EUR 9.38 For Business Accounts Only

(Detailed Report) Pakistan Market: Searching for the Comeback Cure! (AKD Research, Jun 15, 2020)

Pakistan Market Strategy FY21 (Detailed Report)

 

Searching for the Comeback Cure!

 

Budget’21 appears an exercise in frailty where the need to provide Covid related relief measures appears held back by IMF mandated austerity requirements. Government targets of i) 2.1% GDP growth, ii) FBR revenue at PkR4.96tn and iii) fiscal and primary deficit targets of 7.0% and 0.5% of GDP, respectively, appear ambitious and unlikely to be met. On face, the GoP appears to bank on administrative measures to fuel tax collection, where several steps to this end have been announced. From capital markets’ vantage, Budget’21 was anti-climactic and can be characterized as a ‘Construction sector Budget’. Focus will now shift towards Aug/Sep’20 months, the period of expected peak COVID-19 transmission and its fallout on wellbeing – both economic and healthcare. Modeling in a 1Q slowdown in our estimates, we see the index trickling to 39k over the next one year, with upside limited by already justified valuations (P/E: 6.8x) while in a worst case, assuming an aggressive and prolonged slowdown throughout 1HFY21 and de-rating index to 5.3x, we see the market re-testing 27k level intra-year. In terms of preferred plays, technological scrips have lit up screens worldwide particularly given changing corona induced working norms where we like Systems Limited (software development & implementation). On the traditional side, we like MEBL, MCB and UBL in Banks, FFC in Fertz, LUCK & MLCF in Cements and NML in Textiles.

 

Economic tethers – Relief vs. austerity: Aiming for fiscal consolidation, the GoP is targeting a 2.1% GDP growth while restricting fiscal and primary deficits to 7.0% and 0.5% of GDP. Add in a lack of concrete taxation measures and clearly, the numbers appear overly ambitious. That said, prudent move of freezing current expenditures is encouraging, however, overruns in social & health spending could offset the savings from austerity. Our estimates suggest the gov’t would either have to revise the fiscal targets in the coming few months or undertake mid-term fiscal adjustment of at least 1.7-2% of GDP (though assign a low probability to this given expected slow recovery). Other notable mentions in the budget include petroleum levy at PkR450bn where we expect actual collection at ~PkR350bn and issuance of Ijara sukuk worth PkR450bn, boding well for the Islamic Banking and Energy chains.

 

Market Perspective – Construction sector a key beneficiary: From overall market’s perspective, Budget’21 remained largely a non-event with no major capital market related development, as had widely been expected. That said, Construction sector comes out as a key beneficiary including Cements (Reduction in FED to PkR1.75/kg from previous PkR2/kg; reduction in holding period and tax rates for CGT on immovable property) and Steel (Reduction in RD to 6% and 11% from previous 12.5% and 17.5% on HRC; removal of provision 235B of WHT), FOODS ala cooking oil (UNITY, POML – exemption from 2% ACD on import of edible oil and oil seeds), Paper & Board (PKGS, RPL – reduction in CD on import of RM) and 2-3 wheeler Autos (SAZEW. TREET – elimination of advance tax on vehicles up to 200cc).

 

What to look ahead to? Naturally, outlook and ability to deal with the COVID19 pandemic will dictate the direction of PSX where Aug/Sep’20 – the expected peak covid transmission period - is a key timeline to watch. At the same time, with Pakistan becoming more entrenched globally, events shaping the US and other EMs will have major bearings on the KSE-100, particularly in lieu of increasing correlation with the DJIA (0.91x over the past 3 months compared to 10 year historic avg. of ~0.4x). Major near term US events to watch out for include i) FED decisions (interest rate / stimulus), ii) Nov’20 elections and iii) movement of the Dollar Index, particularly given current risk-off sentiment. At the same time, SBP decisions particularly any decision of further easing (potentially 100bps more) may also dictate sentiment, where in any case, we believe improved valuations courtesy interest rate reduction have essentially placed a floor on market downside.

 

Uncertain times call for unconventional picks: In addition to the usual suspects, technological scrips have lit trading screens worldwide where we have a keen liking for Systems Limited (SYS; TP: PkR235) engaged in the business of software development & implementation services. Though not under coverage, for long term story, we also like Avanceon Ltd. (AVN) with its focus on project implementation and turnkey solutions for manufacturing industry (consumer goods, housing et al). Within the Banking sector, we like MEBL, MCB and UBL on valuations, however, we also like BAFL and HBL on technical innovations. Traditional picks include FFC (11% D/Y) within Fertz, LUCK and MLCF in Cements (valuations) and NML in Textiles (export orders despite slowdown; portfolio value).