Also, according to presentation by our CBG department PAEL required

financing for the expansion of electric meter capacity but the capacity of
PAEL is not fully utilized. Further discussion will be required with CBG
and with management of PAEL as well.
• Pak Elektron (PAEL) is a leading producer of electricity distribution
products and home appliances in Pakistan. It has relatively strong
market positions in the sector that it operates in (81% market share in
power transformers, 40% in distribution transformers, 30% in
refrigerators and 10% in air conditioners.
Financial Performance 1Q2018
Home appliances sales resetting lower in 2018
• Pak Elektron had a relatively strong run from 2015 to 2017, growing
refrigerator, air conditioner and deep freezer volumes at a CAGR of
12%, 135%, and 59%, respectively.
• The main reasons for this growth were :
1. Supportive growth in cosumer income.
2. Improving home appliances penetration rates.
3. New product inventions.
4. Dawlance going through its integration with Arcelik, resulting in it
taking its eye off the market for a short period of time.
But What Went Wrong ?
• Not only did Pak Elektron grow aggressively, but set even more
ambitious targets to gain share (highlighted in the table below).
• PAEL’s strategy was partly successful, evident from the strong volume
growth in 2017, but the misstep of overestimating its growth
potential has had far reaching implications for profitability (higher
discounts, increased advertising, inventory holding costs) and cash
flow.
• Management intention to grow aggressively and take advantage of
Dawlance’s lack of market presence, resulted in :
1. Higher discounts given to dealers to push Pak Elektron products;
2. Higher inventory levels to ensure that they could supply the market;
3. Better trade terms offered to dealers.
Consequences Of This Strategy :
• With eventual sales coming in below management expectations, this
strategy has resulted in a significant working capital build-up, leading
to cash flows underperforming the company’s reported profits. Net
working capital (inventories + trade receivables – trade payables) as a
% of sales has increased from 54% of sales in 2013 to 60% at the end
of 2017.
• Analysis in charts given below ;
Rising Inventory And Underperforming
Reported
PEST Analysis :
1. Political Environment :
• Pakistan is facing the situation of great political instability and
uncertainty since last decade.
• There can be political unrest because of the upcoming elections, the
formation of new government most probably be the joint alliance
type.
• Accountability factor is also important.
• There are less incentives for the manufacturers by the government as
compared to other countries.
2. Economic Environment :
• Shrinking reserves and high payments due.
• High circular debt.
• Rupee depreciation against dollar.
• Rising interest rates.
• Highest inflation rate in June 2018 ( 5.21% ) since October 2014.
• The consumers are spending more on their basic needs.
3. Social Environment
• Use of Janani Air coolers.
• People started buying ACs on installment.
• Room coolers are more in demand because of people willingness to
buy but expensive price.
4. Technological Environment :
• New technological development reduced the electricity consumption
• Environment friendly air conditioners.
CRM Department Observations :
• From Dec-17 till June-18 market has recovered 3.56% but PAEL has
declined by 25% , which could be due to its weak financial
performance of 1st Quarter 2018 and debarment from world bank.
• PAEL posted 1QCY18 profit after tax of Rs536mn (EPS: Rs0.97) as
compared to Rs1.1bn (EPS: Rs2.02) in the same period of last year,
down by 52% owing to lower sales of appliances, which is due to
lower sales of refrigerators (which contributes around 44% in total
revenue of the company). PAEL gross margins have also declined by
183bps YoY to 29.03%, which is due to increase in raw material prices,
devaluation of PKR and higher discount on appliances due to stiff
competition.
• In our opinion, Pak Elektron’s woes relate to :
1. Its over-optimistic targets - although appliances volumes grew 25%
Y-o-Y in 2017, it was still 18% below its target. This misjudgment
resulted in higher advertising expenditure (+148% Y-o-Y), higher
inventory holding costs (+60% Y-o-Y) and subsequently weak margins
and cash flows;
2. Delayed power distribution equipment tenders;
3. Dawlance (appliances competitor) regaining previously lost market
share with sales growing 20% Y-o-Y in 1Q18 (in 1Q17 Dawlance had
product availability issues).
• High competition in the home appliance industry and changing
dynamics of the industry where companies offer a higher discount which
lead PAEL to give a dis-count of Rs7.2bn (17% of total revenue) to the
dealer last year.
• As per findings of leading research firm, Chinese brand Haier is taking the
lead in refrigerators (which accounts for more than 60% of PAEL’s
appliances sales) in some regions, owing to its affordability (10‐15%
cheaper than PAEL).
• Similar observation was seen in Air Conditioners (AC) as well, the second
biggest sales contributor to PAEL’s appliances segment. Here, another
Chinese appliance manufacturer Gree is the preferred choice despite the
fact that it was 5‐8% expensive than PAEL.
Recommendation: