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Pakistan Market Outlook 2021: A year of economic stabilization; Index likely to reach 52,500

• We have set an KSE-100 index target of 52,500 by Dec-2021, which is an upside of 25% (USD-based: 18%) from here. In 2020, KSE-100 index is up just 4% (YTD), in spite of a sharp 55% recovery from its bottom in Mar-2020. Generally speaking, the upside in KSE-100, is largely due to P/E re-rating, with the rest because of earnings growth and dividends (as KSE-100 is a Total Return Index).
• We like cyclicals (Cements and Autos) on the back of expected economic uptick, while valuations on Banks and E&Ps are also very attractive. However, we suggest to avoid stocks with exposure to circular debt and having high foreign portfolio investment. We expect corporate profitability to grow by 10% YoY in 2021E and take comfort from (1) pick-up in aggregate demand, (2) a stable currency and (3) low interest rates.
• We are Over-Weight on Banks (as we eye increase in interest rates and higher than expected deposit growth), Oil and Gas Exploration (on the back of undemanding valuations and partial resolution of circular debt under the IMF program), Cements (given robust domestic demand amidst the construction package and low interest rates) and Autos (given demand has come back in strongly with low interest rates and margins are likely to remain strong given a stable currency).
• Our top picks include: Lucky Cement (LUCK), MCB Bank (MCB), MARI Petroleum (MARI), Engro Corporation (ENGRO), Meezan Bank (MEBL), Pakistan Oilfields Limited (POL), Indus Motor Company  (INDU), Searle Pharmaceuticals (SEARL), Fauji Cement (FCCL), Unity Foods (UNITY), Kohinoor Textile Mills (KTML) and IGI Holdings (IGIHL).
• A poll conducted by Topline Securities of top fund managers and corporates show large number of participants expect (1) GDP growth between 1.1-2.0% in FY21, (2) monetary tightening to begin in May-2021 with a likely increase of 75-100bps in 2021, (3) PKR/USD to close at 160-165 by Dec-2021, (4) KSE-100 to close between 45k-50k by Dec-2021 and (5) net foreign selling to continue in 2021.
• We believe the year 2021 to be a year of economic stabilization and consolidation as the impact of COVID-19 dissipates on arrival of vaccines. We highlight that four key factors will shape market’s sentiments in the upcoming year.
• These include (1) the success and distribution of COVID-19 vaccine, (2) the re-entry of Pakistan into IMF fold and its conditions, (3) quantum of foreign portfolio selling and buying and (4) political landscape amidst PDM’s protests.
• We expect Pakistan to re-enter IMF program, where policies may include fiscal austerity, monetary tightening and addressing structural inefficiencies.
• As a result, we expect GDP growth to clock in at 2.0-2.5% in FY21 (vs. last 10-year average of 3.5%) and expect State Bank of Pakistan (SBP) to increase Policy Rate during the year to bring Real Interest Rates close to/back into positive zone. We expect SBP to raise Policy Rate by 100bps in May/Jul-2021.
• Non stop foreign corporate selling has been a major factor affecting share prices and stock market sentiments in Pakistan. We expect another US$200-300mn net foreign selling during year, where overall outlook of Emerging and Frontier Markets is improving.
• The start of year 2021 is likely to be affected by protest rallies by Pakistan Democratic Movement (PDM). PDM is a 11-party opposition alliance, which has launched a campaign to oust Prime Minister Imran Khan and is also seeking fresh elections. If their demands are not met, PDM has threatened to stage a sit-in, in the capital city and/or resign from assemblies. After the Senate elections, we expect movement of PDM to also fizzle out with ruling party able to smoothly pass legislative work with respect to the IMF conditions and FATF.
• The transition from Trump to Biden presidency will also be of key importance to Pakistan, along with growing concerns with the Middle East because of their acceptance of Israel.

We do not expect Pakistan to be on the White List of FATF in Feb-2021. At best, FATF will decide to send a team to Pakistan to ensure compliance on 27 Action Plan, which will take at least six months.