Macro Analysis /

Pakistan strategy: Getting close to the bottom

    Raza Jafri
    Raza Jafri

    Executive Director, Research

    Saad Ali
    Saad Ali

    Head of Research

    Intermarket Securities
    30 April 2019
    • After a strong January (+10.1%), the KSE-100 has closed in the red for each of the last three months, with April’s 4.8% decline taking the YTD return to -0.8%. This follows a 15% decline for the Index in 2017 and 8% decline in 2018. Three years of consecutive losses would be unusual, having last occurred in 1994-1996. Pakistan now trades at a 2019f PE of 7.6x (2020f: 6.5x), lower than its long-term average of 9.0x.  
    • Pakistan enters May against the backdrop of ongoing staff-level IMF talks, and with a new Finance Minister at the helm. The next few months will be eventful, led by expected entry into an IMF programme, which should act as a catalyst, particularly for foreign inflows – so far a muted cUS$35mn in 2019td. Other key upcoming events include the FY 20 Budget, the next FATF review and ICSID’s decision on the Reko Diq case. 
    • Although the Pakistan market can extend its recent downtrend, we think any downside from here should be limited. The Q1 19 result season supports our view – headline profitability is flat but, adjusted for the one-off high taxation for banks,the profitability of our universe (more than 60 companies) is up c10% yoy. We would look to add Pakistan on dips, with our top picks being UBL, HBL, PPL, HUBC and ENGRO.        

    Continued weakness in April 

    The KSE-100 shed 4.8% in April, dragging YTD returns into negative territory. Foreign selling has continued to trickle in (+US$4mn in April; cUS$35mn in 2019td), but this has been more than offset by a net sell of cUS$60mn by local mutual funds in 4M CY 19. We understand the latter is a function of the shift from equities into fixed income; with 3-month T-bills yielding c11% and the interest rate cycle yet to peak, in our view this shift can continue over the next few months. Local sentiment remains weak, affected by higher inflation (March CPI at 9.4% yoy, the highest in five years) and the possibility of tough conditions attached to the upcoming IMF programme, particularly as the fiscal deficit remains bloated (H1 FY 19: 2.7% of GDP).            

    May will be eventful

    Pakistan’s calendar for the next 1-2 months promises to be eventful. Staff-level talks with the IMF are currently underway, and should lead to a new IMF programme. The new de facto Finance Minister is unencumbered by political considerations, which should help accelerate programme entry. This can act as a major catalyst for the market, particularly for foreign inflows, and potentially trigger a rally. Other key events to watch out for across the next few months include: (i) the FY 20 Budget, which is likely to heavily adopt IMF prescriptions, (ii) the penultimate FATF review, and (iii) the ICSID’s decision on the Reko Diq case. Given the border stand-off with India earlier this year, we would also keep an eye on Indian elections as well as the ICJ’s pending judgment on Kulbhushan Jadhav – the alleged Indian spy sentenced to death by Pakistan.

    Better-than-expected Q1 19 results season  

    More than 60 companies that we track have announced their Q1 19 results. Headline profitability under our coverage is flat, but after adjusting for the one-off high taxation faced by banks, earnings growth improved to c10% yoy. Importantly, there were earnings beats from banks and cement, while other heavyweight sectors such as E&P and fertilisers also delivered in-line results. Earnings estimates for our coverage universe have been cut by 8% on average since the start of the year, but we see limited room for further downward revisions. For banks in particular, we see room to lift our earnings estimates since margin expansion has been stronger than expected, while asset quality is holding up. Given that Banks have a high c25% weight in the KSE-100, this should be enough to offset any potential estimate cuts in more cyclical sectors such as cement and autos.

    Getting close to the bottom

    The KSE-100 Index has now shed 0.8% in 2019td to trade at a 2019f PE of 7.6x (2020f: 6.5x), versus the cross-cycle average PE multiple of 9.0x. The Q1 19 results season has reinforced confidence in our earnings estimates and, consequently, in the market’s valuations. We thus believe any downside from here will likely be limited (to c5%), and will represent an opportunity to build positions. We remain positive on Pakistan with our top picks being UBL, HBL, PPL, HUBC and ENGRO.

    Risks: (i) Continued delays in entering an IMF programme, (ii) higher-than-expected adjustments to interest and exchange rates, and (iii) weaker-than-expected corporate profitability.