Macro Analysis /

Pakistan Strategy: Ultra-cheap valuations offset the risks

  • Pakistan had a bruising 2022. The coming year promises to be difficult too, but the risk-reward appears attractive.

  • Elections can reset politics, but the Balance of Payments situation is of concern. The IMF programme is a must.

  • P/E is just 3.5x vs. the 10yr average of 7.9x. Our 2023 KSE100 target is 50,000pts. Top picks are MEBL, SYS and ENGRO

Pakistan Strategy: Ultra-cheap valuations offset the risks
Intermarket Securities
14 December 2022
  • Pakistan had a bruising 2022 on a surprise change in government, severe pressure on Fx reserves, raging inflation, and the worst floods in more than a decade. This extended an already prolonged downturn, with the KSE100 now more than 60% lower in US$ terms from its 2017 high.

  • 2023 promises to be challenging too but offers the chance of a new beginning, with a potential reset in politics (general elections) and a more forgiving global macroeconomic backdrop after the sharp adjustments this year. Disinflation amidst slower global GDP growth may help alleviate Pakistan’s weak Balance of Payments position.

  • Forward P/E stands at just 3.5x vs. the 10yr average of 7.9x. Economic stabilization can take the KSE100 to 50,000pts in 2023, which implies a total return of 31% including 11% dividend yield. Derailment on Balance of Payments may open up prospects of 37,500pts, but we would take dips as buying opportunities with default risk largely in the price already.  

Investment Thesis

Our investment thesis is premised on: (i) gradual Fx reserves buildup under the IMF programme, (ii) possibility of monetary easing from mid-2023, and (iii) valuation rerating as investor confidence improves. Elections will be a major checkpoint, but politics may play second fiddle to the economy in determining the course of the KSE100 across the year. The Balance of Payments position carries the biggest risk in our view, but the cheap valuations limit the downside potential.

Politics: Elections can herald a new cycle

Politics remains polarized - Imran Khan continues to push for early elections, most recently threatening to dissolve the Punjab and Khyber Pakhtunkhwa assemblies to put pressure on the federal government. Mr. Khan retains significant mass popularity, but this may push the PML-N led ruling coalition to hold the fort and complete its remaining term. Our base-case is for general elections to be held as per schedule in October 2023, but a slightly earlier timeline cannot be ruled out. A PML-N win (status quo) or a PTI win (reformist) will shape the medium-term investment case differently, but we flag that the run up to elections usually sees the KSE100 rise in advance. The need to stabilize the economy remains paramount though.   

Economy: Little room for complacency

Default concerns continue to linger, but valuation comparisons with Sri Lanka and Ghana suggest the market has arguably priced these in to a great extent. Instead, recent measures such as the rate hike in November’s MPS and higher levies on petroleum products should help in continuing the IMF programme, albeit with a delay. This must be accompanied by fast-tracking bilateral support from China and GCC, and rolling over bank borrowing where possible. A gradual buildup in Fx reserves and import cover (1.25 months at present), should help align other macroeconomic projections, especially interest rates, which we expect will start coming off from mid-2023. We are less upbeat about the prospects of the PKR however, and another bout of depreciation may occur once import controls are eased.  

Equities: Valuations make for a favorable risk-reward

Pakistan equities trade at ultra-cheap valuations, relative to their own history and regional markets. This has been many years in the making, with forward P/E reducing from 13x in 2017 (inclusion in MSCI EM) to just 3.5x for 2023f. If anything, despite the multitude of adverse developments in 2022, the KSE100 held up reasonably well, losing a modest 6%CYTD in local currency. This backs our view that the bad is largely in the price, leading to limited downside risk (bear-case Index target: 37,500pts), while there is potential for decent upside once the top-down improves (bull-case: 59,000pts). Supportive factors include resilient corporates on improved buffers due to earlier strong profitability, the start of share buybacks by major companies, and significant room for institutional money to rotate into equities.