Wednesday, 23 October 2013

Descon Oxychem Limited - Result for 1st Quarter 2013.

Descon Oxychem Limited announced its result two days back and it was a loss of Rs. 0.5 per share against my forecast of Rs. 0.4-0.5 per share. The basis of my forecast was increased Peroxide Prices which still stands. The result was possibly due to lower volumes as I had already highlighted in my posts.

If investors want to recoup their losses they should probably hold on till December result since apparantly the prices are holding up up till now and any seasonal factors for sales will be accounted for by then as well.


Monday, 21 October 2013

Price Fixing and Power Price Shocks - All in a day for the Cement Industry of Pakistan!

Temporary value drainers like cartel-breaking rumors and electricity prices increases have created significant opportunity in the cement sector which continues to be the most lucrative in Pakistan.

High cement prices, supported by the evil of cartelization, persevering demand (September dispatches were highest in the country’s history) and low coal prices (Coal is the largest cost driver for the industry) are all a few factors that continue to support stellar margins and exceedingly high profits.

Now doubt, the Cement sector has been one of the best performing in the last two years as given by the following graph.

Swamped with cash, companies like Lucky Cement have gone for acquisitions, while others like Pioneer cement have swathes of cash on their balance sheet and no idea what to do with it.

Scares like cartel break-up have hurt investor returns in the last one month, but this only presents the shrewd investor with opportunity. Given investigations and revelations by KASB and other brokerage houses, the scare is unwarranted, and the camaraderie is here to stay. Cement prices are likely going to stay high in the intermediate term and continue to support the margins of these cash cows. In fact just recently there was news of price increases in the Northern region where players have already increased prices by around Rs. 20 per bag.

Given the evil of cartelization, it is thus with a confused and heavy heart that I must present the sector as a viable investment opportunity. While my heart tells me that I should be writing against this evil, let us just put being a Samaritan on the back burner for a while and concentrate on making money.

Owing to recent the cartel scare, along with the electricity price scare, both of which are explained later on cement stocks have been beaten to the point of whimpering. The following chart explains this rather beautifully (as made by me):

Big Scare 1.0

Cartelization is perhaps the most pertinent theme of the industry, perhaps seconded only by low coal prices which is like the sonay pe suhaga. You see the cement industry has vast overcapacity. Days of good development in the early part of 2010s resulted (we all remember financing our cars at 4% don’t we) resulted in increased demand of cement and the industry invested heavily in capacity expansion. However, later on Zardari came and destroyed everything end of story. So now there is significant capacity and not enough demand. Under normal (and fair) economics, the cement companies decrease prices and go into competition, in order to sell more and drive up capacity utilization. But obviously doing so can be disastrous for many as low prices eat into margins. In fact cartelization  was pretty much the case when CCP busted APCMA’s office sometime back ( In don’t know the exact time) and loads of companies such as Pioneer Cement, Gharibwal Cement, Bestway Cement and the world famous Maple  Leaf Cement restructured their debt obligations (effectively defaulted).

Later on, the companies got braver and the country got Zardarier, and ‘The Cartel’ (sounds like the Mafia or something) has been getting its way ever since. Perhaps we need ‘the Untouchables’ to save us. Even Ajay Devgan would do.

However, the scare was not as deadly as it sounds, the apparent damage was caused by a smaller player wanting to drop prices while the a bigger player threatened to walk away which was all amicably resolved later on. No action by the CCP or anything. Just an internal matter. However, the market was not as brave, and the cement index lost significant capitalization as a result. Later on news of a patch up duly appeared the stocks had their heyday again. However, their woes did not end there and then came big scare 2.0.

Big Scare 2.0

Just as stock prices came up at the surface gasping for air, the government dropped another bomb on them by announcing an increase in electricity tariffs by around 60%. The scare hasn’t been felt by the masses as it used to before the present government (political gimmickry?) but cement stocks took hit hard and hence the Big Scare 2.0 as illustrated in above graph.

An increase in electricity prices is especially harmful for those companies, that obviously, buy their electricity form the natural grid rather than produce it in-house. Companies like Fecto Cement take the brunt of such changes.

The price increase would indeed have spelled bad for the industry or specific companies, but the companies have taken a measure to circumvent this by increasing Cement prices by around Rs. 20 per bag - something that they have been doing since the last five years. Here I present a graph that details the quarterly retention prices (prices net of sales tax and other ancillary items) for a few companies during the last eight quarters:

The above chart only presents scanty prices. This is because I am only in the process of building financial models for all these companies. Nevertheless, prices for Pioneer Cement have been plotted back to almost 20 quarters. The graph aptly depicts cement price increase since last 5 years. But stretching back of Pioneer Cement Prices back to September 08 reveals a whole new page of history.

The Big Dip, as highlighted, was a time when CCP took action against alleged cartelization, raided APCMA offices and what not and what ensued was a dip in cement prices. Together with this, many cement companies defaulted since they could not sustain the debt they recently taken up for expansion. Maple leaf, the 16-bagger, is one of them.

Given the fact that the cement companies are getting out hands, would this happen again?

Well, we can only speculate at best. However we do know that the Big Scare 1.0 occurred because of an internal matter and not because of any regulatory action. Secondly, we also know that cartelization is most necessary in face of low capacity utilization. Given September quarter dispatches being the highest in history, I don’t think anyone would want to threaten prices for the sake of increasing utilization. So I believe the high prices are here to stay.

So what about the recent raise in electricity tariffs?

The tariffs will surely have an impact on margins for companies that produce their own electricity, like Fecto Cement. But that is a problem no more, as cement prices have recently been raised by Rs. 15-20 per kg, amounting to around Rs. 300-400 per ton. I have not run any calculations but something tells me they should be enough to cover any margin loss due to the power price hike.

On a side note, companies like DG Khan Cement (despite my detestation for large caps), and others, that produce their own electricity should benefit most from the price hike since for them there has been no price hike. They actually produce their own electricity from gas whose prices really haven’t risen much. Since cement prices move together, these companies will benefit most from the price increase.

Good times are here to stay for the Cement Industry. Inflated prices will keep margins inflated and ensuing earnings which will in fact continue to positively impact valuations. Given the beating the industry has taken over the past few weeks - the prices are at very attractive levels. And given the cement price increase as of late, stock prices are only going to go up and it is only a matter of time when the pre-cartel-breaking-rumors levels are going to be achieved. Perhaps the market already realizes all these factors and for this reason, many stocks in the sector closed at ‘upper-locks’ on the last trading day. Perhaps we are at the advent of another bull run. I see 25-30% returns from current levels in the next few weeks especially in the wake of the upcoming results reason and suggest taking positions as soon as possible for healthy returns, especially in the short term.

The market opens in about 1.5 hours. It is time to jump on the band wagon! 

Saturday, 12 October 2013

The Market Opportunity for Descon Oxychem Limited (DOL)

Despite improving fundamentals and capital structure as noted in my posts here and here respectively, the market appears to be paying no heed to DOL's significant improvement in financial performance for the coming quarters. After rising significantly since the result was announced on 23-09-13, the stock has witnessed serious beating especially during the recent market turn  down.

So why did this happen? Maybe investors were just too cautious around that time and decided to get rid of their more volatile holdings. 

Going through checkered financial performance in the past, DOL has been just that, having been regularly depressed as well as volatile since most of its lifetime as given below. The fact that it has never come above even its par value speaks volumes about the risk investors perceive it with. 

So what awaits us in the future? In line with the previously referenced articles, as well as this one. Significant opportunity has arisen in the last few days:.

Forgive the quirkiness. 

Friday, 11 October 2013

As per the Annual Report of FY13, Descon Oxychem is a much better company now!

As disclosed in its annual financial statements for FY13, management of Descon Oxychem (DOL) has taken steps that will free up some serious cash flow for the next two years. In a nutshell, the company has obtained a grace period of two years for all its debt, including both the bank as well as subordinated debt. Moreover, the subordinated loan will now accrue interest for two years meaning that no finance costs will need to be paid for it.

All this means that the company will save Rs. 300 million each year for the next two years which comes to around Rs. 3 per share per year. Not bad given the stock is currently trading at Rs. 5.5.

While there would be no significant impact on earnings, improved cash flows could reduce short term borrowings and save finance costs. Possibility of dividends can also not be ruled out.  

Now why did the management do this?  The company is in excellent financial shape especially as per the June quarter result. Peroxide prices are at an all time high and will stay high for the September quarter implying that the quarter result will be good.

Maybe they just wanted to be safe given the dip in peroxide prices experienced two years ago.
Fair values are fair values and people rarely take them seriously. However, if they have anything worth, the whole debt restructuring exercise has had a fantastic impact on company valuation. The cumulative shifting of Rs. 600 million in free cash flows two years forward has increased the fair value of the company to Rs. 15, giving us an upside of almost 200% given current levels.

Given the intermediate for the stock appears to be good as per business recorder, peroxide prices are still holding, which implies a good result for September quarter. 

So Descon Oxychem. Lao Maal!

Thursday, 10 October 2013

An EPS Calculator for Engro - With Assumptions!

Ok last time I published an EPS calculator for Engro Fertilizers that spelled the impact of various factors like urea prices, gas supply situation, gas prices and so on, on EPS. However, as a friend noted , it would make much more sense if some assumptions could be incorporated. This would serve to make the model more credible.

 So here are some of the assumptions underlying the model.

  •  Gas consumption metrics are very important for the model. So I list em here.

  • Finance Costs, Depreciation, Salaries part of the COGS, have been assumed as same for last quarter. 
  • Selling costs have been taken as a proportion of revenue. The proportion being same as for the first half. Admin costs are pretty much constant. 
  • Packaging Price per bag is Rs. 25.
  • Sales Tax rate 17%.
  • Income Tax rate at 35% and all that jazz.
Rest is pretty much common knowledge I think. I hope I have not given away the model. :P

Wednesday, 9 October 2013

Engro Laya Rupya!

There seems to be some gaming at play as far the IPO of Engro Fertilizers is concerned. It appears that the stakeholders, that is government, banks and Engro, have all come to an agreement of sorts to supply Engro with some gas for some, so that it can generate some cash, pay of the banks, make some Urea, save government imports, and so on. So in the end, Banks bhi khush, Engro bhi khush, or government bhi khush.

Cash Coming In

Now, is probably the best time to hold an Engro Fertilizers IPO. Engro will have received 4 months of continuous gas supply from the shutdown Guddu Power plant, pouring money, sorry prills through the 300 meter high prill tower. For the quarter ended Sep 30th, 2013 Engro Fertilizers is going to get EPS of Rs 1.2, moreover, the EPS is going to increase in the last quarter, as full gas supply for the quarter takes effect making full year EPS around Rs. 4.2 . Let us just make it Rs. 4.

Assuming a multiple of 8, we can thus conservatively assume an IPO price of Rs. 32 per share. Further assuming the company wants to sell a stake of 10%, that is 122 million shares, that shall give the company around Rs. 4 billion in cash.

Some More ...

Engro Fertilizers made around Rs. 3 billion in operating cash flows during the first half of 2013. Assuming the gas supply continues as is, it will make somewhat more than Rs. 6 billion more by the end of the year. Add to that the Rs. 7.5 billion it had as of 30th June 2013, and the Rs. 4 billion it will raise through the IPO, and further adding some money earned on the cash deposits, the company will have round about Rs. 18 billion by the end of 2013. This amount takes care of any finance costs paid during the half, but excludes any principal repayments.

Now the company has around Rs. 7.5 billion in current portion of long term debt as of June 30th, 2013. Assuming it pays half of that by December, it will have Rs. 14.5 billion remaining in its kitty. This is a significant amount and could be used to pay of a large part of the company’s existing debt, that would still stand at Rs. 60 billion as at December 31st, 2013, thus the paying off could get it down to Rs. 45 billion. 

Such deleveraging could significantly boost investor confidence.

So will the Guddu Gas Stop before 6 months?

I don’t think so. Guddu is one of the most inefficient plants in the country and already ran at low capacity. Moreover, it is under expansion and it makes all the sense in the world for the government to divert its gas it to Engro for urea production. Clearly, that is the best use of the gas for now. I have read that Guddu is currently in expansion phase which will not be completed at least the next six-nine months. So I don’t expect that to speed up or anything especially given its a government plant! Any inputs to this are Welcome!

Foreign investors are selling Engro like hot cakes. Buyers anyone? 

Sunday, 6 October 2013

An EPS Calculator for Engro Fertilizers, Engro Corp.

Being stock market participants, we are often concerned with what the EPS of a company is going to be. This question is important as it greatly impacts valuations, though naively. For some companies, it is easy to calculate due to relatively little variables involved. One such company is Engro Fertilizers, which produces a single product and has a single raw material. Still, gas prices, Urea Prices, Gas availability pose as some of the key risk factors for company profitability. In order to gauge their effects, I have created an EPS calculator for Engro Fertilizers. Obviously, this has a full fledged model working behind it, but I have provided the basic inputs/outputs for analysis. So play and rejoice! a fully working EPS calculator for Engro Fertilizers! Default values are set for current quarter's expectation.

Get Widget