deposits and financial health of five
HBL D- Ba3 B3 major banks of Pakistan. However, ratings have remained unchanged as
UBL D- Ba3 B3 mentioned in the table on the left. Rationales for outlook revision are as follows:
MCB D Ba2 B3 ƒ Financial health is considered to be more vulnerable amidst weak loan
ABL D- Ba3 B3 growth and emerging NPL pressure which may consequently lower
BFS: Banks Financial Strength profitability
LTDD: Long Term Deposits - Domestic ƒ Rating agency linked higher exposure in government securities to event risk
LTDF: Long Term Deposits - Foreign at the sovereign level (sovereign rating stands at B3 with stable outlook).
STRONG ASSET QUALITY AND LOW COST IS THE KEY: BUY MCB
Considering the emerging liquidity and cost related issues, we reiterate our
recommendation bias for banks with relatively stable NIMs and stronger asset
quality. With these criteria in mind, MCB is expected to outperform the peers going
forward.
Comparative analysis for asset quality
NPLs to loan Loan loss coverage (RHS)
15% 100%

12% 80%

9% 60%

6% 40%

3% 20%

0% 0%
NBP BAFL HBL MCB UBL Industry Avg.

Source: BMA Research

Although BAFL carries lowest infection ratio amongst BMA banking universe,
lowest loan loss coverage suggests incremental provision losses going forward.
Similarly NBP outperforms peers on valuation matrix due to low PBV multiple of
0.6x, yet we maintain a Neutral stance on the scrip (fair value: PKR60/share) due to
looming asset quality concerns and escalating deposit cost. MCB, on the other
hand, currently trades at PBV multiple of 1.8x, and offers upside potential of 14% to
our Dec10 based Target price of 216/sh. – recommend Buy!

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 September 3, 2010

OIL EXPLORATION & E&P: TEMPORARY PRODUCTION HALT BUT NO LONG

PRODUCTION TERM CONCERN
MARKETWEIGHT With recent floods affecting as much as 20% of the country’s landmass, it comes as
no surprise that a number of oil and gas producing fields had to be temporarily
shutdown either due to disruption in infrastructure/pipelines or flooding at the filed
site. Encouragingly, however to date no permanent damage has been reported to
any of the E&P assets.
Hamad Aslam, CFA
Flooded Regions and Key E&P Fields
Head of Research

Field/Block Operator Listed companies ownership stake

1 Tal MOL OGDC: 28%, PPL: 28%, POL: 21%
2 Nashpa OGDC OGDC: 28%, PPL: 28%, POL: 21%
3 Chanda OGDC OGDC: 72%
5
4 Dakhni OGDC OGDC: 100% 1 34
2
5 Margala MOL OGDC: 28%, PPL: 28%, POL: 21%
6 Dhodak OGDC OGDC: 100%
7 Mazarani PPL PPL: 88%
8 Miano OMV PPL: 15%
9 Sawan OMV PPL: 26% 6
10 Qadirpur OGDC OGDC: 75%, PPL: 7%

10
7
8
9

Source: BMA Research

LOWER OFFTAKES HINTING TOWARDS A SLOW 1QFY11

Important fields that were temporarily shutdown included Mela, Chanda, Nashpa,
Bela, Pariwali and Qadirpur; however production has recovered to optimal levels for
most of them. We nonetheless estimate 1QFY11 to post a QoQ production decline
of 3-4% for the industry with OGDC being the most affected.

12
 September 3, 2010

OFFTAKES GUARANTEED AS LONG AS THEY ARE PRODUCED

Infrastructure losses and lower farm incomes have raised concerns on demand for
most industries in the short term. The same may however not be true for Pakistan’s
E&P sector whereby indigenous crude oil production only accounts for ~20% of
total demand while demand-supply deficit in natural gas also stands at over 15%.
Thus even an extreme case scenario that depicts an economic slowdown in FY11
is not likely to hurt offtakes for E&P companies.
POSITIVE OUTLOOK MAINTAINED; POL THE BEST BET FROM
CURRENT LEVELS
Given debt free balance sheets, USD based revenues and certainty in offtakes, we
maintain a positive outlook on the E&P sector. Our NAV based fair value of
PKR128/share for OGDC however reflects a reduce stance on the stock while we
have an ADD stance on PPL (fair value: PKR231/share) and a BUY call on POL
(fair value: PKR273/share).
Moreover, upside risks on fiscal deficit have limited the possibility of resolution of
circular debt in the ongoing fiscal year (discussed in detail in the section on
electricity and power). This inherently implies lower dividend payouts and subdued
exploration activity for the sate owned E&P giant i.e. OGDC.

13
 September 3, 2010

REFINERY REFINERIES: CLOSURE OF PARCO

Pak-Arab Refinery (PARCO), Pakistan’s largest refinery (capacity: 100K bpd), is
UNDERWEIGHT located in Muzaffargarh - one of the most severely affected districts. As a result,
PARCO which was earlier operating at 65% utilization has been forced to shutdown
on a temporary basis. On the flip side, refineries in the south have not been
affected by the same.
Muhammad Ali Taufiq POL Product Network
Refinery Analyst Key
1 Attock Refinery 2 Pak-Arab Refinery 3 National Refinery
P orts
Storage Depots
4 BYCO Refinery 5 Pakistan Refinery

4
5
3

Source: OCAC, BMA Research

INCREASED UTILIZATION LEVELS FOR ATRL AMID HIGH GRMS

Temporary closure of PARCO translated into increased offtakes for Attock Refinery
Ltd (ATRL) – increasing its utilization level from 88% to 100% in order to meet the
shortfall in supplies of POL products by PARCO. This, coupled with improved
GRMs is expected to translate into higher quarterly earnings for ATRL.

IMPACT ON OIL IMPORT BILL

Temporary closure of PARCO has also had its impact on oil imports. The overall
utilization level for refineries fell from 68% to 47% as a result of which demand for
imported crude is anticipated to have declined whereas demand for refined
imported POL products has increased.

14
 September 3, 2010

REVISION IN FY11E EPS

ATRL stands to benefit from increased utilization over Aug10 and our revised
FY11E EPS stands at PKR16.0 from PKR15.1 estimated earlier.
ATRL EPS Forecasts
ATRL FY10 FY11 FY12
Old 13.0 15.1 15.1
Revised 13.0 16.0 15.1
%▲ 0.0% 6.0% 0.0%

Source: BMA Research

OUTLOOK: UNDERWEIGHT ON THE SECTOR

Refining industry GRMs have continued to show sequential improvement, however,
current levels are still substantially lower than the average of FY08. Moreover,
circular debt issue continues to haunt the refining sector while inherent regulatory
risks (in terms of potential cut in deemed duty) have aggravated the situation.
Thus we stay Underweight on the sector. The ongoing floods will nonetheless turn
out to be positive for ATRL while there will be no major impact on refineries located
in the south of the country i.e. NRL, PRL and BYCO.

15
 September 3, 2010

OIL MARKETING OMC: SALES DROWNED IN FLOODS

COMPANIES
Recent floods proved to be much more disastrous than anticipated, casting adverse
OVERWEIGHT impacts on the OMCs and refineries. As far as OMCs are concerned, there are
multiple aspects to the losses incurred due to floods: 1) lost sales due to drowning
of retail outlets and reduction in demand for POL products in flood affected areas,
2) damages to infrastructure and 3) supply and logistical disruptions caused by
flooding.
Muhammad Ali Taufiq
OMC Analyst APL however stands out as a major beneficiary of potential increase in post-floods
asphalt sales and thus compels us to add the stock amongst our High Conviction
Investment Ideas.

LOST SALES AND ITS IMPLICATIONS

Approximately 350 or 5.5% of OMCs’ retail outlets have been affected by the floods
and many of these retail outlets have become inaccessible; this has adversely
impacted MoGas (Motor Gasoline) and HSD (High Speed Diesel) sales. Moreover
seizure of sales in flood affected areas and reduction in economic activity in
adjoining areas is expected to cast dark shadows on MoGas and HSD sales
numbers for the month of Aug10. We had therefore revised down our industry sales
forecast for MoGas and HSD downward by 1.7% and 1.9% respectively for FY11.
Flood affected retail outlets

Source: PSO Company Reports, OCAC, BMA Research

16
 September 3, 2010

FO (Furnace Oil) sales for the industry are also expected to experience a 23%
decline for the month of Aug10 due to temporary closure of some RFO based
thermal power plants at Kot Addu Block, Muzaffargarh, Guddu Central Block and
Northern Block. FO is primarily supplied by PSO at these stations and therefore a
decline in FO sales will impact PSO’s earnings for the on-going quarter only.
FO based Power plants affected by floods
% of total FO
Stations affected consumed by Power Status
Sector
Guddu Central Block 3 0.3% Closed for 2 days
Northern Block 1 7.1% Closed for 8 days
Northern Block 2 4.2% Closed for 8 days
Northern Block 3 2.6% Closed for 8 days
Kot Addu Block 1 5.6% Average utilization level of 45.5%
Kot Addu Block 2 13.2% Average utilization level of 45.5%
AES Lalpir 5.7% Closed for 25 days
AES Pakgen 5.2% Closed for 25 days
Total 50.7%

Source: NEPRA, BMA Research

JP (Jet-Fuel) sales, on the other hand, are expected to rise by 10% over the period
of Aug10 - Sep10 due to increased domestic demand driven by air-based flood
rescue operations carried out by the Pakistan Army.
In the non-energy segments, lubes sales are expected to witness a decline on the
back of reduced overall road transportation activity during the month of Aug10.
SHEL whose overall profitability is highly dependent on lubes sales is most likely to
witness a decline in 3QCY10 earnings.
Among the OMCs, Asphalt sales are currently controlled by APL alone. Due to a
massive slowdown in construction activity, Asphalt sales for Aug10 – Sep10 period
are expected to witness the sharpest decline. Floods have done major damage to
road network and bridges (approximately 400km of roads and 36 bridges have
been destroyed). Going forward however, we expect Asphalt sales to increase by
10% YoY for FY11 period on the back of infrastructure development required in
flood-hit areas. We believe APL will remain a major beneficiary of increased net
sales of Asphalt, hence there exists significant upside risks to its FY11 earnings.
Province-wise division of POL products sales
Province-wise % Khyber
Punjab Sindh Balochistan Azad Kashmir
volumetric sales Pakhtunkhawa
Mogas 7.1% 61.6% 27.7% 1.7% 1.9%
HSD 14.4% 57.1% 24.1% 2.5% 1.9%
FO 0.9% 60.1% 14.2% 24.7% 0.0%
JP 0.2% 27.8% 71.3% 0.6% 0.0%
Asphalt 4.4% 62.4% 29.1% 2.9% 1.3%

Source: OCAC, BMA Research

17
 September 3, 2010

Going forward we also expect FO, MoGas, HSD, JP and Lubes sales to return to
their normal levels by Oct10. It should be noted that most of the severely affected
regions are rural areas and do not constitute major portion of POL products sales.
As economic activity revives in adjoining urban areas, industry sales figure are
expected to return to their normal levels.
Company and Province-wise division POL Products sales
PSO SHEL APL Industry
Mogas
Sindh 26.9% 30.3% 9.4% 27.7%
Punjab 61.4% 59.4% 78.6% 61.6%
Khyber Pukhtunkhawa 8.0% 6.2% 8.2% 7.1%
Balochistan 1.7% 2.2% 0.0% 1.7%
Azad Kashmir 2.1% 2.1% 3.9% 1.9%
HSD
Sindh 23.2% 22.6% 11.7% 24.1%
Punjab 56.9% 59.2% 67.2% 57.1%
Khyber Pukhtunkhawa 15.4% 11.6% 17.8% 14.4%
Balochistan 2.4% 4.7% 0.0% 2.5%
Azad Kashmir 2.0% 1.9% 3.4% 1.9%
JP
Sindh 95.3% 42.5% 13.0% 71.3%
Punjab 4.3% 55.7% 87.0% 27.8%
Khyber Pukhtunkhawa 0.4% 0.0% 0.0% 0.2%
Balochistan 0.0% 1.8% 0.0% 0.6%
Azad Kashmir 0.0% 0.0% 0.0% 0.0%

Source: OCAC, BMA Research

DAMAGES TO INFRASTRUCTURE & PRODUCT LOSSES

Initial assessment indicates that PSO has incurred losses to the tune of PKR2.9bn.
However, this figure can go up once damaged sites are accessible and final
assessment is made. Some 200 retail outlets have been directly affected by the
floods out of which ~160 retail outlets are completely inaccessible. Mehmood-kot
installation and storage depot at Lalpir is reported to have experienced the most
damage. PSO has officially reported ~PKR1.8bn in product losses; however our
estimates subject to final assessment stand at ~PKR3.0bn.
Similar damages albeit with much less magnitude are expected to have been
experienced by SHEL and APL, primarily in the Punjab region.

DISRUPTION IN SUPPLIES AND LOGISTICAL ISSUES

During the recent floods many urban areas have reported a shortage of POL
products coupled with closure of Pakistan’s largest refinery in a region
characterized with high sales. Moreover many storage depots in flood affected

18
 September 3, 2010

regions have also experienced several logistical glitches resulting in supply

disruptions in adjoining areas. Therefore, shortage of POL products and disruption
in product supply have resulted in lost sales for OMCs.
REVISION IN FY11E EPS
Lost sales, product losses and infrastructural damages compel us to make a
downward revision to our FY11E EPS forecast for PSO by 34.7% from PKR53.9 to
PKR35.2 (as communicated through our InFocus titled ‘PSO: Floods Erode FY11E
EPS by 35%’ released on August 27, 10). On a similar note we are also revising
SHEL’s CY10E EPS forecast downward from PKR17.9 to PKR13.6.
On the other hand APL is expected to benefit largely from increased Asphalt sales
over the rest of FY11 which has led us to revise FY11E EPS to PKR64.0 from
PKR62.4 earlier.
EPS Forecasts
PSO FY10 A FY11 E FY12 E
Old 52.8 53.9 73.7
Revised 52.8 35.2 73.7
%▲ 0.0% -34.7% 0.0%
APL FY10 E FY11 E FY12 E
Old 55.3 62.4 64.5
Revised 55.3 64.0 64.5
%▲ 0.0% 2.6% 0.0%
SHEL CY09 A CY10 E CY11 E
Old 37.4 17.9 13.6
Revised 37.4 15.6 13.6
%▲ 0.0% -12.8% 0.0%

Source: BMA Research

OUTLOOK: APL ADDED TO HIGH CONVICTION INVESTMENT IDEAS

We expect continued growth in demand for FO in the industry as more RPPs and
IPPs come online. Moreover, MoGas demand is on the rise due to 1) power
shortages, 2) high convenience yield for MoGas on the back of CNG load-shedding
and 3) reduced price differential between alternatives of MoGas.
However given product losses and higher turnover taxes for PSO, we had earlier
removed the stock from our high conviction ideas. APL, on the flip side, offers
exposure to asphalt segment which is likely to benefit from reconstruction activities.
Moreover the company is not likely to face higher effective tax rate due to its
exposure to high margin asphalt. We thus add the stock amongst our High
Conviction Investment Ideas list. At yesterday’s closing price of PKR308/share, APL
currently offers 69% upside potential to our DCF-based fair value of PKR522/share.
APL is also attractively valued with FY11E PER of 4.8x while robust expected
payouts reflect FY10E and FY11E dividend yields of 10.4% and 11.8% respectively.

19
 September 3, 2010

ELECTRICITY ELECTRICITY: CIRCULAR DEBT TO LINGER

The flood catastrophe in its different phases has adversely affected the electricity
OVERWEIGHT T&D infrastructure and power plants. Moreover submergence of road network along
with other means of fuel supply resulted in lower capacity utilization for power
stations situated in the affected areas; consequently swelling the demand supply
gap to over 3000MWh. However, a swift response by PEPCO resulted in
restoration of 93% of the electrical network as well as the power plants with
Nurali Barkatali
exceptions being two Independent Power Producers (IPPs), AES Lal Pir and AES
Electricity Analyst
Pak Gen.
More importantly, the disaster is likely to aggravate already imbalanced fiscal
situation of the country; henceforth a resolution of the inter-corporate debt issue
which has long haunted the entire energy chain does not appear to be a possibility
in the near future.
On the positive side, abundance of water has resulted in increased capacity
utilization of hydel electricity generation resources. Presently utilization of hydel
resources stands approximately 100% i.e. 6,500MWh from an estimate of
4,350MWh in June’10. This resultantly has also brought down the average
electricity cost of generation.
Flood affected areas and key electricity installations

PEPCO-TPS
IPPs
Hydel Generation

Source: BMA Research

20
 September 3, 2010

EFFECTS ON IPPS AND INFRASTRUCTURE

KAPCO, the only listed IPP in the flood affected areas remains protected; the
power units operated at lower load factor (350MWh) on the back of i) lower demand
by PEPCO due to destruction of its network and ii) shortage of fuel supplies.
Currently the power units are operating between 30-50% of the total capacity which
continuously varies based on the above mentioned factors.
We however do not foresee any significant negative impact on company’s
profitability during FY11 as the complex was made available while the generation
units also maintained their required efficiency ratio.
AES Lal Pir and AES Pak Gen: The IPPs have been shut-down and an
investigation will be carried out to estimate the turnaround time and its cost. This
shut-down would be treated under ‘Force Majeure’ clause of the Power Purchase
Agreement; this clause based on the nature of event completely or partially
discharges both the contracting parties from their obligations against each other.
Henceforth under current circumstances, where the ‘Force Majeure’ clause is
invoked due to natural disaster, we are of the view that the company would not be
liable to pay any Liquidated Damages. Both the plants are partially (50%) owned by
Nishat Group.
Apart from production losses of power plants, the distribution network owned by
PEPCO has also faced severe damages; initial estimates for which are being put at
USD120mn.

OUTLOOK: INTER-CORPORATE DEBT RESOLUTION NOWHERE

NEAR
We foresee the government’s higher fiscal deficit to further delay the resolution of
lingering circular debt in the energy chain which currently stands at over USD1.5bn.
This would have an adverse impact on the entire energy chain, specifically the
IPPs. As a result, they will have to opt for short term borrowings under a tight
monetary environment; consequently higher debt servicing cost is estimated to
adversely affect the bottom line.
On the whole however we maintain an Overweight stance on the sector where we
flag both HUBC and KAPCO as attractively positioned bets. HUBC currently reflects
9% upside to our DDM based fair value of PKR40/share while last closing price
offers FY11E dividend yield of 14%. Similarly, KAPCO reflects 19% upside to our
DDM based fair value of PKR49.share and offers FY11E dividend yield of 15%.

21
 September 3, 2010

CONSTRUCTION & CONSTURCTION & MATERIALS: DO NOT

MATERIALS EXPECT TOO MUCH!
MARKETWEIGHT With Pakistan encountering its worst floods in over 80 years, much of the
settlement near embankments has suffered major damages. Massive floods have
rampaged through villages and towns and have led to damage to infrastructure.
While echos of reconstruction are in the air, we do not believe that the cement
uptick is to be significant, based on historical reaction and given that much of the
Omar Rafiq settlements which were damaged were farmlands and villages where cement is not
Cement Analyst a popular mode of construction. In addition, possibility of a cut in PSDP spending to
reign in fiscal deficits emanating from increased spending on rehabilitation, loss in
revenue and constraints under the IMF regime are already being voiced.
Although an immediate (FY11E) 0.6-0.7mn tons of incremental demand required for
rehabilitation can potentially be witnessed, uncertain farm income recovery, overall
shift in construction sentiments, together with possible PSDP cuts and redirected
funds (from construction or rehabilitation) by WB and ADB, keeps us on the back-
foot.

Cement Producers of Pakistan – Geographical Analysis

Askari 1

Cherat

Kohat Askari 2

Fauji cement Fecto

Mustehkam Dandot
Dewan Gharibwal
Bestway

Lucky 1

DG Khan 1 DG Khan 2

Bestway

Flying

Pioneer

Maple Leaf

AC Rohri

Al-Abbas

Dadaboy
Thatta

Dewan
Zeal Pak Javedan
Attock

Lucky 2

22
Source: BMA Research
 September 3, 2010

IF HISTORY IS TO REPEAT ITSELF

We remain contrarian to the general sentiment regarding massive uptick in cement
demand in the post flood scenario (partly driven by history). Pakistan’s cement
consumption growth has remained muted during previous post-flood scenarios. If
semblance is to be made, we do not anticipate any major uptick in demand for the
sector as a whole.

Post flood cement offtake scenario (mn tons)

25

20

15

10

-
FY91

FY92

FY93

FY94

FY95

FY96

FY97

FY98

FY99

FY00

FY01

FY02

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10
Source: BMA Research

As can be witnessed, cement dispatches have followed an organic growth pattern

and have not been significantly impacted by event driven environment.

VILLAGES DROWN, CITIES REMAIN SAFE

Although geographically, recent floods have rampaged through ~18% of the land
mass of the country, it is important to highlight that most of the locales damaged
were either farmlands (low density population regions) or villages (low cement
based construction); with major cities remaining much out of the harms way. As a
result, despite potential uptick in expectations, we believe that demand growth is
unlikely be an overwhelming experience for investors and the industry alike.
Further, redirection of funds from development projects by ADB and WB together
with a probable cut in PSDP is unlikely to result in initiation of major reconstruction
activities.
Reports regarding infrastructure damage, (especially bridges – recent figure
indicating 1,000 bridges being damaged) should be considered with caution as
these include small and medium bridges which are not cement structures at core.

DISPLACED PEOPLE LIKELY TO BE THE IMPETUS ALBEIT SMALL

We believe that slow rehabilitation of displaced people together with lower
disposable income is likely to remain a concern for cement producers of the
country. Although we expect rehabilitation to start as early as 4QCY10, we remain
rather under whelmed by a possible uptick in cement demand as a result of this
during FY11E. This is especially because incomes of affected people have been
hurt and will potentially take time to recover. Further, the upcoming winter season is

23
 September 3, 2010

likely to further add to the seasonality effect witnessed for cement manufacturers
here in Pakistan. Farmers who rely on crop harvesting as a source of income will
now have to wait till the wheat crop harvest to see major inflows in income, thereby
postponing demand for cement to 4QFY11 or possibly later.

OUTLOOK FY11E: LUCK TO BE THE MAJOR BENEFICIARY

Although total industry demand is likely to see a minor growth in dispatches to the
tune of 0.6-0.7mn tons, the same spread over 23 producers in the country is
unlikely to result in any major fundamental change in the outlook of any of the
individual market players. We however feel that LUCK could potentially benefit from
this scenario given its proximity to flood affected regions of KP, Punjab and Sindh.
We currently have a BUY call on the stock with a fair value of PKR79/share for
LUCK providing an upside potential of 15% from current levels.

24
 September 3, 2010

FERTILIZER FERTILIZER: NOT MUCH TO WORRY ABOUT

With a vast number of farmer community either displaced or at the very least
MARKETWEIGHT disturbed, coupled with crop destruction lowering their purchasing power one
wonders how this is to pan out for the fertilizer sector of Pakistan. We believe that
any impact on the fertilizer sector will be transient and self correcting and therefore
envisage a stable outlook for the sector. Our outlook is based on the timing of the
flood (crop calendar: as provided in the economy section), credit availability to
Omar Rafiq farmers, availability of arable land and nutrient rehabilitation of soil.
Fertilizer Analyst Fertilizer Producers of Pakistan – Geographical Analysis

AGL - HPF

AGL - PAL

PAFL

FFC
FATIMA

ENGRO

FFBL

Source: BMA Research

LOCAL COMPANIES UNAFFECTED: IMPORTS TO BEAR THE BRUNT

With a substantial portion of rice and cotton crop damaged and probable miss of the
sugarcane growing season, it is likely that fertilizer offtake will decline for the
industry. We expect urea demand to reduce to ~6.0mn tons for the current calendar
year compared to earlier expectations of 6.6mn tons. Similarly DAP demand is
likely to also see a significant fall where we expect annual demand to settle at
~1.1mn tons in the post flood scenario compared to 1.3mn tons expected earlier.

25
 September 3, 2010

Although demand decrease might be alarming we need to reiterate that these

numbers focus on the calendar year whilst we expect fiscal year based fertilizer
offtake to remain stable.
Revised Annual estimates – Urea and DAP offtakes
Initial Revised
mn tons CY10 CY10E
Local demand Urea 6.6 6.0
Local production Urea
FFC 2.3 2.3
FFBL 0.5 0.5
ENGRO 1.3 1.3
PFL 0.1 0.1
AGRTECH 0.4 0.4
FATIMA 0.4 0.4
DAWH 0.4 0.4
Total Local production Urea 5.4 5.4
Estimated imports Urea 1.2 0.6
Local DAP demand 1.3 1.1
Local production DAP
FFBL 0.6 0.6
Estimated Imports DAP 0.7 0.5

Source: BMA Research

Further although decrease in overall offtake is expected, we need to remember that

Pakistan’s indigenous capacity for N:P:K fertilizers remain well below its annual
requirement and thus we maintain varying degrees of reliance on international
supplies of all major fertilizer products. Although we forecast that due to a slow
3QCY10, total offtakes are likely to decrease, we believe that local manufacturers
will remain immune to such a downturn with import requirements bearing the brunt.
Nutrient offtake pre and post flood scenario - Historical
Nitrogen Phosphate
3.5

3.0

2.5

2.0

1.5

1.0

0.5

-
FY73

FY75

FY77

FY79

FY81

FY83

FY85

FY87

FY89

FY91

FY93

FY95

FY97

FY99

FY01

FY03

FY05

FY07

FY09

26
Source: BMA Research
 September 3, 2010

CREDITS TO BE AVAILED: WHEAT CROP GROWTH UNLIKELY TO BE

HAMPERED
With uncertainty regarding purchasing power of farmers being under question, we
believe that this will not be a major issue for the upcoming Rabi season. While
major farmers are likely to have enough cash resources to furnish out their farm
input demands, small farmers are more likely to be either supported through the
state machinery, ZTBL (Zarai Taraqiati Bank Limited) or will most probably work on
credit with dealers. In either case we do not expect wheat sowing season to be
impeded by these reasons.

WHEAT STILL TO COME: REVIVAL OF AGRO PRACTICE IS LIKELY

Notwithstanding the devastation that floods have caused, we need to assess how
impacts are to pan out for the stake holders. While news concerning destruction of
rice and cotton crops is resounding in the media and such information is likely to
induce sentiments towards possible cut in domestically produced fertilizer demand;
we remain contrarian to the same.
Given that rice and cotton were in their maturity phase and final growth cycle,
upcoming sowing season for wheat and sugarcane is the primary driver for fertilizer
demand by dealers. Fertilizer demand by the two crops (rice and cotton) had
already started to ebb.
With the flood water in parts of Punjab having started to receed (albiet initially on a
slow rate), we expect that within a month rehabilitation would have switched on a
gear or two and most of the agrarian based economy will be back on track. As a
result, although we expect 3QCY10 to pose as a slow quarter for the fertilizer
maunfacturers in term of offtakes, much of the bottled demand is likely to spring up
in 4QCY10.

REBALANCE AND REACH: REVITALIZATION OF SOIL

We anticipate that floods have positively impacted arable land availability in the
long run. Further water availability is likely to be maintained during the upcoming
fiscal year crop season which is to positively impact the sector as increased area
under coverage, possible better yields in the upcoming seasons and improved
water tables is likely to push up demand for fertilizer.

OUTLOOK; DOMESTIC OFFTAKES LIKELY TO REMAIN STABLE

We maintain our outlook on the profitability of the sector as we expect any demand
decrease to be offset by decrease in fertilizer imports. Further we expect that long
run implication of improved water tables, water availability and mineral content
improvements is likely to bode-well for the sector. We believe the above mentioned
factors are likely to improve both the arable land availability as well as the yield on
crops. In sight of the Rabi season (wheat), we believe that (Fauji Fertilizer Bin
Qasim) FFBL is likely to benefit from seasonal offtake increase during 4QCY10. We
currently have a fair value of PKR33/share for FFBL providing an upside potential
and dividend yield of 16% and 14% respectively. Although from our current
valuation stand point (ENGRO Corporation) ENGRO also provides upside potential

27
 September 3, 2010

of 22% to our fair value of PKR208/share, without ruling out the possibility of a
delay in the urea plant we maintain our cautious stance on the stock as earnings
growth can be potentially delayed.

28
 September 3, 2010

AUTOMOBILE & PARTS AUTOS: RURAL/AGRI BASED DEMAND TO TAKE A HIT

UNDERWEIGHT AUTOMOBILE SALES DECLINE EXPECTED AT 20% YOY FOR FY11
FY10 was primarily characterized by improved rural incomes leading to 43% YoY
growth in volumetric sales for the industry. However the devastation caused by
floods is expected to depress agricultural income in the next year and hence
demand for automobiles from such regions.
Sana I. Bawani
Auto Analyst We anticipate a decline of 20% YoY in industry sales to 112,246 units in FY11
(against originally expected growth of 8%). Similarly, individual auto assemblers are
also expected to post declines in their respective sales with INDU expected to sell
20% fewer cars YoY while PSMC may be a bit more resilient this time with its sales
dropping by 15% YoY. With INDU depending a lot more on demand from rural
areas, the company is expected to bear a larger hit than the latter. Despite that, we
continue to like INDU on the back of its prudent working capital management and
debt free balance sheet.

INDU’S FY11E EPS ESTIMATED TO DROP BY 21%!

During FY10, INDU was the key beneficiary of the growth in agri income and
demand for vehicles from the government institutions (sales up 49% YoY). However
it is not expected to sustain this growth going forward.
Our estimated decline in INDU’s volumetric sales of 20% YoY to 40,658 units in
FY11 (against 8% YoY growth originally expected) yields a sharp drop of 21% in
FY11E EPS to PKR32.3. The same has also resulted in 26% downward revision in
our fair value for the stock to PKR203/share.
INDU – EPS Revision
FY10A FY11F FY12F FY13F
Old 43.8 40.8 48.9 57.8
Revised 43.8 32.3 43.6 55.8
Change -21% -11% -3%
Source: BMA Research

TRACTOR SALES TO SUFFER AS WELL

Tractor sales which are directly related to agricultural growth in the country are
expected to remain subdued in FY11 on the back of a slump in agricultural activity
in the flood-affected areas. It experienced a growth of 18% YoY in FY10 to 71,512
units sold during the year with MTL accounting for a larger chunk of sales. Going
forward, a drop in rural incomes can point to a decline of over 20% in tractor sales.

OUTLOOK: DOWNGRADING TO UNDERWEIGHT

Like its peers, INDU has also recently witnessed a decline of 14% MoM in its sales
in Jul10 albeit the least amongst all. While the outgoing month’s numbers may not
be a true reflection (post budget impact), we reiterate our view that sales may suffer
a sharp dip in FY11 as the impact of floods gets pronounced with the passage of

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time. Additionally, JPY has currently surged to new levels against PKR crossing
PKR1/JPY mark which leads us to expect another round of price increases in the
coming months. We thus downgrade our sector stance from Marketweight to
Underweight.

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DISCLAIMER
This memorandum is produced by BMA Capital Management Limited and is only for
the use of their clients. While the information contained herein is from sources
believed reliable, we do not represent that it is accurate or complete and should not
be relied upon as such. Opinions expressed may be revised at any time. This
memorandum is for information only and is not an offer to buy or sell, or solicitation
of any offer to buy or sell the securities mentioned.

ANALYST CERTIFICATION

We, Hamad Aslam, Abdul Shakur, Nurali Barkatali, Sana I. Bawani, Omar Rafiq
and Ali Taufiq, hereby certify that this report represents our personal opinions and
analysis of information. All views are accurately expressed to the best of our
knowledge. We certify that no part of our remuneration is linked either directly or
indirectly to recommendations or analysis covered in this report

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