Monetary Policy Review: Cautious Optimism

100 basis point cut justfied!
A balanced and responsible policy statement was presented by the state bank governor on the 15th of August. The governor clearly stated the positives which have emerged in last six month but was quick to classify them as “nascent positives” and suggested that the economy requires structural reform for the sustainability of the positives. Amidst these positives the central bank decided to loosen its stance on monetary policy and reduces the benchmark discount rate by 100 basis points. The market consensus prior to the statement announcement was 150 to 200 basis point cut. Hence the central bank decision will not be taken as a positive development by the market, and we most likely will see a negative movement in the market in the current week. But a more circumspective view taken by the central bank will help the economy on the long run.
Good news on the Macro Economic front
The country has seen improvement in key macroeconomic indicators following continued implementation of the macroeconomic stabilization program. The CPI inflation continues to fall, the CPI has shown about 7% drop in last three months. Government borrowing from the central bank remains within quarterly limits and the SBP's foreign exchange reserves have increased. These positives in turn, reflect contraction in aggregate demand, much-needed fiscal consolidation, and an improved balance of payments position. The gradual improvement in macro fundamentals has also stabilized the local money market and the PKR and USD exchange rate has remained within a tight range.
IMF targets Achieved
The SBP met successfully, the three main end-June IMF performance criteria. Both the stock of budgetary borrowings from the SBP at Rs 1130 billion and Net Domestic Assets (NDA) of SBP at Rs 1183 billion were below their respective target ceilings of Rs 1181 billion and Rs 1321 billion. Similarly the Net Foreign Assets (NFA) of SBP at $3.98 billion was higher than the targeted floor of $2.37 billion.
Security issues and Electricity shortage: are bringing the economy to halt
Due to electricity shortages and security issues, real GDP growth has fallen to 2.0 percent in FY09, down from 4.1 percent a year earlier. Large-scale manufacturing activity has already seen a record run of 11 consecutive months decline up to May 2009. Furthermore, there has been no growth in credit to the private sector.
Implementation of new interest rate corridor system
The SBP has announced the implementation of new interest rate corridor system that will replace repo market. This was one of the requirement placed by IMF, the hope is that it will help reduce volatility in short term interest rates and bring more transparency in the implementation of monetary policy. The corridor will operate through standing overnight repo and reverse repo facilities, that is, floor and ceiling. The interest rate corridor will consist of two end-of-day standing facilities. Existing three day repo facility would be renamed as SBP overnight reverse repo facility, which would become the ‘ceiling’ and a new SBP overnight facility which absorbs excess funds from the market would serve as ‘floor’ of the corridor. The minimum amount for the overnight repo/reverse repo facility will be Rs 100 million and in multiples of Rs 50million. The newly introduced SBP overnight repo facility will be available at 10% per annum. This will serve as the ‘floor’ for the interest rate corridor. Hence, the floor and ceiling levels for the interest rate corridor are 10% and 13% per annum respectively with the width of 300bps.
MPC and increase in frequency to bring transparency
The SBP also constitutes the independent monetary policy committee (MPC) that will have external experts as members in addition to the SBP and the SBP Board representatives. The inclusion of external members is aimed to ensure that the SBP benefits from expertise and independent views concerning monetary policy and this step will bring in line with best international practices by enhancing the transparency and credibility of monetary policy formulation process. The central bank has also decided to increase the frequency of monetary policy decisions from four to six times in a year.
What’s in it for the market?
Unfortunately the policy statement will not jell well with the market participants in near term. As pointed out earlier the consensus in the market was that the central bank will go for a harder slashing on the discount rate and will cut it by 200 basis points. The bankers were also anticipating a bigger cut in discount rate as reflected in the KIBOR rates. However it is obvious that the central had to take a circumspective view and provide a balanced statement. We would expect 4 to 5% reduction in the index from current point before it consolidates again.

All suffered declining fortunes except FFC in 1HCY09

DAP packed down Urea’s SalesThe improved DAP sales of 172%YoY in 1HCY09 conveyed a reversal impact on fertilizer Sector’s sales and brought its 15.1% decrease to PKR 4.9 Billion during 1HCY09. The industry sales’ grew by 45.0%YoY to PKR 45.9 billion and gave a far-fetched performance in DAP sales by 172%YoY increase but a reversal impact in Urea sales by 7%YoY decrease. The negative sales growth in the Urea was in response to decrease in DAP prices (Economy of scale) and in reflection of reduction in Urea’s production which declined by 0.6%YoY to 2 Million tons. The DAP production drove an addition by 42%YoY to 213k tons.
Industry Performance
1HCY09 for Fertilizer sector has appeared to roll into the downward side. Fauji Fertilizer Bin Qasim (FFBL) declared the profit of PKR 497.8 million and EPS of PKR 0.53 in 1HCY09 compared to the profits of PKR 718.2 million and EPS of PkR0.77 during the same period in last year which means a decline of 30.689%YoY. Engro Chemical declared the profit of PKR 1.043 billion along with an EPS of PKR 3.95 compared to the profit of PKR 1.556 billion and EPS of PKR 3.95 in the same period a year back. Dawood Hercules has posted an after tax loss of PKR 615.284 million and Per Share Loss of PKR 5.63 in the period under review against a profit of PKR 1,213.997 million and EPS of PKR 11.10 in the same period year back. Fauji Fertilizer Company (FFC) was the only company who has increased its profitability from the same period last year. It disclosed the profit of PKR 4.547billion and EPS of PKR 6.70 as compared to PKR 3.286 billion profits and PKR 4.84 EPS previously.
Fauji Fertilizer Bin Qasim
FFBL, being the only DAP producer was the leading recipient of the said DAP Sales Growth. FFBL’s DAP sales evidenced a 207%YoY increase – highest in the sector by growth of 164.3%YoY. The company sold 279k tons of DAP having a shoot of 6.5xYoY as a result of this a PKR 15 Billion in 1HCY09 compared to PKR 5.7 Billion during the corresponding period last year. The Urea sales for the company took a dip of 20%YoY and stood at 281k tons in 1HCY09.
In 2QCY09, the company stationed NPAT of PKR 485.3 Million and the EPS of PKR 0.52 compared to NPAT of PKR 556.1 Million and the EPS of PKR0.60 in 2QCY08 which booked a decline of 12.7%YoY. Apart from the Core operation, the faced a loss from associate Pak Maroc Phosphor (PMP) due to shutdown of their operations for 3 months during the period of 16-Nov-08 – 19-Feb-09 as well as a considerable inventory jot down by the company to bring its stocks at NRV; additionally, it was largely in loss from the Joint Venture project booked mainly in resulting to NRV adjustment recorded by PMP.
Engro ChemicalEngro Chemicals had again a drastic performance in DAP sales which grew by 1.8x in 1HCY09 to plunk at 71.6k tons. The DAP sales increased by 1.7x in 2QCY09 at 28.2k tons whereas the Urea sales declined by 24.1%YoY to 419.2k tons in effect of emphasize on DAP Sales by the industry compared to last year.
In 2QCY09, Engro's Urea sales were 183.3k tons compared to 245.2k tons during the same period last year which put a decline of 25.2%YoY. The gross profit margin of the company declined to 20.3% in 2QCY09 in contrast of 40.7% in 2QCY08.
Fauji Fertilizer Company
The company made an NPAT of PKR 1.9 Billion in 2QCY09 and EPS of PKR 2.74 compared to NPAT of PKR 1.5Billion and EPS of PKR 2.28 during 2QCY08 which brought the growth of 20.5%YoY.
The chief explanation behind the enlarged profitability in the 1HCY09 was due to increase in Urea sales including the increase in Price and Quantity and the higher other income principally in 1QCY09 in the shape of higher dividend from FFBL.
Outlook
Based on my analysis the reasons for lower profitability during the year were decrease in profit margins mainly in DAP, and higher interest rates in 1HCY09. I strongly expect the profitability of fertilizer companies to progress due to continued strong DAP and Urea sales, continuously increase in dividends paid by the industry and lower financial charges which are in the reason of decreasing interest rate environment.

Automobile Sector 1MFCY10 Review

Showed a healthy jump of 32.43%YoY
The latest sales figures of Pakistan Automotive Manufactureres Association (PAMA) for July 2009 depict that car sales are gradually picking up month on month basis; however there is still a long way to go for the auto industry. The sales figures reported for the month of July showed a healthy jump of 32.43% to 9,820units compared to the 7,415units in same month in 2008. The figures have also shown an improvement of 8.07% compared to 9,087units in June 2009.
800CC segment leading the recovery
The recovery in sales is lead by the 800CC category which has shown a healthy growth of 13.3% MoM. Honda City and Corolla in the 1300CC range have also witnessed some improvement in sales, the overall MoM growth in this segment is recorded at 9.12%, and the total number of units sold stood at 4,335. 1000CC segment made the sales growth of 5.85% having 1,555units sales in July compared to 1,469 units in previous month; SUVs and LCVs segment showed the negative sales trend by 13.41% and a sales figure of 1,330units in current period compared to 1,536 in last month. The main contributor was Pak Suzuki with 4,966 units sales followed by Indus Motors with 3,586 units while Honda Atlas Cars and Dewan Motors with 1,140 and 128 units of sales respectively.
Withdrawal of FED helped boost the sales...... but high financing cost is still a dragThe government took a decision to reduce the Federal excise duty on CKD units in the recently announced budget this has helped the car manufacturers in reducing the prices of the cars which in turn helped the sales figures. However the high consumer financial cost and the reluctance of the banking sector to push the car loans aggressively is not helping the cause of the car manufacturers.
The Cars’ Sales decline by 49.68%YoY and SUVs & LCVs’ sales decline by 27.67%YoY. The segment which conceded the biggest shock was 1000CC car category with an average downturn of 71.40% in sales. The recorded downturn was in effect of increase in automotive prices caused by 19% PKR-USD Parity (81.39 in June 2009 from 68.40 in June 2008) which increased the cost of imported completely knocked down (CKD) kits and limited financing due to increase in interest rates.
Indus Motors (Toyota).
Toyota corolla remained the highest selling car with 3,124 units sales, continuously maintaining number 1 slot since October 2008. In spite of July-2008 to June-2009 sales volume which declined by 20.45%YoY, it has improved its market share by further 2 points to 36% this month. The year which started with a sizable hit of 80%QoQ downturn in 2009 with the earlier model is gradually being reversed; it stoutly bounced back to 275%QoQ increase in 2nd Qtr of 2009 leading to a growth of 13%QoQ in next quarter, while the last Qtr depicted growth of 17%. In July 2009 Corolla has made 3% sales growth. On the reversal side of this the sales of Daihatsu Cuore, went down by 52.05%YoY in FY09, then we’ve seen sales to get back into the positive numbers with 22% jump MoM basis in June, and in July 2009 the numbers are again showing the negative sales growth of 17% by selling 331 cars compared to last month figure of 397 cars.
Pak- Suzuki
The highest sales in July 2009 were made by Pak Suzuki with 4,966 cars. The main reason for this spike is mainly due to the cut in prices of vehicles on celebration of 1 million vehicle sales by Pak Suzuki since its operations in Pakistan. With the exception of Liana and Alto all the products of Pak Suzuki has shown tremendous sales surge in the previous month, mainly due to the concerted effort on marketing by the company. The sales figures were lead by Bolan with whooping increase of 69% in MOM sales. Ravi and Mehran also witnessed healthy growth in July with MoM growth of 38% and 21% respectively. Very Surprisingly ALTO seems to be loosing its market and probably conceding to Core and foreign competition in 1000 cc category. While Liana remains weakling in Suzuki family, as it faces hard time with completion from Honda City and Corolla Xli in 1300CC range.

Global stocks, commodities slip; dollar flat

By Dominic Lau

LONDON (Reuters) - Global stocks and commodity prices pulled back on Tuesday as investors paused to assess the state of the economy after pushing them higher in the past two weeks, while the U.S. dollar was broadly flat.

BNP Paribas (BNPP.PA), France's biggest bank by market value, posted higher second-quarter profit, and expressed some optimism over prospects for financial markets, while there were signs of improvement in Swiss bank UBS's (UBSN.VX) underlying performance.

Better-than-expected second-quarter corporate earnings and improving economic data in major economies have helped push global equities, measured by MSCI, up in 13 out of the past 16 sessions.

The index hit its highest level in nearly 10 months on Monday.

"If you run up so fast and so far, it's quite natural that you have some profit taking," Luc Van Hecka, chief economist at KBC Securities, said.

"But the overall trend is certainly positive and the market is of the opinion that the worst is over. It is responding quite logically to the fact that earnings have generally been better than expected."

The MSCI world equity index was down nearly 0.2 percent. Shares in BNP Paribas advanced 1.2 percent, and those for UBS eased 0.3 percent.

Weaker commodity prices weighed on the pan-European FTSEurofirst 300 .FTEU3 index, which was down 0.4 percent.

The European benchmark, which has rallied 45 percent since its March floor, traded at 12.5 times expected earnings, the index's highest price-to-earnings ratio since August 2007, according to Thomson Reuters data.

OIL DROPS

Oil fell below $71 a barrel, paring some of the previous day's 3 percent gain, as worries about a rise in U.S. crude inventories offset optimism from Monday's positive U.S. and Chinese manufacturing data.

"The strong rally in oil prices over the past few days gave investors an opportunity to take some profits. There are also signs of increasing supplies," said Victor Shum, Singapore-based analyst at Purvin and Gertz.

"And we should remember that we are going to enter a period of slow autumn demand. With supplies rising, it will not be surprising for oil to pull back below $70."

Metal prices also eased, with copper down from a fresh 10-month high.

The U.S. dollar .DXY was flat on a trade-weighted basis against a basket of major currencies but it slipped 0.3 percent to 94.93 yen.

The Australian dollar, meanwhile, pared gains from a near 10-month high against the dollar after the Reserve Bank of Australia kept interest rates unchanged and abandoned its easing bias, supporting expectations of a rate hike by year-end.

Yields on the benchmark 10-year U.S. Treasuries were flat at 3.628 percent, while the 10-year euro zone benchmark bund yield was down 1 basis points at 3.335 percent.

(Additional reporting by Atul Prakash in London and Sambit Mohanty in Singapore, editing by Mike Peacock)

PepsiCo to buy bottlers for $7.8 billion; shares up

By Martinne Geller

NEW YORK (Reuters) - PepsiCo Inc agreed to buy bottlers Pepsi Bottling Group Inc and PepsiAmericas Inc in a sweetened $7.8 billion deal, after a decade of operating as separate companies, as it seeks to cut costs and boost profits in North America.

The second-largest soft drink maker said on Tuesday it will pay $36.50 per share for Pepsi Bottling and $28.50 per share for PepsiAmericas, representing premiums of about 45 percent and 43 percent from the bottlers' closing prices the day before Pepsi launched unsolicited bids in April.

Pepsi first offered $29.50 per share for Pepsi Bottling and $23.27 per share for PepsiAmericas. Those bids, at 17 percent premiums, were worth $6 billion.

The price increase was expected since the bottlers posted better-than-expected profits, said JP Morgan analyst John Faucher. Price increases and lower costs helped offset weak demand for pricier beverages because of the recession.

Still, each bottler's shares jumped to new year-highs and were up more than 8 percent in afternoon trading, with PepsiCo up 5 percent at $59.00.

"We think getting the deal done removes a big overhang on PepsiCo," Faucher said in a research note.

The takeout price for Pepsi Bottling, the much larger bottler, is about 16 times estimated earnings, in line with the stock's average multiple over the last 10 years, said Jim Tierney, analyst and portfolio manager at W.P. Stewart, which owns Pepsi shares among its $1.5 billion in assets.

"I don't think in any way they're overpaying for this," Tierney said. "Nor do I think it's a tremendous deal."

STRATEGY

Buying the bottlers will consolidate 80 percent of Pepsi's North American beverage volume, which Pepsi said will speed decision-making and eliminate friction between the companies.

PepsiCo, whose drink brands include Mountain Dew, Tropicana and Gatorade, is the bottlers' largest shareholder and largest supplier -- a relationship that sometimes puts their interests at odds, especially when it comes to the price of the beverage concentrate they buy from PepsiCo.

Tierney said the deal aligns the companies' interests so they can focus on improving performance in North America, where sales have sagged industrywide as consumers cut back amid expanding waistlines and shrinking budgets.

"You now have one entity focused on one thing -- selling more soda, selling more water, selling more tea, selling more Gatorade," Tierney said. "That's really what's key here."

Pepsi spun off the bottlers in 1999, following a similar move from top rival Coca-Cola Co.

It is buying them back because the current model makes it difficult to achieve sustainable long-term profit growth since there is not enough profit in total to support investment in separate companies, Chief Executive Indra Nooyi said.

Coca-Cola, which has a decentralized system, declined to comment on the deal or Nooyi's assertion. Last month, Coke CEO Muhtar Kent reiterated his commitment to its model.

SAVINGS

The deal, expected to close late this year or early next year, should produce annual savings of $300 million by 2012, Pepsi said. That is above the $200 million it had expected.

Analysts and the bottlers thought that number conservative. Stifel Nicolaus analyst Mark Swartzberg estimates savings of $450 million.

Once those savings are realized, Pepsi said the deal should add about 15 cents per share to its full-year earnings. While Pepsi will incur one-time costs of about $300 million, the deal should add modestly to profit in 2010.

Although PepsiCo and Pepsi Bottling sparred over PepsiCo's initial bid, the ice apparently thawed after Nooyi met Pepsi Bottling director Ira Hall in person, a source familiar with the matter said.

Pepsi Bottling Chief Executive Eric Foss said Pepsi Bottling employees should benefit from greater career opportunities while shareholders will benefit from the deal's cash-and-stock structure, which lets them "participate in the significant upside we see in the combination."

Under the deal's terms, the bottlers' shareholders have the option to choose all cash or all stock, as long as Pepsi pays half cash and half stock in total.

PepsiCo said it will take on about $4 billion of additional debt because of the deal, but is committed to dividends and buying back shares.

Nooyi declined to say what management changes would result from the deal, leaving unspoken the fates of bottling executives Foss and PepsiAmericas CEO Bob Pohlad.

Pepsi Bottling shares jumped $2.74 to $36.36, while PepsiAmericas rose $2.28 to $28.43.

(Additional reporting by Jessica Hall in Philadelphia; editing by John Wallace and Maureen Bavdek)

GE to pay $50 mln to settle SEC fraud charges

By Scott Malone

BOSTON (Reuters) - General Electric Co will pay a $50 million civil penalty to settle charges by the U.S. Securities and Exchange Commission that it misled investors with some fraudulent accounting in 2002 and 2003.

The SEC found that the largest U.S. conglomerate had intentionally wrongly accounted for some commercial paper hedging activity and the sales of railroad locomotives, in an effort to make its financial results look better.

The world's largest maker of jet engines and electricity-producing turbines said on Tuesday it did not admit or deny wrongdoing as part of the settlement.

"GE bent the accounting rules beyond the breaking point," said Robert Khuzami, director of the SEC's Division of Enforcement. "Overly aggressive accounting can distort a company's true financial condition and mislead investors."

Two other accounting irregularities, regarding how GE accounted for swap derivatives and for how it recorded profit on sales of spare parts for jet engines were negligent, but not intentional violations, the SEC found.

The news comes a day after the SEC, which got a new head in Mary Schapiro in January, reached a multimillion-dollar settlement with another major U.S. company, Bank of America Corp. The bank said it had agreed to pay $33 million to settle SEC charges that it had made false statements to investors about bonuses when it took over Merrill Lynch & Co.

MASSAGING NUMBERS

The SEC said in court papers that GE had met or exceeded analysts' profit targets in every quarter from 1995 through 2004, but said that its top accountants signed off on improper decisions to make its numbers look better.

"On four separate occasions in 2002 and 2003 ... high-level GE accounting executives or other finance personnel approved accounting which was not in compliance with Generally Accepted Accounting Principles ("GAAP") so as to increase earnings or revenues or to avoid reporting negative financial results," the SEC said.

"In one instance, the improper accounting allowed GE to avoid missing analysts' final consensus EPS expectations," the regulator said.

KPMG, GE's auditor, was not named in the court papers.

GE shares were flat at $13.72 on the New York Stock Exchange.

The company has already restated some financial statements from 2005 through 2008 and said no further restatements would be needed.

"We have concluded that it is in the best interests of GE and its shareholders to resolve this matter and put it behind us," GE said in a statement. "The errors at issue fell short of our standards, and we have implemented numerous remedial actions and internal control enhancements to prevent such errors from recurring."

In addition to the $50 million penalty, GE said it had incurred about $200 million in related legal costs.

"It did cost them a quarter of a billion dollars over the years, so it is good to have it behind him," said Edward Jones capital goods analyst Matt Collins.

GE had a long streak of meeting or beating analysts' forecasts, dating back to its prior chief executive, Jack Welch. Its record broke in April 2008 when the company reported an unexpected drop in profit during the early days of the financial crisis.

Since then, GE has stopped giving Wall Street specific per-share profit targets, instead providing a "framework" of how it expects its individual units to perform. Collins said the era of GE's laser focus on hitting Wall Street's targets may have come to an end.

"Those days are fading," Collins said. "With the collapse at GE Capital and the global recession, you just don't have any levers left to pull. I think earnings quality should improve from here on."

(Reporting by Scott Malone, editing by Gerald E. McCormick, Maureen Bavdek, Leslie Gevirtz)

PepsiCo deals a welcome windfall for investors

By Jessica Hall and Doris Frankel

PHILADELPHIA/CHICAGO (Reuters) - PepsiCo Inc won over its two largest bottlers by raising its takeover offers more than 20 percent to $7.8 billion, giving investors a welcomed but not unexpected windfall.

PepsiCo said it will pay $36.50 per share for Pepsi Bottling Group Inc and $28.50 per share for PepsiAmericas Inc. That is up from its April bids of $29.50 per share for Pepsi Bottling and $23.27 per share for PepsiAmericas.

"The market was betting on mid-$30s price for Pepsi Bottling and a mid-to-high-$20s price for PAS, so the final offer is actually at or slightly higher than expectations," said one arbitrageur who declined to be named because he was not authorized to speak to the media.

"PepsiCo had tried to argue that its previous bids were 'full and fair' but now the offers finally are close to that," the arbitrageur said.

PepsiCo, which already owned stakes in the bottlers, said buying the remaining shares it did not already own would consolidate 80 percent of Pepsi's North American beverage volume. That would speed the decision-making process and eliminate friction between the companies, PepsiCo said.

The shares of both Pepsi Bottling Group and PepsiAmericas had been trading above the initial offer price, indicating investors expected a higher offer to emerge.

"The share prices of both Pepsi Bottling Group and PepsiAmericas since the original buyout offer in April reflected that Pepsi would come back with a higher bid," said Paul Foster, an option strategist at Web information site theflyonthewall.com.

"Large share price gains were already built in both Pepsi Bottling and PepsiAmericas after the deal was rejected in May and thus, option traders refrained from participating because the takeout valuations were already built in."

The existing option contracts held by investors in Pepsi Bottling are concentrated on the $30 and $35 call strikes granting investors the right to buy Pepsi Bottling shares at $30 and $35 apiece, respectively, by August expiration.

On the put side, the contracts outstanding lie in the strikes allowing investors to sell PBG shares at $25 and $30 a piece, mainly by September expiration.

The August calls at the higher strikes of $30 and $35 indicate the impasse between the companies, "that the current board (PBG) would not agree to a $29.50/ share price and a premium would be required," said Steve Claussen, chief investment strategist at online brokerage OptionsHouse in Chicago.

The put activity, especially in the September $25 put strikes with 12,354 outstanding contracts, represented the fear Pepsico would walk away and, "the Pepsi Bottling share price would crumple as the company has a ton of debt and its valuation without the deal would likely be much lower," Claussen said.

"Given that today's premium over the prior bid was 20 percent and the PBG stock is up only 8.3 percent on the acceptance of the increased bid, this is not a huge surprise to the market," Claussen said.

The negotiations concluded faster than some investors expected, however.

"We expected this to drag on past Labor Day, so this is a nice surprise. The deals aren't expected to close until late '09 or early 2010, so the time value of money reduces the premium a bit. But it's still a bump from what we expected," said a second arbitrageur, who declined to be named.

The deal is expected to create annual savings of $300 million by 2012 and add about 15 cents per share to its earnings when the savings are fully realized in 2012, PepsiCo said.

"The accretion and synergies are below our expectations, but that may change as they get further along with the consolidation process," the second arbitrageur said.

(Reporting by Jessica Hall and Doris Frankel; editing by Andre Grenon)