- The KSE-100 declined steeply by 6% in June, to close FY19 and 1H19 down by 19% and 9%, respectively. Although the Index had a strong start to the year, gaining 10% in January alone, it has closed lower in each of the following five months, it’s longest ever losing streak. Local mutual funds remained net sellers in June, while FPI also recorded an outflow of US$5mn (foreigners are net buyers in 1H19).
- The market has been led lower by a weak macroeconomic backdrop that has necessitated a greater-than-expected adjustment to interest and exchange rates. A prolonged delay in securing an IMF program has not helped. Key events during the month included: (i) the FY20 Budget, (ii) Pakistan remaining on the FATF watch list (final decision due in October) and (ii) MSCI not putting Pakistan on watch for downgrade to FM (against expectations).
- We do not rule out further downside in the KSE-100 in the near-term, owing to the possibility of higher interest rates and the lack of positive triggers. That said, the Index is now trading at a forward P/E of 6x, which is a cross-cycle low and supports a buy-on-dips stance. Our top picks are UBL, HUBC, OGDC, EFERT and PSO.
Low investor confidence leads to steep losses…
The KSE-100 shed 6% in June, extending a losing streak into its fifth consecutive month. As a result, the Index closed out FY19 with a 19% decline and 1H19 with a 9% decline. June’s decline was broad-based with all sectors closing in the red. This was partly due to low investor confidence, reflected by daily traded value of US$46mn (flattish mom and down 35%yoy). Key events during Jun’19 included: (i) the FY20 Budget which was largely punitive on individual sectors but supportive of a better tax culture, (ii) Pakistan failing to meet FATF checkpoints (final decision due in October), (iii) MSCI not putting Pakistan on watch for potential downgrade to FM (against expectations) and (iv) Pakistan securing bilateral assistance from Qatar. Fresh PKR weakness was also a key talking point in the outgoing month.
…sparked by multiple negative triggers
In Jun’19, Pakistani authorities instated measures to comply with the IMF’s “prior conditions” following the staff-level agreement in May’19. This has been most visible in interest rates more closely tracking inflation outlook and the PKR shifting to a “market based” regime. As a result, interest rates could continue increasing given that June saw fresh 7%+ depreciation in the PKR, which will add on to inflationary pressures. The FY20 Federal Budget was also laden with removal of tax concessions and was followed by 30-190% increase in gas tariff and PKR1.5/kwh hike in power tariff. As a result, the prolonged tough period faced by the Pakistan market can potentially extend across the next few months, in our view.
Major corporate developments included: (i) local OEMs increasing car prices by 15% on average (inclusive of FED), (ii) a PKR50/bag increase in cement prices, (iii) removal of zero-rating (local sales) for the textile sector and (iv) intimation that SEARL will explore the feasibility of potentially investing in/acquiring the operations of OBS Pakistan (Pvt.) Ltd.
Interplay of weak confidence and cheap valuations
We estimate that the Pakistan market trades at a 2020f P/E of 6x, which is a cross-cycle low. That said, investor confidence is weak and could potentially drag the Index lower to test the year-to-date low of 33,167pts (closing basis), particularly if interest rates rise quicker than expected in the monetary policy due later this month. Key checkpoints in July include: (i) likely approval by the IMF Executive Board for Pakistan’s request for a 3yr US$6bn EFF program, and (ii) clarity on the government’s plans to rebuild Fx reserves via privatizations and telecom license renewals. We retain our buy-on-dips stance where our top picks are UBL, HUBC, OGDC, EFERT and PSO.
Risks: (i) Greater macro adjustments hereon, (ii) political/security concerns, and (iii) worsening outlook for earnings growth.