According to the Pakistan Bureau of Statistics, Large Scale Manufacturing (LSM) rose by 9.7% yoy in December in 2019, after continuously posting sharp decline in the previous five months (average decline of 6% yoy). During the July-December 2019 period (1HFY20), however, LSM fell 3.4% yoy compared to a similar decline in FY19 (3.4% yoy).
Since interest rates had peaked by December and inflationary pressures were on the rise, the very positive LSM data is surprising to us. A breakup of the same is more telling. Major growth was seen in the Food & Beverages category, followed by Paper & Board and Leather. The first two sectors are led largely by domestic consumer demand, while the latter is a major export sector. The table in the full report corroborates that the strong uptick in LSM data in December was led by Consumer products (mostly domestic demand).
In our view, the key takeaways of the data are:
- If it is a trend, consumer demand growth has preceded disinflation and monetary easing. But it is too early to be sure of this. LSM data for January-February will be critical to ascertain this trend amid renewed inflationary pressures during these months.
- Food inflation during January-February spiked substantially, which was majorly attributed to supply disruptions in major food items. We think that the LSM data may be pointing to an upsurge in demand for key consumer staples as well. While this is encouraging for consumer sectors, it also raises questions whether the recent food inflation was indeed temporary, in our view.
Based on the December 2019 results announced so far, relevant Consumer and Packaging companies have posted 19% yoy growth in cumulative net sales.
Recall that in our 2020 Strategy report, we highlighted that during past macroeconomic recovery periods in Pakistan – when the economy transitioned from an adjustment period to higher GDP growth – the sectors which exhibited the earliest rebound in sales and profits were: Consumer Staples, Paper & Board (taken as a proxy for consumer demand) and Textiles. Hence, we think the December data may be pointing to nascent economic growth, despite the lack of conducive macroeconomic indicators.
As the market has adjusted to new expectations on the timing of future monetary easing (into 1HFY21), the KSE-100 index has corrected 7% from its recent peak. Even so, our thesis of likely macroeconomic recovery during 2020 – which will continue market rerating towards historical mean levels and build the foundation for strong earnings growth in 2021 – remains intact. This emanates from our view that recent inflationary pressures are temporary and that authorities will immediately embark on pro-growth policies at the earliest sign of disinflation (potentially during 1HFY21).
Risks: (i) Sharp inflation in Jan-Feb’20 will detract LSM growth, (ii) upcoming power and gas tariff hikes will be other deterrent to growth, and (iii) delay in monetary easing later than 3QCY20.