Macro Analysis /

Pakistan Economy – Macro estimates revision

  • We now assume higher inflation and interest rates and a weaker exchange rate for FY22/23f

  • We have also increased the risk-free rate in our models to 11% from 10.5% earlier

  • Market P/E of 5.6x suggests monetary tightening is also priced in, and further valuation de-rating should be limited

Saad Ali
Saad Ali

Head of Research

Intermarket Securities
11 November 2021

Revising our macro estimates and lifting our risk-free rate to 11%  

  • We are recalibrating our macroeconomic assumptions in light of the worsening of external account and inflation in recent months. The change in outlook has emanated from earlier-than-expected tightening measures and seemingly tough IMF conditions (though timing of the program resumption remains uncertain). In sum, we now assume higher inflation and interest rates and a weaker exchange rate for FY22/23f.

  • Broadly, we see little risk in Pakistan achieving GDP growth of 4-4.5% in FY22 (from 3.9% in FY21), because of robust Agricultural output and Services segment rebounding over complete absence of lockdown (for much of the year) and multiyear high commodity prices (consumption). LSM, however, is likely to slow but only toward the end of FY22, because of the tightening measures. Sustaining GDP growth of over 4% in FY23f could also be a challenge, in our view.

  • We have thus increased our risk-free rate to 11.0% from 10.5% earlier, to coincide with the higher interest rates and lower corporate profitability ahead (for the cyclical industries). This is in line with the average yield of 11% on 10yr PIB since 2005 – the benchmark for long-term return on a risk-free security in Pakistan.

  • As a result of these changes, the target prices – for June/December 2022 – across our coverage has decreased by 5% on average. Not surprisingly, the greatest decline is seen in cyclical industries such as Cement, Autos, and Steel (by 10-30%). We also tilt our preference for defensive industries and stocks (including some among the cyclical ones), where our most preferred stocks are picked on the basis of high dividend yield (of over 12%) and ROEs (of over 20% given average COE across our coverage is now around 17%).   

  • During periods of monetary tightening (of 200bps or more over a period of 2-3yrs), the Pakistan equity market tend to de-rate by 30-35%. Since the market – at a forward P/E of c.5.6x – is trading below the lower end of its long-term average P/E of 9.0x, we think that the market has already priced in monetary tightening of about 200bps and weaker corporate profitability. We draw two conclusions from this:

Further valuation derating of the Pakistan equity market should be limited

But, the market could trade in a narrow P/E range of 5-7x until the time pro-growth policies are reinstated by the authorities

In this backdrop, we shift our preference for Banks (UBL, MEBL, BAFL), Fertilizers/IPPs (EFERT, FFC, HUBC), E&Ps (POL, OGDC), Textiles (GATM, ILP), and select names in the cyclical space (LUCK, MLCF, KOHC, MUGHAL, ASTL, INDU and MTL).