Equity Analysis /

Pakistan Strategy: Rally extends but could snap in February; Buy on dips

    Intermarket Securities
    3 February 2020
    • The KSE-100 extended its rally in January, gaining 2% mom to bring returns from mid-August 2019 to 45% (up 49% in US$). Local institutional buying came through on an improving import cover and civil-military harmony (the Parliament approved a term extension for the army chief). Local individuals opted for profit-taking while foreign investors largely continued to be bystanders. 
    • The rally thus far has been almost completely led by valuation rerating, with macroeconomic stabilization fueling expectations of interest rate cuts from 1H 2020. However, valuations may come off in the near term before resuming their uptrend; the SBP did not cut interest rates in January and with CPI jumping to 14.6%, monetary easing could be delayed into 2H 2020, in our view.
    • As the market adjusts to a higher-for-longer interest rate outlook, a correction is likely. That said, we retain our December 2020 Index target of 51,000pts and reiterate that Pakistan’s positive outlook is unlikely to get derailed on temporarily high inflation. We would take a correction as an opportunity; stocks that we would recommend to Buy on dips include UBL, BAFL, HUBC, OGDC, LUCK and INDU.

    Rally extends in January…

    The KSE-100 gained 2% in January, bringing gains from the mid-August 2019 low to 45% (up 49% in US$). Important news flow for the month included: (i) parliamentary approval for the army chief’s term extension, (ii) GoP relieves Fertilizer producers of GIDC charge leading to lower Urea prices, (iii) continued foreign inflow into government treasuries (cumulative US$2.9bn) lifting SBP’s Fx reserves to an import cover of above 3 months, and (iv) positive progress on FATF, as per news reports. Local institutions turned buyers in the month under review (up US$18mn), led by mutual funds and banks, while individuals opted for profit-taking (down US$23mn) and foreign investors continued to remain on the sidelines (up US$3mn). However, signs that the rally has been losing steam have been evident over the last few weeks, manifesting in a range-bound Index and dip in volumes (January ADTO: US$60mn, down 20% mom). 

    …but could snap in February

    In line with expectations, the central bank kept interest rates on hold in the January monetary policy. With January 2020 CPI coming in at a steep 14.6% (vs. the 1HFY20 average of 11.1%), the market could take a breather as it digests a higher-for-longer interest rate outlook, in our view. This should coincide with sector rotation – cyclical sectors such as Oil Marketing, Steel and Pharmaceutical gained the most in the rally over the last six months and could now come in for profit-taking (Cements and Autos also appear vulnerable). On the flipside, underperformers such as Banks, Power and Textile should be better placed, in our view, to weather any selling pressure that comes through. 

    Positive outlook remains intact; a correction should be availed

    We believe that temporarily high inflation does not derail Pakistan’s positive outlook. The reform process continues apace, underpinned by a strong external account and an improving fiscal side; and, while there are nascent risks on tax collection (the FBR chairman’s ill health is inopportune), is expected to remain on track. In the context of global concerns over the new coronavirus strain, we flag that Pakistan very much remains a domestic driven story; exports to China are just 0.6% of GDP (imports are a higher 3% though) while falling international oil prices are a key positive. Moreover, domestic liquidity remains strong both at the institutional and HNWI levels. Any correction in the market would thus be an opportunity to build new positions, especially for foreign investors who have largely missed the bull-run over the last six months (foreign bond investors have been quicker to act). 

    Risks: (i) More strict measures demanded by IMF, (ii) negative review by FATF in Feb’20, and (iii) delay in monetary easing.