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(Detailed Report) Pakistan Market: The Prancing Horse!, January 02, 2020)

Pakistan Market Strategy CY20 (Detailed Report)

 

The Prancing Horse!

 

Time to go all in as Pakistan’s perceived macro de-risking and entailing euphoria is carried through to another year. Our CY20 index target comes in at 53,600 - a bonanza year for equities with the KSE-100 racking up another 32% gain. Thematically, Pakistan’s investment case hinges around three factors, i) the economic reform process being undertaken, ii) monetary easing likely to be initiated in CY20 (AKD estimate: 150bps) and iii) undemanding valuations (P/E: 6.6x, D/Y: 7.4%; earnings growth: 22%YoY). A key check point, however, remains the FATF plenary session in Feb’20 where Pakistan is largely expected to remain in the grey list. Of particular importance will be Pakistan’s international successes in CY20 where role in US troop withdrawal may open diplomatic and financial corridors, while the country will also look towards materialization of investment flows from Saudia (US$7bn) and China (CPEC Phase II). From a global context, Pakistan’s current situation remarkably mirrors that of Brazil in 2016 and Egypt in 2017, with indices of both countries staging spectacular rebounds amid economic reforms. Flow based investment may remain the mantra as ample liquidity seeps through to equities with major investor categories barring Individuals playing catch-up, reinstating the sentiment that defined the latter part of CY19. While bullish over a broad spectrum, preferred plays include Banks (UBL, HBL, BAFL, BOP), Power (HUBC), E&Ps (OGDC, PPL), Cyclicals ala Cements (LUCK, KOHC) and Textiles (NML).

 

The PSX – Resistance is futile: Targeting 53,600 level, market sentiment will continue riding high amid positive economic undercurrents led by the GoP’s reforms. Expected interest rate cuts will likely form the crux for investment case where AKD Research forecasts rate decline by a cumulative 150bps, starting May’20. In this regard, differential between expected one year forward PIB rate (10.5%) and earnings yield (15.3%) further vindicates our bullish stance. Market is also likely to take cue from macro developments including i) capital market transactions within privatization phase I, ii) issuance of Energy Sukuk II and iii) investment flow on account of CPEC Phase II and Saudi Investment. Flow based investment will remain in vogue as ample liquidity (aided by investment switch-over) results in other category investors joining Individuals.

Economic reforms – continuing but at a lower clip: Undergoing large and painful adjustments in CY19, Pakistan’s economy in CY20 will directionally witness much the same, only at a lower clip. Under GoP’s reform agenda, economic indicators have already started showing marked improvement where i) FY20 Current Account Deficit (CAD) is likely to narrow to 2.2% of GDP (FY19: 4.8%), ii) Primary Deficit expected at 1.4% of GDP compared to 3.5% a year earlier (though still above target), iii) CPI having peaked in Nov’19 and should start tapering from Mar’20 onwards and iv) necessary currency adjustments already made. That said, policy focus in CY20 will look towards addressing fiscal and quasi fiscal issues where budget deficit in FY20 is expected to remain high at 8.0% of GDP.

 

Market Strategy – Bullish over a broad spectrum! Remaining across-the-board bullish, we believe investors will eye progress on reforms and easing in the policy rate as vindication of GoP policies. In its second year, the incumbent government needs to start focusing on growth and confidence building measures. From a portfolio allocation perspective, we continue to like Banks (high ROEs, capital gains on equity/debt investments – HBL, UBL, BAFL, BOP), Oil & Gas (valuations; impact of previous PkR deval – OGDC, PPL), OMCs (Sukuk issuance – PSO), Power (valuations; Sukuk issuance – HUBC) and Textiles (valuations, improved core earnings – NML). Given Pakistan’s easing theme, we also like Cements for CY20 (LUCK, KOHC) but only after an initial dip as the sector may undergo a corrective phase in the initial months (capacity expansion, cement price decline, delayed easing). Fertilizers appear a mixed bag where, while we do like FFC and EFERT (higher offtake, strong year end results), concerns over gas pricing and GIDC lead to us preferring FFC over the latter. A similar story to Cements could play out for Steel as well, however, the sector appears unimpressive over valuations.

 

AKD Research