Macro Analysis /
Pakistan

Pakistan strategy: Macro concerns drag market lower

    Raza Jafri
    Raza Jafri

    Executive Director, Research

    Saad Ali
    Saad Ali

    Head of Research

    Intermarket Securities
    3 June 2019
    • KSE-100 lost 2.2% in May, taking FY 19td decline to 14.1% (3% CY 19td), following renewed concerns on greater macro adjustments and a tough Budget ahead of an IMF programme; however, it recovered 8.5% from its intra-month low. Amid Ramadan, market activity fell 13% mom to 123mn shares. There was a net FIPI inflow of US$18.4mn taking total net inflows in CY 19td to US$52mn.
    • Key checkpoints for June include (i) FY 20 Budget announcement, which is expected to entail tough measures, (ii) market support fund (cUS$150mn), and (iii) clarity on GoP plans to increase FX reserves. 
    • We have a thematic preference for (i) Banks (HBL, MCB & UBL), (ii) Oil Marketing & Diversified Energy (PSO, HUBC & ENGRO) and (iii) E&Ps (OGDC). We remain cautious on cyclical sectors and pharmaceuticals, but selectively like LUCK, INDU and SEARL.        

    Renewed optimism on market support fund 

    The KSE-100 lost 2.2% in May, taking FY 19td decline to 14.1% (3% CY 19td); however, it recovered 8.5% from its intra-month low. The turnaround has come about on improved local sentiment, following expectations that market support funds will be launched soon. There are challenges to the sustainability of this rally given that the FY 20 Federal Budget – tentatively scheduled for June 11 – is likely to be a tough one. That being said, several important checkpoints will be reached in June, which can help bring significant clarity for the market. We remain positive on Pakistan, where the FY 20f PE of 6.2x has sizeable room to rerate through the cycle (long-term mean is c9.0x).            

    Important checkpoints scheduled for June

    FY 20 Budget: As part of the IMF’s pre-conditions, interest rates rose by 150bps last week, and the PKR slipped another c7% to bring total devaluation in this cycle to more than 30%. The fiscal deficit remains high (5.0% of GDP in 9M FY 19), but this is expected to be addressed in the upcoming Budget. A target primary deficit of 0.6% of GDP (vs c2.0-2.5% in FY 19) will likely entail tougher taxation measures and higher energy tariffs. Once budgetary measures are in place, however, greater clarity can emerge on earnings outlook.

    FX reserves rebuild: The IMF Board’s approval for the US$6bn programme, as well as the first tranche, can potentially come through in June. This should quickly be followed up by World Bank ADB budgetary support. Other sources for FX include: (i) pending license renewals of cellular companies (unlisted), which can raise US$0.5-US$1bn and (ii) restart privatisation where we understand mandates to privatise two LNG-based power plants have already been awarded.

    Market function: Market support funds (totaling cUS$150mn) are expected to come through shortly. These are likely to be set up along the lines of the Equity Market Opportunity Fund (EMOF) in 2008 and the State Enterprise Fund (SEF) in 2009. The EMOF did not have any restrictions, but the SEF was mandated to only buy stocks of eight state-owned companies ie OGDC, PPL, PSO, PTC, SNGP, SSGC, NBP and KAPCO. Expectation around the new funds has taken the KSE-100 higher in the last two weeks, but this momentum is now arguably in the price. Instead, more longer-lasting implications may arise from (i) the recently revised share buyback rules, and (ii) MSCI’s country classification review in June, which may see Pakistan being put on watch for a potential downgrade to FM.

    Our preference remains in defensive sectors

    The new economic team (de facto Finance Adviser, SBP Governor and FBR Chairman) has ushered in more urgency on economic reforms. The IMF programme (Board approval awaited) is likely to be a difficult one, but this can lead to sustainable benefits for the economy. The KSE-100 has been drifting lower for the last 2.5 years, but we believe improved performance is on the cards from H2 CY 19. At current levels, we have a thematic preference for (i) Banks (margin expansion to more than offset a higher cost of risk; we like HBL, MCB and UBL), (ii) Oil Marketing & Diversified Energy (power sector reforms can improve cash flows; we like PSO, HUBC and ENGRO) and (iii) E&Ps (better pricing incentives can come through; we like OGDC best). We remain cautious on cyclical sectors and pharmaceuticals, but selectively like LUCK, INDU and SEARL.

    Risks: (i) Macro woes and greater macro adjustments, (ii) delays in materialisation of market support funds, and (iii) tough budgetary measures.