Profit E-Magazine Issue 97

Readers Say When prices are low, they can take credit for it. It can be used to score political points and it also gives the impression that they are doing something for the people. It is easier to hold large meetings to set the petrol price rather than making actual reforms. There isn’t enough room in the budget for reforms anyway. If they deregulate prices and also allow imports, then there may still be shortages from time to time until the market corrects itself, but crucially it will not be our leaders’ fault. Conversely, when things are going well they won’t be able to claim credit for ensuring cheap and smooth supply of fuel! Apropos: Why do we keep having petrol shortages?

Anonymous, Website The same principle should be applied whenever inquiries are conducted in Pakistan's public sector. The accused (individual or institution) shouldn't be asked to investigate their own malpractices. This also goes for the judiciary by the way, which means the Supreme Judicial Council. Having said this, our government, regulators, legislatures, and the news media should start paying more attention to the reports put out by the Auditor General of Pakistan. Probably the only independent and trustworthy public sector watchdog in the country And yes, NAB is useless. Apropos: Why do we keep having petrol shortages? @K_Iroy, Twitter Great analysis by Ariba Shahid. Let’s summarize it another way: Oil shortage was primarily an issue of Governance. The Government was supposed to not ban imports in panic. Apropos: Why do we keep having petrol shortages?

S M Naeem Nawaz, Twitter A very in-depth analysis and an article worth reading. I think these statistics were something which everyone is looking for nowadays, especially in order to get their business strategy plans in order accordingly. Eager to look at such amazing insights from other industries as well.

Great work indeed. Apropos: Survive or Thrive – how eCommerce reacted to C19 lockdown Haidee, Website,

facebook.com/Profitpk twitter.com/Profitpk linkedin.com/showcase/13251020 profit.com.pk profit@pakistantoday.com

HOW TO CONTACT

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A very detailed and interesting read. Current ecommerce scenarios are excellently summed up in this article. The facts like organic traffic surge, revenue growth, more and more vendors being interested in ecommerce, local brands are coming up in the e-commerce market more aggressively through marketplaces.

This ecommerce growth is here to stay, but we

need to be innovative. We have to move from conventional ecommerce. Probably in the next article, we can look into innovative initiatives taken from e-commerce players. We also need to see how we can leverage the platforms which are badly affected due to this COVID period. One of these is the ticketing channel.

Apropos: Survive or Thrive – how eCommerce reacted to C19 lockdown Tanvir, Website The bank is now on a strong footing, A bank of small scale, that too a microfinance bank, digesting such heavy loss and still getting investments means it has a high brand value and strong product and customer confidence.

Exponential growth even after such incidents, which cause financial and reputation loss to the bank, is proof of good controls.

Apropos: Telenor Microfinance Bank reports Rs16.3bn loss for 2019 Anonymous, Website Gentle questions from telenor Management’s: 1. Has all corruption been done by the lower staff of the bank? 2. Why have those officers been terminated whose responsibility was to review the reports carefully before submission?

3. Did telenor not plan to close its branches in 2020 and digitize the system? Then why telenor bank terminated employees and destroyed their future? 4. Isn’t it true due to non-updation of the system, the customer's information issue stands? 6. Isn’t it true drivers, guards and peons were made BOs against state bank policy? If All the questions mentioned above are true, then who is responsible for financial and reputation loss? Apropos:Telenor Microfinance Bank reports Rs16.3bn loss for 2019 Abdul Haque, Website It seems totally ridiculous.Workers of Telenor bank have had to demonstrate their protest against the management, which made a wrong decision that affected thousands of employees nationwide. They are compelled to starve along with their families, and the telenor CEO is showing ‘generosity’ and pretending to care.

Telenor bank is doing an economic massacre of its employees in Pakistan, ruining their future and life on the basis of so called investigation.

Telenor Pakistan and Norway seem to be blind, they can’t see and observe workers protesting on social media, and in newspapers. Workers are asking for their rights, but telenor management is deaf to their voices. Apropos: Telenor Microfinance Bank reports Rs16.3bn loss for 2019 Anonymous, Website

COMMENTS

CONTENTS

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10 Inside the secret $1.5 million stealth direct-to-consumer startup from Unilever Pakistan 14 TOMC takes the IPO route to raise cash for working capital, and for expansion

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18 Why (and how much) Pakistanis overinvest in real estate 24 The True Cost of Cash on Delivery (COD)

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28 Pharmaceuticals in Pakistan: extracting whatever they can from the pie

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32 OGDC’s new discoveries start adding to company’s bottom line

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33 Despite the SBP’s best efforts, lending has stayed flat over the past year

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36 Does KAPCO have life beyond its PPA expiration? Some analysts think so 37 Growing pains: Unity Foods raises equity to finance working capital needs

IN BRIEF Bad times won’t end: Telenor Microfinance Bank announced a loss after tax of

Rs16.35 billion

in 2019, after reporting a loss after tax of Rs2.51 billion in 2018.

Lahore-based health-tech startup ‘emeds. pk’ successfully secured $250,000 in seed funding from a London-based firm. emeds.pk is a digital pharmacy that delivers medicines to customers.

“We will provide additional 100MW electricity to K-Electric to overcome loadshedding” Minister for Power Omar Ayub Khan

Halal meat exporter The Organic Meat Company closed the book building process of its IPO this week.

The company is to offer 40 million shares, or 35.7pc of its stake in the IPO, at a floor price of Rs18 per share.

The State Bank of Pakistan cut the interest rate for two of its refinance schemes from

6% and 7% to 5%, in an effort to boost long-term investment in domestic and export-oriented sectors.

Bus-sharing service Swvl had a security breach on July 3, wherein customer data such as names, email addresses and phone numbers were compromised. An investigation into the matter is still ongoing.

Schools and universities are to reopen from

September 15, according to Education Minister Shafqat Mahmood. The decision will be reviewed in August again.

Luxury fashion brand Hugo Boss placed its first order of sportswear to a Pakistani company.

The German brand is most well known for its men’s suits.

Pakistan’s death toll from the Covid-19 pandemic has crossed the

5000

mark. There are now 243,000 cases of the virus recorded in the country.

Friendly neighbours: China is to provide

$4 million worth of training equipment for vocational training institutes and schools across Pakistan.

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WELCOME

Getting our act together

It was only a matter of time, we suppose. Last week, the United States joined the European Union in banning Pakistan International Airlines (PIA) flights from entering its airspace and landing at its airports. The move from both regions came as a response to the revelations in Parliament that approximately one-third of pilots employed by PIA do not have real licences and instead are relying on fake credentials.

The harsh reality is that Pakistan – it really is not about just PIA – is stuck in this morass because we, its citizens, choose for it to be this way. We would rather win silly ideological battles – again, based on no real expertise because who the hell bothers to actually study policy matters in depth – rather than allow an idea that we did not come up with, or did not favour, to succeed.

We would bemoan the usual incompetence at PIA and the government, but what disturbs us is the extent to which the debate around how to move forward is completely stuck in Pakistan: everyone agrees that PIA is awful and something must be done, but the minute even a single solution is proposed – regardless of what it is or which ideological orientation it comes from – it will engender not just opposition, but venomous vitriol, which will seek to malign the idea as the height of amorality.

We say this in the context of the fact that every decision the current administration has taken with respect to dealing with the sclerotic mess that are the state-owned companies in Pakistan, they have encountered opposition so intense that they have had to withdraw their proposals. Of course, it does not help that the current administration is almost entirely spineless on anything that matters. But surely, there could possibly be one idea that people might express anything less than the most stringent of opposition.

Why are we so dug into fixed ideas – based on no real expertise, by the way – on everything? Why is discourse on matters of policy in Pakistan so poisonous and unproductive? Why can we not share ideas with each other and learn from each other, iterating and improving our ideas during the course of a constructive conversation?

Surely we are not quite that divided? Or perhaps it is we, the writing staff of Profit, that are delusional.

Farooq Tirmizi Managing Editor

Executive Editor: Babar Nizami l Managing Editor: Farooq Tirmizi l Joint Editor: Yousaf Nizami Reporters: Syeda Masooma l Taimoor Hassan l Abdullah Niazi l Meiryum Ali l Hassan Naqvi l Shahab Omer Director Marketing: Zahid Ali l Regional Heads of Marketing: Muddasir Alam (Khi) Zulfiqar Butt (Lhr) l Mudassir Iqbal (Isl) l Layout: Rizwan Ahmad l Photographers: Zubair Mehfooz & Imran Gillani l Publishing Editor: Arif Nizami l Business, Economic & Financial news by 'Pakistan Today' Contact: profit@pakistantoday.com.pk

FROM THE MANAGING EDITOR

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By Babar Khan Javed

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t the start of the pandemic-induced lockdowns, a meme started doing the rounds among professionals on LinkedIn: “Which of the following has done the most digital transformation at your company or industry? The CEO, the CTO, or Covid-19?”

There are of course exceptions and in this case, executives at Unilever Pakistan had set out to address a large problem statement in Q4 2017 around playing a larger role in the direct to consumer (DTC) space around its Wall’s business division. Following a hackathon with NEST IO in March 2018 and the similarity of ideas that reinforced the value of the approach, the idea became a joint venture between Unilever Pakistan and VentureDive by mid-2018, with the beta version rolling out in mid-2019 to a select number of users. According to sources familiar with the matter, the initiative was

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granted $1.5 million in internal funding. By Q4 2019, plans were in place for the initiative to be assigned a dedicated team across operations and marketing. Going after the snacking category market - valued at €1.6 billion according to a spokesperson from Unilever Pakistan, the idea is a snack delivery app called Munchies.

And it has been operating in stealth mode ever since, with 40 thousand total downloads, averaging 12 thousand monthly active users, and an unknown average revenue per user.

The app first came to the attention of Profit after several LinkedIn posts advertising the role of Growth Manager at VentureDive for a product called Munchies. Across both Google Play and the Apple Store, the app points to VentureDive as the creator with no indication towards Unilever in any manner. During its investigation, Profit looked at all app update logs and marketing materials going back to Q1 2019 to reach the conclusion that the app has ties to Unilever Pakistan. The overabundant presence of Unilever’s dehydrated mixes and frozen desserts portfolio across both Facebook and In-

stagram also confirmed this hypothesis. Profit reached out to Unilever Pakistan and interviewed both Zaeem Khan, digital transformation manager at Unilever Pakistan Limited and Saad Fazil, co-founder & managing director at VentureDive to understand the business case, operating model, portfolio mix, revenue model, pivots due to C19, and the macro-challenges faced on a daily basis.

“At the Unilever end, we look after the operations - which is the fleet - and the marketing of the platform with the team that we have,” said Khan. “With VentureDive we look at the growth aspect with VentureDive looking at the technology and product lens apart from creating and refining the ecosystem overall.”

Speaking to Profit, Fazil said that while structurally there is a distinction between Unilever and VentureDive, both companies work as one unit around Munchies. A spokesperson declined to comment on the joint venture status of Munchies, adding only that the structure would be formalized and finalized in the future.

“We are scaling very fast so there are things which tend to get delayed. As we were rolling out in Karachi, marketing channels were not very hyperlocal so in Karachi everyone would know about the Munchies app and when they opened it, it didn’t give them the option of delivery if they were outside the planned localities” Saad Fazil, managing director at VentureDive

Justifying a $1.5 million investment for delivering snacks

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peaking with Profit, Khan shared that the digital transformation team is, a relatively new department at the global consumer goods business and has been tasked to modify existing processes, experiences, and workflows to meet the new normal and experiment with new revenue streams initiatives. One of these initiatives is Munchies, which Khan said he has been looking after since December 2019 to disrupt the snacking delivery market in a very nontraditional way. “[Munchies] started way back end of 2017,” said Khan. “It was an idea that was actually conceived by our vice president of customer development at that time, now our CEO, Amir Paracha. We were actually thinking of avenues of implementing new channels for our ice cream business, that’s where the thought process really initiated. With ice cream in Pakistan, it’s a very traditional retail-based model with a slight pivot to our bike model. Like any snacking product, one of the key fundamental requirements is instantaneous fulfillment of any snack craving that you have which is triggered by the advertisement that we do on TV or on digital.”

Khan told Profit that instant fulfillment was missing in the ice cream scenario, with interested buyers left to either go to the nearest store to buy the product or to wait for the Wall’s bicyclist, Unilever wanted to create a digital direct to consumer platform wherein the product is delivered to the customer doorstep within 30 to 40 minutes. Over time, the team looking after this initiative realized that instead of zoning in on selling one product category, it was far more prudent to launch a marketplace.

“We did not want to enter the grocery market as well, because like you’ve seen post C19 there’s been a lot of entrance and space is heating up,” said Khan, adding that the team settled on the documented & branded

snacking market, which Profit was told is a €1.6 billion growing at a compound annual growth rate of around 12pc year on year. “It’s growing faster than overall grocery - we have these huge manufacturers who are investing a lot in growing the market so we really saw this as digital whitespace, where if we create an online marketplace which is snack relevant only - with the promise of instant fulfillment within 20 minutes - and that is something as the days go by, we are trying to cut down on it.”

Khan told Profit that the decision to work with VentureDive came from an internal realization that Unilever lacks the technological know-how to create an algorithmically powered marketplace on its own. After a meeting between Peracha and the co-founders of VentureDive in 2018, the joint venture began to create an ecosystem that satisfies any snack craving in a very short period of time.

For Unilever, this investment ranks as one of its foremost digital transformation investments, with Khan sharing that the official launch was around May 2019 representing the alpha testing phase in product rollout.

By Q4 2019, Unilever made five dedicated internal appointments for Munchies: Faiza Shafqat, Zaeem Khan, Humza Mahfooq, Muhammad Nehal, and Muhammad Saqib Pervez as the end to end operations lead, digital transformation manager, marketing lead, project resource, and the end to end operations manager respectively. During Q4 2019, Munchies made ten thousand deliveries according to people familiar with the matter and executed a robust fleet management strategy that has dropped the estimated time of arrival from two hours to under 30 minutes.

The operating model - when testing met learning

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uring the alpha testing phase of Munchies in mid-2019, the operating model consisted of an app for the retailer to ensure stock

fulfillment was 100pc accurate. In this model, after an app user placed an order, a nearby retailer would be informed and after confirming the existence of the desired product, he would confirm within the apps user interface, whereupon a delivery person would come to pay and pick up the item for delivery.

“Our fleet model at that time was more of a crowdsourced model and not a dedicated model. Also, [at the time], Munchies was so small that a lot of retailers didn’t even bother accepting the order,” said Khan. “We faced a lot of difficulties in that so we decided to let go of the retailer app, keeping it simple by selecting outlets based on a survey which desired a 90pc accuracy that SKUs on the app were available.”

Learning from this, Munchies currently operates on a dedicated fleet hyperlocal model - doing so since November 2019 - that depends on predictive algorithms directing delivery personnel to the retailers that are most likely to stock the product being ordered. A probability model created by VentureDive makes an educated guess on which nearby delivery person is the best fit to reach the retailer that has the request stock-keeping unit (SKU) and prioritizes & takes into account the least possible time from order demand to order fulfillment.

“Initially we started in DHA, Clifton [Karachi] for the longest time for the first three months that was our pilot,” said Khan.

“Got a good response there, we expanded to PECHS, Bahadurabad, and right now we are covering around 80pc of the consumer community in Karachi including Gulistan e Johar, Gulshan Iqbal, Garden Town, Soldier Bazar, North Nazimabad, FB Area, and so forth.”

Aside from revamping the workflow after a customer places an order, Munchies shifted from a crowdsourced fleet model to a dedicated model, initially thinking that work-

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Munchies branding

ing with Foodpanda and Careem would be enough, realizing later that Munchies would need build equity to attract delivery bikers in downloading the app. Since November, Munchies has a dedicated fleet with a fixed and variable salary that is focused entirely on the snacking app. A source familiar with the topic told Profit that the dedicated fleet consists of 300 personnel, which spokespersons from Unilever neither confirmed nor denied.

The portfolio model expanding beyond the core

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hile the intention of the Munchies marketplace was to list frozen desserts, mixes, and beverages under the Unilever portfolio, marketing material as early as April 2020 indicates the arrival of snacking products from PepsiCo, Nestle, and Mondelez with chips, yogurt, biscuits, and chocolate joining the fray.

“We actually did not approach these companies and add them - it was the other way around,” said Khan. “We did send out a feeler, with subtle approaches to these organizations.

Officially, I think, around February [2020], we approached [these companies] because we wanted to have a proof of concept in terms of how well this is received from a consumer point of view.”

When asked whether Munchies would be open to list products from direct category competitors - such as the frozen desserts from

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Engro Foods or instant noodles from Nestle - respondents from Unilever shared that the initiative is still in its most early stages and the decision to list a direct category competitor is still unknown. Interviewees also declined to share whether participating CPG businesses had demand category exclusivity, such as PepsiCo demanding to have the sole vendor listed for the chips category.

The revenue model, burning cash for growth

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s stated, Munchies claims to have a dedicated fleet for product delivery, compensated through a fixed and a variable salary. When a user places an order - say for PKR 10,000 in products the rider visits the assigned retailer, hands over the PKR 10,000, and delivers the items in record time to the interested buyer, who in turn pays either an additional PKR 50 or PKR 150 for the delivery itself. Including the costs around marketing and technology refinement, the fixed overheads for the business unit far outweigh the recurring revenue stream.

While spokespersons from Unilever declined to share the strategy and future models for creating project profitability, it was inferred by Profit that there is a larger data play at hand, wherein the project serves as a chance for Unilever to create its own D2C digital business which is relatively cheaper than a billion-dollar acquisition and own first-party customer data, an area it struggles

with [details in the forthcoming CPG study] along with the larger CPG ecosystem in Pakistan.

“Right now it’s very early days, we want to grow first, create value,” said Khan. “We want to gain a lot of consumers, we want to gain our brand equity, and that is the first stop. Yes, models around revenue/profitability will be built as we go along, We do not charge a premium, just a delivery fee, and not share any margin from the retailers.”

C19 has entered the chat

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han told Profit that C19 impacted Munchies because retailers ordered the shut shops at the time of the day when snacking orders were at the highest, based on existing customer behavior data. In response, the team dedicated to Munchies experimented with mini-warehouses to fulfill orders after stores are shut down.

“Initially, when we didn’t have that warehouse it really affected our demand,” he said, adding that since May 2020 the business unit expanded pivoted drastically, adding essentials such as antiseptic soaps, which is arguably against the snacking delivery ethos envisioned by Unilever for the platform.

Across the Google Play Store and Apple App Store, the app has a 3.6 rating and a string of negative reviews, the lion’s share of which refer to the period following C19 and the lockdowns. The complaints range across

app loading speed, false advertising, lack of pricing incentives, and limited delivery range.

“We are scaling very fast so there are things which tend to get delayed,” said Fazil.

“As we were rolling out in Karachi, marketing channels were not very hyperlocal so in Karachi everyone would know about the Munchies app and when they opened it, it didn’t give them the option of delivery if they were outside the planned localities.”

Fazil insisted that a big percentage of Karachi that was not covered even a month ago, adding that the app now covers nearly 80pc of the city, and is confident that the stated issues will be addressed and the reviews turned around in a very short amount of time.

Teething problems and challenges

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rom a technological standpoint, the perfect execution of the operating model would ideally involve an accurate understanding of the inventory at every major large, medium, and small retailer within the coverage range. This would involve a high level of product cataloging and point of sale tracking, augmented with application programmatic interfaces connecting fleets owned or crowdsourced - through a reverse auction to determine the best fit retailer and delivery service. Unilever, through VentureDive, has none of these capabilities.

“We don’t know the products the store is carrying,” said Khan. “We select stores based on the probability of the SKUs that are on Munchies, we don’t have inventory linked or integrated with our platform. One of the key areas we will have to improve, moving forward, is availability for our consumers.

That is part of the pipeline because we are asset light, we have to be dependent on inventory and our algorithms due kind of give us a read on the historical data based on which hub is suitable in terms of availability and its not 100pc accurate.”

Fazil told Profit that his team uses big data and data science to predict the likelihood of a product being in stock and by how many units. He said that the algorithm created by VentureDive does try to pick a store and route that has the best chance of fulfillment.

Respondents to the forthcoming CPG study by Profit shared that the combined frustration of working with online marketplaces and the need for supply chain optimized owned channel at scale resulted in an internal business case to partner with Brandverse, a D2C infrastructure solution for product cataloging that populates branded sites with high-quality images, content, and integrations with an agile fulfillment network, including pick-up points determined through a reverse auction. Fazil told Profit that while he was

aware of Brandverse and its ability to solve the problems faced by the Munchies initiative, he would not confirm whether the company would be hired to help Unilever tackle these challenges in its D2C infrastructure.

“As you scale, you have to ramp up quality and ETA,” said Fazil. “We focus on a balance of low ETA with best service, I think the challenge will be as we scale very fast how do we keep the same ETAs, same service quality? So far so good, that’s something that keeps us up at night.”

Why do CPG companies experiment with the D2C model?

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hen Unilever acquired the widely popular and deeply unprofitable Dollar Shave Club for $1 billion in 2016, it served as a direct signal to a long time rival P&G that it was going up against Gillette and was vital for acquiring the type of agile talent that have formed small businesses that are eating market share of the larger, slower market leaders. Unilever paid $1 billion to own what was 16pc of the shaving market at the time and benefited with a technology-oriented brand to teach its own budding intrapreneurs the building blocks of a D2C enterprise.

In a paper titled “COVID-19 and Global Commerce: An Analysis of FMCG and Retail Industries of Tomorrow”, researchers from the Devi Ahilya University - Institute of Engineering and Technology said that CPG companies struggled to serve the market demand at the panic buying phase-in the last weeks of March and the first half of April, due to disruptions in their supply chain. As stated in the Profit CPG study, this includes sourcing raw materials, manufacturing, till lastmile distribution. With lockdown and travel restrictions, companies are still producing at sub-optimum levels and pushing sales of only essential items.

“Though D2C has not been a new model, many companies [that] followed traditional supply chain models had no plans of adopting the D2C model,” said the researchers. “In D2C, the FMCG company would try to eliminate all the intermediate levels between itself and the consumer. These levels would have distributors, wholesalers, etc.

The company would try to directly reach the retailer or the consumer.”

The frozen desserts business at Unilever Pakistan already has two direct to consumer (d2c) concepts - nearly five thousand bicyclists for Wall’s and the limited presence of the Magnum Store at select malls or prime

locations. The dehydrated mixes and beverage business at Unilever Pakistan have ‘Snack Up’ stations and vehicles that serve Knorr and Lipon at tourist spots across the Khyber Pakhtunkhwa province, offering residents and visitors instant soups & noodles including tea.

The activation allows companies like Unilever to demonstrably position their products with prospective customers and initiate repeated trials, at the buyer’s expense.

When the share of the throat - the measure by which companies such as Unilever determine category-specific market share - trumps profitability, the D2C model has been pushed by leading CPG companies.

Challenges of the D2C model

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ccording to an analysis by Profit of data from the Pakistan Bureau of Statistics’ Household Integrated Economic Surveys, the retail industry is worth $125 billion a year, of which $48 billion are just groceries. As the CPG survey by Profit repeatedly states, the most common challenge faced by CPG companies in Pakistan, following the C19 lockdown, was redirecting an inflexible set-in-stone supply chain apparatus to be agile and that too with eCommerce in the mix.

Simply put, the set-in-stone supply chain infrastructure that CPG companies have come to rely on for millennia has no room for flexibility nor agility, evidenced by the rapid bottlenecks created within just one day of the C19 lockdown. As explained in a supply chain report from Profit, the retail supply chain in Pakistan depends on four stakeholders: manufacturer, distributor, wholesaler, and retailer.

Unilever is a manufacturer and it sells to large retailers and distributors. Carrefour, Metro Cash & Carry, and Imtiaz fall into the former category due to affording direct relationships with CPG companies due to their scale and their size, resulting in buying products in bulk. The latter category sells to retailers and small wholesalers, which can be small retailers or even kiryana stores.

“It is possible as a retailer to have all three places to choose from,” said the authors of the Profit supply chain report. “It could have a direct relationship with a manufacturer for some products (usually unlikely), and it could also maintain a vast network of distributors for some goods. It can also buy from a small wholesaler. Many kiryana stores also buy not just from small wholesalers, but from the large retailers themselves. This is how one often sees quasi-distributors, shopping in bulk at places like Carrefour, alongside other customers.” n

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By Hassan Naqvi and Meiryum Ali

gricultural economies are often confused with agrarian ones. The former include all kinds of agriculture, including livestock, while the latter specifically has to do with the cultivation of land. While Pakistan is definitely high on the agrarian agenda, it is an agricultural economy, and one dominated by the livestock sector.

According to the Economic Survey of Pakistan for fiscal year

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2020, livestock contributes around 60% to the total agriculture sector, 11.7% to total Gross Domestic Product and 3.1% to Pakistan’s exports. Even though Pakistan is clearly a large meat producer, it only ranks 18th in world meat exports, and only serves 3% of the global market.

Hoping to improve those numbers and become a major player in the halal meat industry in the process is The Organic Meat Company (TOMC), one of the largest halal meat processors and exporters in Pakistan.

Only last year, the company’s sales accounted for 7% of Pakistan’s meat exports.

With a growing Muslim population around the world, and more and more countries adopting halal meat generally, the currently $3.4 billion dollar industry is expected to grow by another 6% in 2020. Pakistan has generally faced stiff competition from meat exporters based in Australia and Brazil. However, TOMC will be looking to expand and get a significant slice of this growth in the market.

The company is well-placed since it has the largest export market access from Pakistan, and frequently exports to markets like the Gulf Cooperation Council (GCC) countries, Malaysia and parts of Europe and Central Asia.

To this end, the company made the year’s first initial public offering (IPO) in late June, and closed their book-building phase in early July, ending up with an oversubscribed IPO. The goal is to use the capital for the investment heavy industry, and to expand at the same time. But is it a good buy, and more importantly, what does it mean for Pakistan’s meat industry? Profit takes a look.

the only company which is currently exporting to the Middle East region via sea. It is also the only company working outside of these traditional markets, and looking to export to Far East, China, Russia, and even former Soviet countries like Ukraine.

According to a recent report by Business Recorder, TOMC is already nearing the $20 million figure in annual exports, with a double digit average annual growth rate over the past five years. This is compared to the rest of the industry, where gross value addition of livestock segment has grown from Rs1.3 trillion to Rs1.5 trillion at a 5-year average growth rate of 3.2%.

Why then did TOMC need to raise money? For starters, the nature of the meat industry is risky. The livestock is acquired through upfront cash payments, but the buyers of the meat expect to be extended credit that can run for several months at a time.

This means that historically TOMC has depended on short term borrowing from various banks for working capital requirements.

Currently, TOMC has short term borrowings of Rs718.7 million. However, the currency devaluation forced the company to consider reducing its dependence on banks.

It can thus be expected that the company will use a good portion of its IPO collections towards working capital needs. In fact, of what the company was hoping to raise from the IPO, two-thirds are expected to be used for working capital. But as the Recorder report also points out, “if fully subscribed, TOMC may boast one of the most solid financials within the meat processing segment.”

The impressive numbers

IPO structure

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he company has been billed as a success story. The halal meat processor and exporter, was incorporated in 2010 and commenced operations in 2011. Initially, it only had two products, and a capacity of three tonnes per day for beef, and five tonnes per day for mutton. Currently the company has a daily production and chilling capacity of 75 tonnes per day.

With four product categories – frozen meat, vacuum-packed chilled meat, fresh chilled meat, and offal – the company owns a 9.8-acre slaughterhouse and a processing facility in Gadap, Karachi, with sufficient animal holding area for 2,000 goats and sheep and 2,000 cows. Its current slaughtering capacity stands at 60 heads per hour for beef and 120 heads per hour for mutton. The company has a daily production and chilling capacity of 75 tonnes per day and currently has the approval to supply products to 16 countries.

TOMC claims it is the only company which deals in white offal products and also

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n an IPO, a company offers shares to the public in return for capital it can use, usually for expansion or operational purposes.

Book-building refers to a period when the IPO is open and bids are collected from investors at various prices, which are above or equal to the floor price. After this, an offer price is determined, that is used for shares to the general public.

In the case of TOMC, their bid for IPO will be both for operational and expansion purposes. During this period, they auctioned 40 million shares in the book building process from July 3 to July 7, 2020. This was Pakistan’s first IPO after 15 months, and has finally closed its book building process. They were offering 35.8% of post-IPO paid up capital of 112 million shares at a floor price of Rs18 per share to raise Rs720 million.

Despite the coronavirus-led economic contraction, investors’ response was far better than expectations. Bids of Rs1.4 billion received in the first phase of offering to qualified investors. About 68.1 million shares bid was

received for 40 million shares, which means it was not just fully subscribed, but oversubscribed by 1.7 times, with retail offering set to happen this week.

“There is always demand for quality businesses run by experience management,” said Muhammad Sohail, who was consultant to this deal. “Despite the economic contraction and lockdown, we saw good participation by local and foreign investors, which bodes well for future IPOs at Pakistan Stock Exchange (PSX).”

What’s TOMC going to do with the money?

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art of the Rs720 million goal was to be used for two specific facilities. The first is an offal processing facility in Korangi to process locally collected offal, costing about Rs167 million. The second is an offal production facility at Karachi Export Processing Zone (KEPZ) for exports to China and Vietnam, costing around Rs104.4 million.

The remaining funds will be used to increase TOMC’s product portfolio.

Offal is the viscera and entrails of a butchered animal. Essentially the products made from the innards and remains of livestock that are not from the traditional, clean, ‘meat’ cuts. More significantly, TOMC proudly says that it is the only company that deals in white offal, which includes the harder to process but more in demand parts such as the brain, spine, bone marrow, etc.

The company also has another offal processing unit in Korangi with investment of Rs167.2 million to process locally procured offal. The remaining proceeds will be utilized for working capital purposes and further enhancement of TOMC’s product portfolio.

The principal purpose of the issue is to increase offal processing capacity by setting up 2 new facilities it will take up the offal processing capacity from 5TPD to 25TPD. The company has mentioned one of the main purposes of the IPO is to generate funds to finance TOMC’s expansion plans. The company intends to enhance its processing capacity in the ‘high-margin’ offal category.

Post expansion the offal processing category is expected to rise by 5 times to 25 metric tons.

Industry overview

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espite having immense potential, Pakistan’s meat industry has not shown significant growth in recent years due to FMD (Foot to Mouth) disease, lack of traceability (farm to fork), and lower yield (usable meat obtained from carcass). Lack of traceability mechanism makes it difficult for local exporters to penetrate the European Union as a market.

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“TOMC will become a choice investment for many very soon but at a much higher rate. To be honest, I really don’t understand that our floor price is based at a PE of 4.56X and any performing food sector entity should be valued much highe” Faisal Hussain, CEO TOMC

Pakistan’s meat and edible meat offal segment exports stood at $242 million in fiscal year 2019 as compared to $211 million in the previous year, an increase of 15%.

Muhammad Shahroz, research analyst at Insight Securities, a brokerage firm estimates that Pakistan’s meat exports are expected to grow by 25% in fiscal year 2020 in US dollar terms. The domestic meat sector is dominated by different players mainly Al Shaheer Corporation, Fauji Meat, PK Livestock, Al Tazij Meat, Anis Associate etc. Al-Shaheer Corporation and Fauji Meat are both also publicly listed companies.

Of these, TOMC’s major competitors is Al Shaheer Corporation (ASC) which has a presence in the export as well as domestic market, through its Meat One and Khaas brands.

Analysts at BIPL Securities, a brokerage firm, state that ASC’s presence in the local space has translated into higher gross margin for ASC compared to its export-only competitors.

Despite this, TOMC has a better net profit margin than ASC. For the nine months ending March 31, 2020, TOMC’s net margin was 8% compared to 5% for ASC. Furthermore, with the addition of offal processing plants the net margin is expected to expand further.

Shahroz says that Pakistan’s major export destination is in the Middle East region.

In terms of share in total export UAE, Saudi Arabia and Kuwait are top three destinations with 37.5%, 17.7% and 13.9% share respectively

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in 2019. He maintains that China and Japan are the biggest importers of meat, having shares of 14% and 8% respectively.

“We believe export to these countries will be a real game changer for the local meat industry and TOMC is eyeing for the Chinese market,” says Shahroz.

Key Strengths for TOMC

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ccording to KASB Securities, a brokerage firm, the management of TOMC is one of the most experienced within the industry, spanning decades spread over several countries. It is the crown jewel in a fourth generation livestock processing merchant family. Faisal Hussain is the company’s CEO and the primary sponsor of TOMC with a stake of 71% in the company. He possesses over 21 years of experience within the offal processing industry and more than a decade of experience in the meat processing industry.

Hussain has pioneered several concepts within Pakistan’s meat processing industry including the introduction of vacuum packaging, which enhances the product’s shelf-life and enables exporting meat to longer distances.

As mentioned, the bulk of TOMC’s revenues originated from export receipts during fiscal 2019 (93%) with expectations of even higher inclination towards export receipts during fiscal 2020 (98%). The company has

kept an export-oriented focus enabling improved margins. The export receipts also offer a hedge against the weakening rupee, allowing the company to further improve margins if the domestic currency depreciates.

The analysts at KASB also noted that a domestic footprint is generally a costly venture with heavy competition from the informal meat market. In Pakistan, the organised meat retail outlets generally price their products around 80%-100% premium over their informal counterparts to cover their expensive overheads. This pricing discrepancy generally compels the bulk of the domestic market to stick to the informal sector, resulting in underperforming sales.

Notable risks

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eedless to say, no business venture is without its risks, and TOMC is no different. Analysts identify four key risks: the pandemic induced lockdown and their impact on supply and demand, the working capital constraints structurally built into the business model, rising domestic livestock prices, and the possibility of dilution for equity stakeholders as the sponsors convert their interest-free loans to the company into equity.

“Despite economic contraction and lockdown, we saw good participation by local and foreign investors, which bodes well for future IPOs at Pakistan Stock Exchange (PSX)” Muhammad Sohail, Consultant on TOMC’s IPO deal

The coronavirus pandemic likely to subdue demand and constrict margins:

According to KASB Securities, the coronavirus pandemic has generated notable hurdles for the meat processing industry. The outbreak and the resultant lockdowns have greatly disrupted supply chains across the globe including sharply limiting port activities.

These factors are expected to come into play for the export-oriented company. The limited sales outlook may likely compel the company to offer discounts to ensure adequate plant operations during fiscal 2021 and onwards.

Moreover, the pandemic is also expected to increase the hygiene and quality criteria for most meat export processing units including TOMC. This fact is likely to enhance the exporting costs for the industry and may limit access to certain markets. Furthermore, the Covid-19 led restrictions have greatly hampered the demand of processed meat from key purchasers, including restaurants and hotels, a scenario that significantly limits the commodity’s growth till the pandemic situation normalises.

A constrained cash-flow cycle:

The company largely procures its cattle from the informal market, which generally deals in cash.

The company, however, receives around 30% of its export receipts at the time of sale/booking while the remaining 70% is received upon the issuance of bill of lading.

This scenario creates a potential for a cash-crunch and enhances the company’s working capital requirements. Case in point, based on the company’s FY19 financials, its trade debt stood at Rs 823 million while loan advances stood at Rs293 million. For this reason, 62% of the projected IPO proceeds (Rs448 million) will be utilised for TOMC’s working capital.

Rising domestic meat prices to further augment procurement costs:

According to KASB Securities’ analysis, domestic beef and mutton prices have a very high correlation with inflation. While the rupee depreciation supports the company’s revenue receipts,

it also augments the country’s inflationary outlook, reflecting in domestic mutton and beef prices. Consequently, meat prices have grown at a 5-year average growth rate of 9%. Higher meat prices generally result in higher procurement costs and restricts margins growth.

Interest-free loans from sponsors may potentially get converted: Based on the available financials, the company has Rs159 million in interest-free loans from the sponsors on its books. These loans have the potential to become interest-bearing or have an equity conversion option after the IPO. KASB predicts that conversion to an interest-bearing loan may enhance finance costs by Rs13 million while an equity conversion option may increase the company’s outstanding shares by 9 million (8% of post-IPO shares) if converted at the floor price.

Is it a good buy?

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rsalan Hanif, an investment analyst at Arif Habib Ltd (AHL) says the management believes volumes to grow by an average of 20% in the next five years as the company is currently seeking approvals to export to China, Russia and Thailand because demand of meat related products is high in these countries and they are untapped markets. For him, TOMC, being an export-based company, conducts business in foreign currency (USD) which is providing a natural hedge against rupee devaluation.

However, when asked, some analysts say the floor price for TOMC is too high, and it should have been between Rs12 and Rs15.

TOMC’s CEO Faisal Hussain says: “TOMC had an EPS of 3.04 last year, and this year we are expecting much improved earnings, in fact we expect the earnings to continue to improve and this is the reason why we believe that if the market basis price on fundamentals.”

“TOMC will become a choice investment for many very soon but at a much higher rate.

To be honest, I really don’t understand that our floor price is based at a PE of 4.56X and any performing food sector entity should be valued much higher,” Hussain said.

When asked about any additional expansion plans apart from the one listed in the

prospectus. He says, currently, they are focused on the plan at hand, which is to successfully commission the two plants. “Once consistent numbers are driven, of course the next step would be to expand organically within our current operational areas. There is still much room for growth in these areas,” he says.

Despite Covid-19, Hussain is confident, and says that right now, household usage exports have massively increased, and the company wants to take a hold of this market until the hospitality sector gets back on its feet.

“We are getting some good responses from good prospective investors despite the pandemic situation. The business has grown, and it seems the investment community is seeing the strong fundamentals of the business, so no, we don’t believe that TOMC’s IPO was impacted.”

The international competition

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f course, as an export-oriented company, TOMC is competing on a larger level where halal meat processors from around the world are also trying to get a slice of the market. Hussain says that who the competition is becomes a very relative question, based on which product we are talking about. “For fresh chilled meat, there is no international competition for Pakistan’s meat for destinations like the Middle East. For the frozen meat segment, our meat competes with South American suppliers as our meat qualities are comparable,” he says.

“We are also halfway through having government to government protocols established with China, we reckon that in another year or so, the exports should start for mainland China.

This will be a big market for us.”

“We have tried to keep ourselves ahead of the curve through close monitoring of the international meat sector dynamics and learning from what products and processes are being followed in the developed world countries,” he says. n

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By Farooq Tirmizi

iven the surprising level of passion the subject of real estate can engender among Pakistanis, we shall start off this article by stating categorically what we are not saying. We are not saying that real estate is not a good investment and that you should not buy a home or seek to buy a home. We are not saying that you cannot make good money off of real estate. We are not even saying that other investments do not have drawbacks, or that real estate is an unstable asset.

We agree that, in general, it makes sense for people to try to

own a home, and that an investment in real estate is typically an appropriate one for most people, and even that you can make good money off of it. With all those caveats aside, let us get down to what we are saying: Pakistanis invest a little too much in real estate, and we would be better off both as individuals (in the aggregate) and as a country if we diversified towards other asset classes.

The obsession with real estate has understandable foundations and originates in a fundamentally good idea: the need to buy assets that generate inflation-beating returns. But it has gone too far and is now starting to create a drag on economic growth, investment opportunities, and housing affordability.

In our analysis of the Pakistani real estate sector – which is

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notoriously difficult to find reliable data for – we have found the following: first, that it has generally been a reasonable investment for most (but not all) people who have invested in it. Second, that Pakistanis invest too much in it, and we have multiple measures to indicate that the investment in real estate is too high.

Thirdly, we found that the over investment has consequences for real estate affordability, not just for low-income households, but for all households except the wealthiest. And lastly, we have found that all of the advantages of a real estate investment can be replicated using other, more economically productive investments as well.

One big caveat that readers should be aware of before reading this story: the author is the founder of a fintech startup that seeks to provide investment advisory services to

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individuals in Pakistan. While none of this article is meant to be a solicitation of investment advisory services, you should be aware of the incentives and potential conflicts of interest of the person whose writing you are reading.

With that, let us dig in.

Real estate as an investment

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t is tempting to look at the data (whatever little is available on the sector) and conclude that something irrational is going on. Prices are much higher in Pakistan relative to average income levels across almost the whole country, rental yields are abysmally low for both residential and commercial real estate (though marginally better for commercial than residential), and there is no meaningful mort-

gage financing market to speak of for residential real estate, and a virtually non-existent one for commercial real estate.

One would be tempted to conclude that investing in real estate is an irrational decision that most people make based more on emotion than on hard evidence. Part of this perception is likely due to the fact that, for much of Pakistani history, hard evidence on the advisability of a real estate investment was hard to come by. The only real estate investments one could analyse were one’s own family and friends, which is hardly a representative sample of data from which to draw informed conclusions.

Over the past few years, however, Zameen.com – Pakistan’s largest online real estate portal – has collected a considerable amount of data on the sector and compiled an index that makes it easier to track the performance

not just of one’s own real estate investments (which has always been possible), but that of the sector as a whole.

This article relies heavily on pricing data from Zameen.com and its real estate index, though we seek to correct for the upper-middle income-level bias in the Zameen.com data by using additional data on housing from the Pakistan Bureau of Statistics on dwelling sizes and the relative distribution of them.

We compared real estate as an investment to other asset classes: the stock market, gold, government bonds, and foreign currencies, and compared all of these investment categories against average inflation. We compiled an index to show average returns across these asset classes in Pakistan since January 1, 1999 through the end of June 2020.

What we found was that real estate was the third-best performing asset class available to ordinary Pakistanis, behind the stock market and gold.

(Gold’s performance as an asset class is a little inflated right now owing to the fact that the commodity is priced in dollars and the Pa-

kistani rupee has just taken a massive hit to its value, combined with a global run-up in gold prices. We believe over a longer period, gold is unlikely to sustainably outperform real estate.)

Over that 21-year period for which we have data, real estate has yielded an average annual price increase of approximately 11.3% per year. (Zameen.com’s data only goes back through January 2011; we have projected real estate prices backward to 1999 using the company’s data.)

This price appreciation is comfortably higher than inflation, which averaged 7.6% during that same period. But what makes real estate even better is that it does not just result in inflation-beating price appreciation: it also generates rental income.

Data on rental income is difficult to generate, so we analysed a large sample of properties for which we could find Zameen. com sale price data and the looked for comparable properties for which we could find rent data. This is an imperfect methodology, but it resulted in rental yields – defined as the annual rent divided by the total property price – of

between 2% and 4%. We assumed that the average rental yield for residential real estate in Pakistan is approximately 3% per year.

So that would take the total average returns on real estate to 14.3% per year if one combines the price appreciation with the rental yields.

If one had bought a Rs1 million (Rs10 lacs) property that yielded the same returns as the national average, that property would be worth Rs9.4 million (Rs94 lacs) today. In addition, it would have yielded Rs8.3 million (Rs83 lacs) in rent over that 21-year period ending June 2020.

For context on the power of compounding, and how even slight differences in growth rates can yield big differences over time, consider the following fact: to have the equivalent value of Rs1 million in January 1999, one would need to have Rs4.8 million towards the end of June 2020.

In other words, that real estate investment would have comfortably beaten inflation.

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But are we overdoing it?

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hose numbers suggest that Pakistanis who park their money in real estate are being completely rational. They want an asset that is stable, and can beat inflation over time, and even generate a bit of income. Clearly real estate is doing the job.

So, what is the problem?

Well, for starters, yes, it is doing the job, but there can be such a thing as overdoing even a good thing. Just because real estate is a good investment does not mean that one should invest everything – or almost everything – one has in that asset class. But before we even say why over-investing is a bad thing, let us first examine the extent to which Pakistanis over-invest.

Based on a combination of Zameen.com and Pakistan Bureau of Statistics data, we estimate that the total value of all real residential estate in Pakistan – urban and rural houses and apartments, and residential plots in urban areas – is approximately equal to $1,211 billion.

We arrive at this data by using Zameen. com pricing data, PBS data on the distribution of rural and urban dwellings by size, and a sample of Zameen.com data on the square footage of dwellings by number of rooms (to map onto the size distribution data from PBS).

This is, by no means, an exhaustive estimate of the total value of real estate, but we believe we are in the approximate range of accurate.

That number means that the total value of residential real estate holdings of Pakistanis is equal to 3.3 times the gross domestic product (GDP, or the total size of the economy) of Pakistan. For context, in the United States, the total value of all real estate in the US is equal to 1.6 times the US GDP. Now, there are several quibbles that people can have with this data. For starters, Pakistan has an unusually large amount of empty residential plots compared to the US (this is anecdotal based on the proportions of listings of homes in Pakistan relative to plots on Zameen.com and comparing those with similar listings on Zillow for the US).

So let us exclude the data for residential plots and look just at housing, which comes out to $726 billion, or about 2.74 times the GDP. That still implies that Pakistani residential real estate is overvalued by 67% and prices would need to come down by approximately 40% to reach the same levels as the United States relative to GDP. One might argue this is not entirely a fair comparison. The United States is a developed economy with its own dynamics and Pakistan is a very different economy as well. There is also likely a far higher proportion of the Pakistani GDP that is undocumented compared to

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that in the United States.

Fair enough, so let us consider another methodology of valuation that does not rely on GDP or any other economy at all and instead looks at the intrinsic characteristics of real estate within Pakistan itself.

There is, for instance, a very wide gap between the amount of money a property can generate in rent and the amount of money its owner would have to pay in a monthly mortgage payment, assuming a 25% down payment (standard requirement at Pakistani banks) and a 12% interest rate (the average interest rate over the past decade) on a 20-year mortgage (the longest duration allowable by most Pakistani banks).

The numbers are not even close.

Based on a sample of data we collected from Zameen.com, we found that the average urban property rents for about half the amount of money one would need to pay on a mortgage in order to finance the property.

And by the way, we ran numbers across the full 20 year mortgage: the initial difference is so wide that even with rent increases, the total amount of rent collected over that 20 year period usually does not end up equal to the total mortgage payments. (We did assume some variation in mortgage interest rates, based on the pattern of the past 10 years.)

That disparity implies that Pakistani property prices are about twice what they should be and would need to decline by approximately 50% in order to get to a level where they can be conveniently financed.

Note the similarity between the two methodologies on how much we estimate Pakistani real estate is overpriced by: anyway you think about it, Pakistani property prices are too high. And they are too high because Pakistanis are putting too much money into real estate, mainly because it is the only inflation-beating asset class that everyone can trust.

So what, you might argue? If I am making good money, why not continue? Two reasons: it is bad for you, and in the long run, it is also bad for the country.

Why is it bad for you? Because a lack of diversification can be a massive problem, particular when one approaches the age where one actually needs to start spending the money they have saved up. And I will illustrate this with the example of my father.

About seven years ago, I convinced my father to sell a plot he owned in Karachi and invest that money into the stock market.

Without disclosing how much he received for that lot of land, I can tell you here is what happened next. My father sold that land and I invested that money on his behalf in blue chip stocks (this can also be done through the use of equity mutual funds if you do not have expertise in the stock market.)

Over the course of the next seven years, my father paid for my brother’s wedding, my sister’s wedding, part of my wedding, and bought himself a nice car, and still had the same amount of money that he did when he first gave me that money to invest. The profits

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from his investments paid for everything.

More importantly, as with land, when you have a big expense coming up, there is no option but to sell the whole thing. And if it is a bad time in the real estate market, but you really need the money (like last year, when it was a terrible time to sell, but suppose your child is getting married and you need the cash), you end up selling at a deep discount.

That gets to the heart of the problem of overinvesting in real estate: it is illiquid, and therefore less stable than it looks. Because it takes time to sell real estate, if you need cash quickly – say in a few days or weeks rather than months – it can be difficult to get the full price for the property, and one might have to take a substantial haircut on the price in order to get the cash when one needs it. That’s the problem: real estate prices tend to stay stable – certainly more so than the stock market – but stable prices do not mean that one will be quite so lucky when it is time to sell.

We want to be clear about one thing: home ownership is a worthy goal and most people absolutely should try to own at least one property that they would be comfortable living in, if you can afford it (more on what constitutes affordability below). But anything beyond that should be seen as any other type of investment, and therefore real estate should be considered the same as just any other asset class: your decision to invest should consider all of the options before you deploy your money.

As we will demonstrate later, many of your non-housing needs are likely to be better filled with other types of investments rather than continued investment in real estate.

There is, of course, the larger consideration on what so much over-investment in housing does to housing affordability, and how that impacts the wider economy.

The great affordability crisis

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lack of housing affordability is something that has plagued most economies in recent years, but even by global standards, the situation in Pakistan is really, really bad.

According to data from the Pakistan Bureau of Statistics’ Household Integrated Economic Survey, the average urban Pakistani household had 1.9 earners and had a combined household income of around Rs53,000 per month. That translates to Rs636,000 a year.

Now let us take a look at the average urban house/apartment price, which, according to our estimates based on PBS and Zameen data, is about Rs11.7 million (Rs1 crore, 17 lacs), or about 18.4 times the average income.

By no stretch of the imagination can the aver-

age household afford that average house.

Here is what happens when the average household cannot afford the average house: either that average person looks for ways to stop being average, and dramatically increase income (and sometimes is willing to cross some legal and ethical lines to increase that income), or they decide that they do not really have a stake in the country. They either try to leave the country, or if they stay, they tend to not have much of a civic spirit, which is why most Pakistani cities – barring Lahore and Islamabad (and those because the people who control the government live there) – have a dilapidated look about them.

Personal finance experts agree that a house price should generally not exceed four times a person’s annual income. If you live in Lahore, Karachi, or Faisalabad on a household income of Rs53,000 a month, you can afford a Rs2.5 million (Rs25 lacs) home. There are some reasonable properties in that price range, but not very many.

And that, by the way, assumes that this average person has the kind of savings they need to put a 25% down payment on that home and then qualify for a mortgage on it, all of which – while theoretically possible – is practically a bit difficult.

So what does a person do when they cannot afford to buy their home? They do what the vast majority of Pakistanis do: they never leave the family home. Sometimes, if they are lucky, that home belongs to their parents, but often it can belong to their grandparents, meaning they have at least three, sometimes four generations living in one place.

It does not matter how big the house is (or how big the dil are), at a certain point, things start to get crowded.

One argument against pointing out the fact that young people cannot afford their own homes is that it will fray the social fabric of joint family households. But look around: by definition, joint family households eventually split off into multiple households. There is a reason why most people are not living with their fourth or fifth cousins.

So what is the appropriate point? Our contention is that the time at which families decide to get their own house is less determined by social dynamics and more by money.

Most traditional parents in Pakistan would be offended if their child wants to move into their own apartment in the same city if they are renting. But change that situation to buying, and they are likely to be proud of their child.

People want to buy homes and their families want them to buy homes. But too many of them just cannot afford them because too many people are bidding up the prices.

That, in turn, also creates a housing shortage and means that the housing-related sector of

the economy – construction, materials, etc. – is far smaller than it should be, which in turn has a cascading effect on the rest of the economy.

What else could you be investing in?

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o if not real estate, what else could you be investing in? The answer is obvious: stocks and bonds, both of which have the added advantage of financing businesses, and therefore the creation of economic activity and jobs.

Here is a simple principal to remember: if you are saving money for something that you will need to spend on in 10 years or more, you should probably be investing in stocks in order to save for that purpose. So, for instance, say you are 35 years old and are fortunate enough to have saved Rs1 million that you want to dedicate for the expenses related to your child’s education. Your child will go to college in 15 years and you want to be ready.

In that situation, do not put that Rs1 million in a plot. Over 15 years, the expected value of that plot will be Rs7.5 million, but of course, inflation will have taken its toll too. Based on historical averages, one would expect the rupee to lose two thirds of its purchasing power. Because of the way mathematical compounding works, the inflation-adjusted price of that plot would be more like Rs1.6 million in today’s terms.

By comparison, if you invested that money into stocks through a well-diversified mutual fund, the expected value of your investment in that stock portfolio would be Rs12.2 million in 15 years. In inflation-adjusted terms, that would be the equivalent of having Rs4.1 million today.

Of course, past returns are no guarantee of what will happen in the future, and stock investing is more risky than real estate investing, but look at the difference in profits.

And stocks have the added advantage of funding some of Pakistan’s best companies, helping them finance their expansions and creating jobs.

Indeed, stocks outperform real estate by so much that you could invest half your money in stocks and the other hand in government bonds, and still have a portfolio with the same capital gains and higher cash flow yield than real estate, with the added advantage of liquidity, meaning you would not need to sell the whole property just to use a small amount of the cash proceeds.

In short, the only property one should consider essential to buy is a home to live in.

Any other properties are not essential, and likely to be outperformed by other asset classes, especially stocks.n

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By Meiryum Ali

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ere is a statistic that should concern all of us: the World Health Organization estimates that nearly two billion people globally do not have access to essential medicines. This has to do with problems in global supply chains, and also the very basic fact that most medicines are simply not accessible or affordable for the very poor. And it’s a problem that affects developing countries the most, with their large populations that live below the poverty line.

So, if you are the head of a large developing country, and you want to make medicines more affordable, what do you do?

Well, if you are Zulfikar Ali Bhutto in charge of Pakistan in the 1970s, you control the prices of drugs. It is a straightforward, kind of deal: price controls will keep drugs affordable. You can also layer in an additional set of safety regulations, which would prevent the manufacturing of substandard drugs. Thus, Pakistan was gifted the Drugs Act of 1976, which is the legislation that covers pharmaceuticals in the country to this day.

Except, in the 44 years since then, the pharmaceutical sector in Pakistan has not followed the rules. Actually, that is not quite right: a more accurate description is, in trying to circumvent the rules set by the drug act, pharmaceutical firms have tried to come up with ingenious ways of still trying to make a profit.

The result? Over pricing and low quality production. It has also led to a dysfunctional, inefficient sector: the top 100 firms capture a 97% market share, while around 650 firms compete for the remaining 3% market share. And the $3 billion industry has also not grown at the same pace as other sectors within manufacturing: for example, it contributed less than 1% as a share of total exports in 2019.

It is this strange turn of events – an act designed to control prices leading to overinflated prices anyway – that Kabeer Dawani and Asad Sayeed, two leading economists, examine in their working paper “Anti-corruption in Pakistan’s Pharmaceutical sector: a Political Settlement Analysis”.

The two dub the current landscape as private sector corruption, or a sector involved in rule-violating and rent-seeking processes that ultimately harm Pakistani citizens.

The paper methodology is largely qualitative: between them, Dawani and Sayeed conducted 14 interviews in 2018 and 34 interviews in 2019 of the whole gamut, ranging from pharma CEOs and government health department officials to small medical store owners. They also conducted three focus group discussions in Karachi, Lahore and Islamabad.

And this is not the first time Dawani and Sayeed have dabbled in the same space together. In fact, in August 2019, the two co-authored another working paper titled: “Pakistan’s Pharmaceutical Sector: Issues of Pricing, Procurement, and the Quality of Medicines”.

While there is some overlapping material between the two papers, what makes this year’s paper particularly interesting is a brief political explanation of Pakistan. After all, the pharmaceutical sector, or the manufacturing sector does not exist in a vacuum. There are powerful players with vested interests, and all manufacturers and businessmen have to play by the rules. It is what leads to such rent-seeking behaviour in the first place.

But first, what does rent seeking mean?

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ent seeking is when a group wants to create wealth, but does not create any added productivity. There is no net gain to society or the community from the generation of this wealth; instead the group has manipulated

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economic resources to gain money.

This is very different from profit, in which one could argue wealth is generated because of some productive inputs, and productive outputs.

An old example of this is a feudal lord, who installs a chain across a river in his land, and then hires a collector to charge boats a fee (or rent) to lower the chain. ‘Wealth’ has been created out of nothing, even though fundamentally, the chain and the collector are basically non-productive.

In the modern world, rent seeking can look like a company lobbying the government for grants, subsidies, or tariff protection. Wait, is this legal? Well, technically yes: the company has managed to capture rents (by limiting competition), whilst not doing anything productive.

It becomes corruption when a company decides to bribe the government in order to capture rents. According to the paper’s authors, private sector corruption can be defined as “rule-violating rent-seeking processes that create, capture or distort rents.”

When looking at Pakistan’s pharma sector, Dawani and Sayeed found it odd how skewed the structure was. There are 750 firms in Pakistan, but the top 50 firms account for 89% of the market, and the top 100 firms capture 97% of the market. Meanwhile, 650 firms compete for 3% of the market.

“While the pharmaceutical sector is relatively concentrated across countries, the distribution of firms in Pakistan suggests that many firms in the industry may be capturing rents,” the authors noted.

Pakistan’s political landscape

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o we have explained what rent-seeking behaviour could look like: but who are these companies seeking rent from anyway?

No business in Pakistan operates in vacuum. Depending on where a business is located geographically, or who its end customer is, any business has to navigate the certain key players,

and their interests.

According to Dawani and Sayeed, there are five key players in Pakistan’ political settlement: the military, political parties, religious organizations, the judiciary, and the media.

Broadly speaking, the military has significant business interests, and has shaped economic outputs; while religious organizations have benefitted from links to the “non-elected state” (read: the military). The judiciary has great autonomy, and can affect public opinion, while the media alternates between aligning with political parties, religious organizations, and the military Now, these five players (for the last 20 years at minimum) have been fighting it out for control for rents and resources, with no long term plan in sight, for the most part. As the authors note: “Pakistan’s political settlement is characterised by a high degree of fragmentation and competition between various organisations.

The nature of the political settlement has meant that enforcement capabilities have remained weak and ruling coalitions have always operated on short time horizons.”

Now, while fragile political coalitions were being made, the country’s economy was still plodding along–for the most part. As the paper notes, Pakistan’s economy is characterised by low growth rates, with the manufacturing sector performing particularly abysmally.

There is also a low private investment rate, which typically have been attributed to such developing country problems like infrastructure, energy crisis, violence levels etc.

However, Dawani and Sayeed take a different approach. According to them, “Pakistan has received significant geo-political rents over the last four decades and this contributed to a distortion of incentives. These rents were centrally disbursed and largely supported consumption-led growth.”

This, in turn led to growth in speculative activity, like real estate or the stock market, as compared to productive sectors, like manufacturing – because manufacturing has not been important for any of those five players mentioned above.

Pakistanis are currently forced to pay over the top prices (due to the very price controls initiated to protect them), and are also forced to consume substandard medicines made by companies that the government is failing to regulate. A 44-year-old act is leading to excessive rent-seeking behaviour by an inefficient and blatantly corrupt sector, which the government will not consider changing, simply because it is worried about the optics 26

Indeed, within manufacturing, textiles and food processing make up a whole two thirds of value, and textiles get so much importance because they have some export value.

Within manufacturing, only those sectors get any leeway that are politically close to political parties or the military: think automobiles, construction or sugar. These sectors have captured rent – even though they are not remotely competitive.

Meanwhile, electronics and pharmaceuticals are unable to capture rents. As the paper co-authors note: “Although individual firms have managed to capture rents through overpricing, low-quality production, and preferential treatment in the public procurement of medicines... the sector as a whole does not receive any significant rents.”

Wait, so do you want pharmaceuticals to capture rents? No. But it is worth pointing out that the playing field is somewhat skewed, with political patronage, and short-term thinking leading to the manufacturing sector having such a small section of the pie. If there is little room to wiggle around to begin with, you best believe the pharmaceutical sector will do its best to maximise what has been given, which is what leads to its own rent-seeking behaviour.

Besides, it’s not like there will be reform of this system anytime soon: the fractured distribution of power means little to no enforcement of rules, and avoidance of actual reform.

How to price a drug in Pakistan

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roadly speaking, there are two ways in which the pharmaceutical sector tries to capture rent: by exploiting price controls, and by compromising on quality.

In the first case, Pakistan is unique in terms of how it regulates the industry via price controls. This was started through the 1976 Drug that has been the primary piece of regulation since.

One of the more interesting things about these maximum prices, is that once the price has been set, it is actually very difficult to increase it. The cost of producing a drug is not in check with the rate of inflation in the country.

For example, Dawani and Sayeed point out that between 2001 and 2013 there was a price freeze, and that even when prices were increased in 2013, it was revoked after an extreme backlash.

Now, theoretically, there should be some rules-based criteria for how a maximum retail price is determined. However, practically speaking these prices are determined in an ad hoc manner, and even price revisions are also granted arbitrarily.

“A natural consequence of the discretion in pricing is that price setting and price revisions became prone to classical rent-seeking,” the authors note.

Thus, a pharmaceutical company goes out of its way to bribe a bureaucrat, in order to gain the maximum possible price to maximise its profits. The pharmaceutical company is also incentivised to do this because they know fully well that because of price rigidity, there may not be a price increase for months, if not years.

These price controls also mean that companies are simply not incentivised to produce certain drugs – and why would they?

“As costs of production rise much faster than price increases – especially with currency depreciation which makes raw material imports more expensive – margins are squeezed and the manufacture of medicines becomes unprofitable over time,” explained the authors.

This has led to an unavailability of medicines in the market: for instance, there are 80,000 drug products registered with the Drug Regulatory Association of Pakistan, but only 10,000 are manufactured.

This is basically leading to two problems: that end-consumers have to pay high prices, and also face the threat of scarcity of certain medicines. And that expenditure bit is worrying: total money spent on medicines as a share of total health expenditure jumped from 45% in 2011 to 80% in 2016 for the lowest income decile in Pakistan.

Obviously this system was untenable.

In 2015, a Drug Pricing Policy was introduced (thanks to the judiciary – one of those five key players), which was then revised in 2018.

Instead of arbitrarily setting maximum retail prices, the average price for a product in other South Asian countries, Bangladesh and India, was used to set the price. This kind of reference pricing was hoped to eradicate rent seeking.

But as the authors note, there was massive uproar over the very idea of raising prices of goods like medicines. The authors dub this a ‘populist’ stance that has been perpetuated by the judiciary and the media, and which political parties acquiesce to [more on this later].

Low-quality production

For a medicine to be acceptable, some good manufacturing practises need to be followed.

Government data on the subject is overly optimistic, which suggests that only 1% to 5% of drugs are of poor quality.

But Dawani and Sayeed’s qualitative data, based on their focus groups, suggest that actually a lot of pharmaceutical companies are engaged in ignoring good manufacturing practices, in order to reduce costs.

This behaviour is particularly rampant in the bottom 650 firms, which explains why they still exist. Despite receiving the maximum retail price, they comprise on practises to cut costs, and thereby capture rents.

And it is not to say that the top 100 com-

Sizeable market

$3

billion

The total size of the Pakistani pharmaceutical market

panies do not also scrimp on these regulations – even within the top 100, only 20 companies produce medicines of high enough quality to be considered for exports.

Most of this behaviour also has to do with what kind of pharmaceutical company it is.

The bottom firms tend to be ‘embedded’ which is defined as those dependent on a network of personal ties and local professional experience.

The top forms tend to be ‘technocratic’, often possessing international professional experience, and a tendency to follow regulation.

In short, price controls restrict the space needed to make profits, leading to some companies to compromise on quality, cut costs, and capture rents. Why should Pakistanis consume harmful, low quality drugs?

A way forward?

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o, what is to be done? Dawani and Sayeed point out the obvious: remove price controls, and allow price competition.

In the long run, this will lead to prices declining. There would also be a weeding out of firms, particularly in the bottom tier, who will not be able to survive the competition. This has the added advantage of removing some low quality products from the market as well.

However, there are a couple of problems with this approach, First, there is no political appetite to increase the prices; as the authors note there is consensus across the political spectrum that prices should not increase.

Second, under the existing political settlement, it is not like one of the five key players have some sort of stake in pharmaceuticals and will listen to them – this is not real estate, after all.

So, there is no way to exert pressure for reform.

Third, regulatory efforts are unlikely to work well in developing countries, simply because there is weak enforcement.

Instead, Dawani and Sayeed come up with a completely left-field idea. They want the media to highlight how price controls are bad.

In a scathing, succinct indictment of the

Exorbitant expense

80%

The proportion of total healthcare spending taken up by the cost of pharmaceutical drugs for the bottom decile of the income distribution

landscape, they write: “In the Pakistani media, the pharmaceutical sector is reported on by two desks: the economy or business desk and the city news desk. However, knowledge and capacity among reporters and editorial staff on both desks is low, which leads to uncritical journalism that does not appreciate the bigger picture around the harmful outcomes of price controls.”

If the media could exert pressure to change the narrative around price controls, then perhaps the government may follow suit. In an ideal world: “A feasible anti-corruption strategy is to build a coalition between the media and large firms. These firms can provide financial support to independent journalism schools to train journalists working in print and electronic media on the impact of price controls on social welfare, who in turn can improve the policy discourse on pricing issues.”

This is not an ideal world: we at Profit believe this is a dystopian world. Journalists do not exist to be mouthpieces of pharmaceutical companies, nor to be on their payroll. Obviously, it is somewhat ironic for us to say this, considering we just willingly devoted a few pages of magazine space to a working paper that is about price controls, but the larger point still stands.

It is not the media’s job to lobby for specific policies. That job lies with those whose interests are served by the changes they demand.

As it stands, Pakistanis are currently forced to pay over the top prices (due to the very price controls initiated to protect them), and are also forced to consume substandard medicines made by companies that the government is failing to regulate. A 44-year-old act is leading to excessive rent-seeking behaviour by an inefficient and blatantly corrupt sector, which the government will not consider changing, simply because it is worried about the optics. Yes, there is short term inertia, but up till what point will reform be avoided?

There–we suppose this article (or this paper) is doing the job for you. n

PHARMACEUTICALS

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By Adam Dawood

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here has been a lot of discussion of late on how the pandemic will help digitise Pakistan’s eCommerce market and on how we can finally move away from our reliance on Cash on Delivery (COD). I believe the pandemic alone however, is not enough to convince customers to make the move. Before this happens, we have to first overcome a lot of challenges faced by eCommerce merchants. I order on COD fairly frequently myself and believe that every merchant who cares about their customer should offer it as an option, but greater development needs to take place within our payment systems for us to make the gradual shift away from COD. First time online shoppers will always experience a level of mistrust combined with a fear of the unknown. They might have heard of how convenient online shopping is but many shy away from the actual process of completing a full order because of apprehensions regarding online payments. COD has given many the faith that even if their order is not delivered, they have not committed any actual money towards their perceived gamble and through this process they have protected themselves from any possible grievances. I have always believed that once our customers have taken this pivotal first step towards online shopping, it then becomes the task of the entire eCommerce industry from vendors, to logistics partners, to payment gateways and finally regulators to support eCommerce stores satisfy the customers needs. Only once trust is established between customers and merchants can online payment platforms finally take off in a real way.

Safety and security will always be a foremost concern. Banks, Fintechs and regulators play a key part in supporting and assisting

merchants to promote the utilisation of prepayment methods. We shall be examining their roles more closely in this article.

Therefore there is a component of insurance that needs to be built in for cash handling whether it is done formally or informally.

action taking place. However, with COD the money is only deposited days after the delivery was successfully made.

The True Cost of Cash on Delivery

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ast weekend I ran an informal survey on Facebook and Twitter the outcome of which echoed my beliefs that the majority of merchants think COD is more expensive than prepayments. Let's first start by exploring the actual cost of COD and why it is in the interest of the majority of merchants to try and move away from it where possible.

MDR of COD vs PrePayment Methods

Step 1: Simple MDR Calculation

The most simple comparison that many people make is that the Internet Payment Gateway (IPG) deducts their charges upfront. This is usually the comparison that is made off the bat but we all know this is not the complete picture.

Note: I have taken the default delivery rates from a logistics companies website to give a transparent comparison.

Rates in the markets are lower for both COD and standard delivery based on your business volume and size.

S

o after the delivery and deposit we can see for our example that the MDR for COD is 25.8%, for Card transactions its 19.6% and for wallet transactions its 18%. While actual costs will vary based on key circumstances such as the price of the product, its weight and the delivery costs, for most scenarios COD will end up costing much more than prepayment methods.

I have made available my worksheet here for anyone who wishes to enter in their own variables to determine the true costs of MDR on their product line.

Other Factors

Step 2: Greater Logistics Costs

We have to take the cost of operations into account, there is a real difference in the cost of delivery for COD parcels vs non-COD parcels.

The average non-COD parcel takes just 3-5 mins to deliver (time from when the courier reaches the destination to moving onto their next destination). Whereas a COD parcel will take anywhere from 12-15 min on average. This 4-fold increase is usually factored as a cost by logistics companies. COD clients also have a 1st attempt delivery rate being anywhere between 75%-85% depending on the category of the merchant and the product. Most logistics companies try and make at least 2 or 3 attempts at delivery and each of these costs are then passed on to the merchant as well.

Furthermore, there is a cost for handling the cash generated by these deliveries. After every few COD deliveries or when a certain cash threshold is reached, logistics companies want their drivers to deposit the collected cash either into a bank which wastes additional time, or to an Easypaisa or Jazzcash agent which incurs more charges or to their area office which has to be manned by finance personnel. All of this adds to the final cost of delivery. Handling all this cash comes with risks as well with the possibility of the cash being stolen from the couriers.

Step 3: Rejection at Doorstep

We have already mentioned how the ‘first attempt’ success rate is between 75-85% and even after the 2nd or 3rd delivery attempt a percentage of deliveries still remain undelivered. These parcels then have to be returned back to the merchant. The merchant will of course be charged for these failed delivery attempts so we have to build this into the costing model. If we assume a 5% failed delivery attempt rate it would lead to an extra Rs. 12 per kg. These are not the kind of costs any efficient store owner would ignore.

Step 4: Net Present Value of Delayed Cash

Finally, we also have to take into account the time value of money. The IPG’s deposit the money within a few days of the trans-

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here are other factors and costs that eCommerce merchants must consider to arrive at the true cost of COD. Conversion rate of Prepayments is lower due to the high failure rate of non cash methods.

I have seen failure rates as high as 50% for certain prepayment methods and there is always a risk that the customer may not attempt another order thereby denying the merchant of any revenue opportunity completely.

Unlike prepayment transactions, COD transactions generally do not have to be verified. eCommerce merchants prefer to verify COD transactions via calls, sms or robocalls to try to lower their ‘rejection at doorstep’ rate (step 3).

One could argue that card transactions, as per the IPGs request at times, require customers to

fill in their card details and this indeed is a very cumbersome activity. The conversion rate for prepayments is also slightly lower due to the number of extra fields the customer is asked to fill.

We also have to examine refunds on both

E-COMMERCE

types of payment methods and particularly chargebacks on prepayment methods. While we can ignore any refunds that occur for genuine reasons, (mainly because their occurrence is common across the two payment types), we have to look at some other factors as well. While COD suffers from a ‘rejection at doorstep’ problem, in the case of prepayments (especially credit cards) customers can conduct friendly fraud or demand a chargeback even after receiving the products.

The burden of proof is then on the merchant and this can add to the overall cost. However, it is much harder to judge these costs and I believe their occurrence is far lower than the problem of COD’s ‘rejection at doorstep’ rate..

The hassle and effort of giving refunds is also much greater for COD orders when compared to the some prepayment options (see IPG section for full details). With certain prepayment methods the ability to do instant refunds is available with 1-click or an API, whereas with COD, refunds have to be handled manually.

These variables change considerably when the key assumptions such as the price of the product, the weight of the product and the logistics costs are changed. Each merchant should look at this relationship for each product or category of products individually to arrive at the best solution for their own category mix.

What Should Merchants Do?

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he key reason for writing this article is to help merchants be aware of the true cost of COD. I truly believe it is in their best interest to try and move customers towards prepayment methods and potential-

ly even incentivise them to do so in an attempt to lower costs and save money. In the past I have found that the majority of first time customers to eCommerce stores placed an order via COD. However, after segmenting out customers who received their delivery successfully, the COD percentage subsequently fell rapidly by the 3rd or 4th transaction.

Having conducted regular sessions with customers to learn of their preferences, I have also found that they do not want to use COD (if they have an alternative mode of payment).

They however still use COD because of the lack of trust they have in eCommerce merchants.

These same customers are happy to pay online for services such as FoodPanda, Netflix and even AliExpress, but when it comes to retail shopping within Pakistan, there is a trust deficit.

It is up-to the merchants to earn that trust from customers and trust is only built in one way, CONSISTENCY. Merchants have to consistently perform and meet the expectations of their customers. The majority of the burden falls on the merchant and that is why merchants need a lot of support to help establish trust.

How IPGs Should Help?

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merchant’s ability to convince a customer to use prepayment methods is only possible if he has the tools he needs to provide customer support at every interaction. There are four key areas where merchants need support: 1. Signup 2. Integration 3. Order Placement

4. Refund There are currently too many merchants who don't have access to IPGs because the steps required to initially sign up are too cumbersome and time-consuming. To even begin our journey towards digitisation prepayments need to be an option on every eCommerce site, not just the 1559 as stated by the SBP until Q3 FY20. (The figure refers to accounts created, I would wager a double digit percentage do not have their website actually integrated with the gateway yet.)

Integrations should be foolproof. When a merchant comes onboard, most of the integrations IPGs provide are not as easy as they should be. To integrate Stripe or the PayPal checkout into an eCommerce store is literally a 5 minute task for non developers on platforms such as WooCommerce, Magento or Shopify.

I request every Bank CXO with a desire to bring on eCommerce merchants to test this out themselves. If your team cannot show you a live working integration within 5 mins there is something wrong.

The first key customer moment is when they are placing a prepayment order. Merchants at this point only care about 1 thing - their conversion rate. If that's the case why do so many payment gateways redirect you to another website. All the processing should happen on the merchants page in a secure form to ensure the best results. Finally there are still so many manual processes that the merchant has to undertake.

Take refunds for instance, some of the largest IPGs in the country still make you process refunds manually to the point where they ask you to submit hard copies of refund requests. How is this even an option today?

Every IPG should have a refund button on their merchant portal and the best should have refund API’s. There is no other way about it.

When more than 5% of your transactions end up going into refunds the “happy flow” for the customers needs to extend that far as well. Product managers and designers at all banks and fintechs need to take this into account. It’s beyond me how so much time and effort can go into building a product, but a core part of the operation which occurs regularly can be so badly ignored.

Conclusion

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his article in no means wishes to convince merchants to turn off COD as an option to customers, I actually feel that will do more harm to the merchant at this moment in time, while taking away a much needed option for customers. Instead I hope merchant look critically at the true cost of COD for their specific business and product line and start making moves towards building trust so that customers actually want to use alternative payment methods. I am a firm believer in Pakistan’s digital potential. We just need to make sure we are taking the right steps towards it. n

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OGDC’s new discoveries start adding to company’s bottom line

The nation’s largest oil and gas company has been able to continue finding enough new fields to replace its older ones as they reach depletion levels

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t is hard for a company as large as the Oil and Gas Development Company (OGDC) – the largest publicly listed company in Pakistan by market capitalisation – to sustainably continue growing. Yet OGDC keeps managing to find ways to grow its bottom line.

The company, established in 1961 by the Government of Pakistan (which still owns a majority and controlling stake), is the country’s largest oil and gas exploration and production company. It covers 50% of domestic oil production, and holds 28% of domestic gas production, and has significant

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oil and gas fields in Nashapa, Qadirpur and Maramzai, to name a few.

The company’s two new fields continue to add to its production capacity and are helpful to the company maintain production levels even as some of its older fields are depleted. These are chiefly: two new production sites in Kohat, stable exploration efforts, and buffers in place for any field depletions. Plus, it helps to be counted as an ‘essential’ industry in the middle of any lockdown.

To the first point: OGDC is benefitting from two production sites in Kohat. The first is the Dhok Hussain Gas field, which was dis-

covered in December 2017. This has a capacity of 15.4 million cubic feet per day of gas, or 360 barrels per day of condensate, according to Ali Asghar Poonawala, a research analyst at AKD Securities, an investment, who wrote about the company in a note to clients on July 6.

While the field was meant to start production in September 2018, the project was significantly delayed, in what is alleged to be ‘political elements’ who tried to stop the pipe from being laid down. Nonetheless, the field has finally begun operation this year. It has an annual earning impact of Rs0.45 per share, (helped in part by the fact that OGDC owns

97.5% of the asset).

The production site was discovered in August 2019, in Togh-1. This has an initial flow of 12.7 million cubic feet per day of gas, and 250 barrels per day of condensate. But though it is smaller in size, Togh-1 was able to be added to production in less than eleven months. As OGDC has a 50% stake in the field, the annual incremental earnings impact amounts to Rs0.21 per share.

Together the two new discoveries contribute 1.6% to annual crude production, and 3% to annual gas production. Why does this come at a crucial time? Well, during the first nine months of fiscal year 2020, the average oil production slipped 7% year-on-year, when compared to the same period the year before, while gas production fell 8% year-on-year.

Despite this, the company is experiencing a stable success ratio. During the first 11 months of fiscal year 2020, the success ratio stood at 37%; it stood at 38% in 2019; and 33% in 2018. Sure, these ratios are not as great as the peak levels of 2016 (40%) or 2017 (57%) but they are still roughly in the ballpark range of the average between 2014 and 2018 (36.8%).

In 2020, OGDC found four discoveries from six exploratory wells and five development wells which were spudded - or commenced drilling - during the year.

“Based on the same, we believe renewed exploration activity in North region, is likely to remain firm,” said Poonawala, noting that OGDC acquired 1,503 line kms of 2D of seismic data during the first half of fiscal year 2020, compared to the 1,324 line km of data acquired in the same period the year before.

That is an impressive 75% of seismic activity domestically for the first half of 2020.

Even the fact that some of OGDC’s fields are naturally being depleted does not faze the company. To illustrate, the fields Nashpa, Sinjhoro and Qadirpur are naturally depleting, some seven gas wells have reported declines, and there has been lower gas demand from WAPDA run state independent power producers. As mentioned before, oil production fell 6.7% year-on-year, while gas production fell 8% year-on-year, which are levels previously seen in 2012.

But, the company has an ‘aggressive developmental project pipeline’ up its sleeve, according to Poonawala. Between fiscal year 2020 and 2022, new gas projects are expected to add 840 million cubic feet per day of gas production. The Uch field will be the largest, at 460 million cubic feet per day, followed by Qadirpur field, at 280 million cubic feet per day.

The company has not always been the greatest about hitting its drilling targets.

Mostly this was due to very Pakistan-specific problems, such as an absence of a decent road

network, or an unstable security situation.

But since security has somewhat stabilized, and rigs have become cheaper for a fall in international oil prices, perhaps exploration is also looking up. This year, the company spudded 15 wells (nine explanatory and six development) manainting its trajectory since 2019, where it spudded eight explanatory and eight development wells.

For the coming years, Poonawala estimates that the price of Arab Light will be at

$40 a barrel, while the US dollar will appreciate around 4.5% against the rupee. Even if the currency were to further devalue however, Poonawala notes that a “dollar denominated top-line provides effective hedging.”

One spot to watch out for? OGDC has said that it will cut capital expenditures if crude remains below $40 a barrel, which would sacrifice any growth in exploration.

Again thought, that would also depend on how long oil prices remain at that low level. n

Despite the SBP’s best efforts, lending has stayed flat over the past year

Total lending by banks grew by just 1% over the past year, even as deposits continued to grow by about 12% during the same period

I

f one visits the State Bank of Pakistan website, you can access a whole dedicated tab to the measures the SBP has taken in the middle of the Covid-19 crisis.

It has slashed the interest rate by 625 basis points over the course of four months, with the benchmark discount rate down now to 7%. It has introduced refinancing schemes for housing finance, small and medium enterprises, microfinancing – and then extended these schemes all the way to September 2020. It has reduced the capital conservation buffer from 2.5% to 1.5%. Borrowing limits have increased; principal payments on loans can be deferred.

In short, the SBP is doing its best in the middle of a pandemic to say: “Please, go on and take a loan. Do not kill our economy.

This is the best time to invest, trust us.”

Except, of course, no one is taking the bait.

As Syed Fawad Basir, a research analyst at Topline Securities, an investment bank, points out in a note sent to clients on July 7, the banking sector’s loan book only grew by 1% year-on-year, from Rs8.1 trillion in June 2019 to Rs8.2 trillion in June 2020.

And if you look at it on a monthly

basis, the amount of loans outstanding actually declined 2% month-on-month, from Rs8.4 trillion in May 2020, to Rs8.2 trillion in June 2020. This, as Basir notes, is despite the aggressive cuts in interest rates by the central Bank since March 2020 and is at least partially reflective of the steep downturn in economic activity since the beginning of the pandemic.

“This is due to the impact of the pandemic Covid-19, which has caused the overall slowdown in the economic activity,” says Basir.

It is a view echoed by Amreen Soorani, research analyst and deputy head of research at JS Global Capital, another investment bank, in a note issued to clients on July 7.

“Banks remained reluctant with fresh lending. Despite various initiatives such as space in capital requirements, increase in borrowing limits and extension in regulatory credit limits announced by the SBP overall loan growth remained flat during the quarter,” Soorani said.

She added: “Moreover, lower interest rates have also not encouraged borrowing as yet as the sharp cuts have been a part of relief for the masses in the ongoing economic scenario.”

ENERGY

On the other hand, according to the latest central bank data, deposits in Pakistani banks have grown by 12% year-on-year, and 5% month-on-month to Rs16.23 trillion by June 2020.

In particular, in the second quarter of 2020, deposits increased by 7%. According to Basir this is higher than expected, and can be attributed to as Net Domestic Assets (NDA) of the banking system increasing by 6% during this period, on the back of an 11% increase in government borrowings to support the budget.

The combination of these two factors – deposits rising but lending staying flat – mean that the loans to deposits ratio dropped to 51% in June 2020, down from 56% in June 2019, and 55% in March 2020.

Basir expects the deposit growth to stay in the range of 10-11% during 2020, which roughly corresponds to the three-year historical average growth of 11%. However, lending is only expected to grow by around 5% during the year, which is significantly lower than the

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historical average three-year growth of 14%.

So where are all those deposits going, you may ask? Why, government bonds, of course. The banks’ investments in government bonds grew by 40% year-on-year through June 2020, and 3% in just the month of June, to Rs10.7 trillion.

According to Soorani: “During the quarter (the second quarter of 2020), the sector continued to lock in higher yielding assets amid sharp interest rate cuts and deployed deposits into government securities, leading to 40% year-on-year growth in investments,” The currency in circulation, or CIC, increased by 17% to Rs6.19 trillion. CIC as a percentage of M2 (or money supply, which includes CIC, demand deposits, and foriegn deposits) stood at 31%. This is above the past 5-year average of 27%. And Pakistan’s CIC tends to be among the highest in the world.

What this means is that Pakistanis are more likely to use physical cash than most other countries in the world.

Additionally, Basir noted in his report

that their top picks remained MCB Bank, and Meezan Bank. While he did not cite a reason, this is inline with EFG-Hermes reports released in June, of which two praised MCB Bank specifically, noting its strong deposits and lending style, and one praising Meezan Bank for its strong capital buffers.

With the government’s voracious appetite for borrowing and the ease with which banks can deploy deposits into government bonds without significant capital requirements, it is no wonder that the banks are not willing to lend, least of all in the middle of a pandemic with constrained consumer and business spending resulting in declining revenues and cash flows across many businesses.

Yet this lack of willingness to lend has significant negative consequences for the economy: businesses that do need capital to continue their growth are not able to borrow, either the amounts they need or sometimes not at all. This, in turn, reduces economic activity to lower than it could be and causes overall economic growth to slow down. n

BANKING

Does KAPCO have life beyond its PPA expiration?

Some analysts think so.

The company’s ability to generate electricity from LNG imports may position it well relative to other IPPs in the sector

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he market hates independent power producers (IPPs) right now, and one that has been running for 35 years is probably at the bottom of the totem pole as far as investor interest is concerned. Add in a power purchase agreement (PPA) that is expiring next year, and investors absolutely could not be bothered with the company in question.

Yes, it certainly does look like its best days are behind the Kot Addu Power Company, one of Pakistan’s largest power producers.

And it is not as though it has not been a good run for KAPCO. Maybe it is time to call it quits on this company? Not quite yet, according to some analysts, who argue that the company is better positioned than most to run for at least another five years, and possibly another decade.

The power plant at Kot Addu was constructed by the Water and Development Authority (WAPDA) in five phases between 1985 and 1996 in Muzaffargarh district in southern Punjab. In 1996, the same year that it was incorporated, the company was partially

36

privatised, with 36% of its shares divested to strategic investors. Then, in 2005, the company was listed on the Karachi Stock Exchange.

The company has plodded along, operating and maintaining the 1,600-megawatt (MW) multi-fuel fired power plant (gas, furnace oil and diesel) at Kot Addu. It is the country’s largest combined cycle power plant, which means that it reuses the heat from the steam generated in its first thermal engines to continue producing energy. Combined cycle power plants are more efficient than most other types of thermal power plants.

“The plant combined cycle technology enables it to use the waste heat from the gas turbine exhaust to produce steam in the heat recovery steam generator, which in turn is used to run the steam turbines thereby resulting in fuel cost efficiency and minimum wastage,” the company explains on its website.

The plant comprises 10 gas turbines and five steam turbines, all neatly organized in three energy blocks with each block having a combination of gas and steam turbines.

All of that capacity, however, has been sitting idle over the last few months. During

the first quarter of 2020 (the third quarter of the company’s fiscal year, which ends June 30), KAPCO's plant generated 346 gigawatt-hours (GWh) of electricity, which accounts for only about 11.8% of the plant’s total capacity.

Meanwhile, receivables stand at Rs125.4 billion at the end of the first quarter of 2020, the latest period for which financial data is available. And even the government’s recent attempts to clear the energy sector’s inter-corporate circular debt – which piles up every year due to rampant electricity theft in the country – have only made a minor dent in the company’s liquidity problem. The government’s Energy Sukuk-II, an Islamic bond which was meant to pay down the circular debt, only resulted in Rs11.7 billion in cash inflows for KAPCO. Add in the fact that KAPCO, like every other power generation company in Pakistan, is legally allowed only to sell to WAPDA, and that the agreement that governs that relationship – the PPA – is expiring on June 26, 2021, and the situation looks quite bleak for the company’s future.

Except KAPCO is not quite ready to go yet. KAPCO still has five to ten years of

operational life left, according to Nabeel Dochki, a research analyst at Taurus Securities, a brokerage firm, in a note issued to clients on July 7. He notes, however, that there just may not be an appetite left for independent power producers (IPPs) among investors anymore.

Let us explain. When a power plant is constructed, it signs a PPA with the government of Pakistan. This document decides the terms and condition of the tariffs, of any government support, about how much electricity the government will buy etc.

This PPA is now ending, which is unfortunate because KAPCO can continue to be utilised for between five to ten years to generate power for Pakistan on a “Take and Pay” basis. This will be especially handy during the summer months when demand peaks.

So, what is in KAPCO’s favour? Well, liquefied natural gas (LNG) imports have rapidly increased in the last few years since they were allowed in Pakistan. And the fact that KAPCO’s plant can run on multiple fuels means that KAPCO can utilise that cheaper LNG rather than relying on the still relatively expensive furnace oil. Indeed, the proportion of electricity generated by KAPCO using LNG as the fuel has jumped from just 9% in 2015 to 77% in 2019.

This is good news, because LNG prices have dropped internationally, touching a low of $2.7 per million British thermal units (mmbtu) in February this year. The government also issued three provincial licenses for LNG regasification terminals. All in all, the government’s dependency on LNG is set to increase in the future.

“We believe this will increase the chances of utilisation of KAPCO’s plant beyond June 2021,” says Dochki.

In other words, if KAPCO can revise its PPA to include a greater utilisation of LNG as its main fuel, there is a strong chance that the government will renew a modified PPA with the company.

This expected PPA revision is particularly important because otherwise, it is not really a great environment to be an independent power producer. As Dochki notes, headwinds for IPPs have choked off investor sentiment, interest and any price upsurge for the last 18 months. There have also been lower electricity sales due to a new energy pricing mechanism that prioritises the cheapest fuels, which most IPPs do not use. And of course, there are always the rising receivables.

But perhaps the worst turn of events happened in March of this year, when a bombshell report published on IPPs was made public. That report claims that IPPs have been able to game the regulations to extract significantly higher profit margins than they are legally entitled to. That allegation, in turn, has led to IPPs

Idle plant

11.8% now falling under extreme scrutiny. “The long term prospects of the company now depend on the revision of its PPA. Under these conditions, the PPA revision for KAPCO is consequential,” says Dochki.

For investors, the biggest fear is whether

The load factor of Kot Addu Power Company’s power generation units, or the amount of their capacity that is utilised as of the first quarter of 2020 dividend payouts will fall. KAPCO paid out a dividend per share of Rs1.5 in the third quarter of fiscal year 2020, with Dochki expecting a dividend pay out of Rs2 in the fourth quarter.

This would actually lead to the highest dividend yield in the market, at 19%. n

Growing pains:

Unity Foods raises equity to finance working capital needs

Rapid revenue growth for the company has meant that it keeps running up against limits to borrowing and needs to finance its working capital by issuing more shares in the stock market

I

t seems that Unity Foods can take no misstep. An unlikely spinning mill decided to switch gears three years ago, and enter the edible oil industry three years ago. It then grew at an astonishingly rapid pace that surprised just about everyone: from Rs2.8 billion in fiscal year 2018, its revenue shot up a shocking 407% to Rs14 billion in fiscal year 2019.

And 2020 is proving no different. Already at the nine month mark of fiscal year 2020, the company’s revenue has grown 120% year-on-year.

But as Fawad Naveed, a research analyst at Abbasi and Company, a securities brokerage firm, noted sagely in a note sent to clients on July 7, that with growth in revenues comes higher working capital requirements.

And Unity Foods is well aware of this fact. That is why Unity Food is issuing

450 million ordinary shares at Rs10 each, which will be offered in a proportion of approximately 82.71 right shares for every 100 shares held. The share transfer books of the company will be closed from July 18 to August 1, to determine the entitlement of right shares.

Previously, in February 2019, the company raised Rs3.75 billion from the equity markets with a follow-on offering, which increased the company’s share count by 222%. The proceeds of that offering were being utilised almost exclusively towards capital expenditures.

The company has specifically done this issue of shares to increase the paid-up share capital of the company, and to meet the increased working capital requirements of the company.

And just in time as well: the shortterm borrowings of the company had reached around Rs4 billion in the first nine

ENERGY

months of fiscal year 2020, compared to the Rs2.6 billion during the same period last year, or a growth of 54%.

That is why the debt to equity ratio of the company had reached 0.7x in the first nine months of fiscal ear 2020, compared to 0.45x during the same period last year. Meanwhile, the company had exhausted nearly all working capital lines available to the company.

“Therefore, in our view, the decision to issue right shares would help the company to mitigate cash flow constraints, reduce debt levels in order to bring the capital structure to the optimal level, and decrease the burden from the bottom line through the reduction of finance cost hence, enhancing the expected returns for the shareholders.” Naveed summed up succinctly.

And as per usual, Unity Foods continues to defy all odds, for a former spinning mill. For instance, the company imports raw materials on a month to month basis: soybean and canola seeds from the United States, and palm oil and specialised fats from Malaysia and Indonesia.

Now, one would think that the 55% devaluation of the rupee against the dollar over the last two years would have some impact on the company’s gross margins, but no: in fact, it has been continuously on the rise. The company posted gross margins at 9.1% in fiscal year 2019, compared to 8.9% in 2018 “This depicts the prudent decision making by the senior management with respect to inventory management,” Naveed notes

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glowingly.

The company has acquired a crude palm oil refinery at Port Qasim, that has the capacity to produce 500 tons per day. For Naveed, this is a good sign: “Going forward, we expect the company’s gross margin to remain stable as the establishment of the oil terminal would allow the company to hold inventory and thereby control costs.”

Yet another factor that Unity Foods has going for them: consumers just really like them. This is very impressive: the edible oil business is perhaps the most competitive in Pakistan, and highly commoditized. This means that companies are effectively price takers and do not have the ability to set their own prices, and customers can switch to other products quite easily.

Yet the company’s products have been rapidly accepted by consumers. For instance, Unity introduced two new brands, ‘Zauqeen’ and ‘Ehtemaam’, which both cater to the discount segment, and are both popular. Unity Foods was just in the right place at the right time: stricter regulatory requirements on sales of edible oil has increased the demand for good quality, hygienic processed edible oil.

As for the Covid-19 crisis, Unity Foods has the luxury of saying “What crisis?” As Naveed notes, the company is impervious to the crisis because it is a provider of essential goods. If anything, it is actually briefly benefiting from this moment: under the government's relief package, the company is exempt from

a 2% Additional Customs Duty on edible oils and oil seeds, which is exactly what they specialize in.

“This has made the fundamentals of the company much more attractive,” says Naveed.

The company is also going to expand into the flour business, hoping it pays off the same way the switch into oil worked. The company wants to acquire 69% of shares in Sunridge Foods, by raising Rs367 million through internally generated funds. Sunridge Foods is a flour company started in 2015, which has a capacity to produce 36,000 metric tons of wheat flour per year at a plant at Port Qasim.

Unity’s decision to venture into the food business after having abandoned the textile business is by no means unique in Pakistan.

As the textile industry continues to struggle owing to its uncompetitive business practices and increased competition from Bangladesh and Vietnam, many textile mill owners have decided to give up on the business and move their productive capacity to other, more profitable ventures.

Unity Foods appears to have been taken over by a consortium of investors who had previously had experience in the commodities trading business, specifically rice and wheat trading. Abdul Majeed Ghaziani is the chairman of the board and a rice exporter. Farrukh Amin Godil is the CEO, and comes from a family with significant holdings in wheat and rice trading. n

FOOD