Macro Analysis /

Pakistan market in August: Downturn extends amid volatility

    Saad Ali
    Saad Ali

    Head of Research

    Intermarket Securities
    2 September 2019

    During a highly volatile month, the KSE-100 lost 7% mom (the 7th consecutive decline) in Aug’19, despite a short spell in between when the index rose 11% from the month’s low. Market activity improved – average daily turnover was of US$26mn (up 44% mom) – while foreign activity turned negative (net outflow of US$5.3mn). 

    Key triggers extending the pessimism include: (i) worsening relations with India over Kashmir, (ii) a large fiscal deficit figure of 8.9% for FY19, recovery from which will likely require additional austerity measures, (iii) poor result season so far – only defensive sectors avoided a sharp earnings decline. Notable positives were GoP contemplating to reduce NAB’s power to investigate private entities and a modest CAD in Jul’19. 

    Going forward, new SECP decisions aimed at improving market activity may help to elevate investor confidence. Our Universe suggests market P/E for FY20f of nearly 5.2x (10yrs low). Our top picks are OGDC, HBL, ENGRO and EFERT (for defensive attributes and high dividend yields). Among cyclicals, we selectively like LUCK, APL  and HCAR.  

    Volatility abounds but positives in the end

    At one point during Aug’19, the KSE-100 Index had fallen 10% mtd to a new 2019td low of 28,765pts; but then staged a remarkable recovery of 11% in only four sessions. The brief spell of optimism was driven by: (i) extension in tenure of the existing COAS Qamar Bajwa (pointing to civil-military harmony), (ii) GoP looking to clip NAB’s authority over investigation of private individuals and entities (which will improve business environment), and (iii) Jul’19 C/A deficit of US$579mn (testament of the efficacy of macroeconomic adjustments thus far). These, along with SECP decisions (announced end-Aug) to improve market regulations and liquidity, may help to lift investor sentiment going forward. The Index has fallen 20% CY19td and is presently trading at 10yr low forward P/E of 5.2x (at a 53% discount to MSCI EM). Key checkpoints for the market in the near term include (i) the first IMF review (due end-Dec), (ii) MPS in Sep’19, and (iii) FATF review due in Oct’19.     

    Major events during Aug’19:

    Tensions in Kashmir: India decided to unilaterally revoke Article 370, which granted special status to Indian-administered Kashmir; this led to Pakistan downgrading diplomatic ties with India. The issue was raised by the UN Security Council and US President, but ended with moderate international intervention Escalating  tensions may have negative implications for Pakistan’s ability to tap the global Eurobond market, in our view. 

    Large FY19 fiscal deficit: Pakistan recorded a very high fiscal deficit of 8.9% for FY19 (primary deficit of 3.5%), which was a sharp revision from the initial estimate of 7.2% of GDP. In light of IMF’s target of 0.6% primary deficit, we think Pakistan may resort to greater tax measures (potential mini-budget) than proposed in the FY20 Budget. This will in turn negatively alter inflation and interest rate outlook, in our view, potentially delaying monetary easing.

    Sharp declines in Jun’19 results: 45 of the 66 companies we track have posted Jun’19 results. Broadly, profits are down 19% yoy (down 9% yoy ex-banks and ex-HASCOL) with oil marketing, cements, autos and pharmaceuticals posting the sharpest attrition. Results of some key energy companies – including OGDC, PPL, PSO and HUBC – have not yet been announced; SECP has exempted these companies for application of IFRS-9 until Jun’21, which would have led to hefty provisions. 

    Recovery contingent on macroeconomic improvement

    We think the upcoming MPS will be key to gauge  as to what extent fiscal slippages will weigh on monetary policy, even as inflation is likely to remain within the expected range of 11-13%, in our view. An early resolution of grey-listing by FATF, status quo in MPS and acceleration in buildup of Fx reserves will help improve confidence. Our top picks are OGDC, HBL, ENGRO and EFERT (for defensive attributes and high DY). Among cyclicals, we selectively like LUCK, APL and HCAR. 

    Risks: (i) More strict measures demanded by IMF, (ii) Pakistan remains on FATF grey list, and (iii) greater monetary tightening.