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Pakistan Strategy - Revisiting market thesis amid escalating uncertainty

The flames that initially re-ignited the KSE-100 index to a noteworthy recovery appear to have dimmed recently with the benchmark index losing 7% of its value from highs recorded during Jan’20. The market’s doldrums can largely be attributed to the absence of any notable triggers with investor sentiments likely being influenced by heightened inflationary pressures and geo-political uncertainty.

 

As the situation continues to unfold, the air of uncertainty over the economy’s ability to strike a sustainable balance between growth and stabilization has compelled us to revisit our investment case. In view of the aforementioned economic ambiguity, we have tweaked several of our assumptions, particularly our target PE, which we have revised down to 8.0x. Consequently, we lower our CY20 index target to 49,000pts (previously: 55,000pts).

 

Pakistan inclusion into FATF’s Grey List back in Jun’18 was seen as a definitive blow to the already waning investor sentiments and was considered one of the prime instigators of the Index’s eventual free-fall. Cutting to the present, the government continues reinforcing its claim of substantial progress on the implementation of FATF’s 27 points while asserting heightened confidence on irrefutably defending at least 22 of those conditions in Feb20’s plenary meeting.

 

The notion of carry trades has started gaining grounds within Pakistan’s financial ecosystem over the past few months with foreign investments in T-Bills and PIBs crossing the USD 3.0bn mark. These carry trades allow investors to cash in on interest rate differentials and benefit from a spread. These foreign flows into the debt market alleviate Pakistan’s external imbalances by ramping up SBP’s reserve buffers without amplifying the country’s external debt levels. A probable scenario of proliferating investments in Pakistan’s debt market is that the aforementioned investor confidence may carry over to Pakistan’s equity markets, potentially reversing the trend of foreign outflows witnessed during the past 4 years.

 

The US-Pakistan relationship is once again in the limelight as the Trump Administration continues reinforcing its stance on withdrawing troops from Afghanistan. The US has explicitly requested Pakistan’s assistance in brokering a peace deal with Afghan Taliban, providing an opportunity for taming the rocky relationship.

 

For the medium term, we foresee the Pak Rupee to continue depicting strength in anticipation of a prolonged monetary tight stance and the resulting foreign flows to Pakistan’s debt market. Moreover, we believe high interest rates will continue limiting growth avenues, further reducing demand for import-based consumption. Overall, the Pak Rupee will likely show stability for the remainder of CY20 and may continue holding its ground till we witness a substantial pickup in economic activities.

 

We believe Banks and E&Ps have the potential to outperform the broader market. The banking industry is set to benefit from an estimated 40% increase in earnings supported by NIMs expansion due to high-yield investments and cost normalization emanating from an absence of one-offs. The E&P sector may gain traction once the SPO supply overhang is addressed, potentially allowing the industry to converge towards its fair value. Out top picks for CY20 include HBL, MEBL, BOP, OGDC, PPL, HUBC and FFC.