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Pakistan Strategy: Market Fall Provides Selective Entry Point; Select Stocks Warrant Attention

• The benchmark KSE-100 Index has fallen by 7.0% (23% in US$) in 2018YTD to 37,647 index levels and is down 29% (44% US$) from its peak of 52,876 on May 24, 2017. Pakistan equities have been under pressure since its peak in May 2017 on the back of 1) economic concerns, 2) political upheavals and 3) net foreign selling.
• Pakistan’s fiscal and external imbalances (FY18 fiscal deficit at 6.6% vs. 5.8% last year and FY18 current account deficit at 5.8% vs. 4.1% last year) continue to expand that has now led the new govt. to the familiar path of International Monetary Funds (IMF), where a fund program is expected to be in place within the next few months.
• The IMF program will be accompanied by further 1) currency devaluation (Rupee has already devalued by 21% in 2018YTD), 2) hike in interest rates (policy rate up 2.75% in 2018YTD) and 2) increase in energy prices to name a few.
• In anticipation of the tough economic measures and expected slowdown in economy (FY19 GDP growth expected at 4.0-4.5% vs. FY18 GDP growth of 5.8%), the market has been embroiled with negative sentiments and is currently trading at forward PE of 7.3x compared (close to 5-Year low) to market 10-year average PE of 8.5x.
• The disqualification of former Prime Minister (PM) Nawaz Sharif in July 2017 led to increased political uncertainty and subsequent clash with the state institutions, which at one time also had led to assertions that the July 2018 elections could be delayed. However, the timely elections and a new govt. has to some extent allayed political noise.
• There had been across the board sell-off in emerging markets lately, on the back of U.S. trade war with China and country specific issues that led to weakening of emerging market currencies against dollar. To note, Morgan Stanley Capital International (MSCI) Emerging Market (MSCI EM) index is down 15% in 2018YTD. This also had a spillover effect on Pakistan’s market which has seen net foreign selling of US$375 in 2018YTD.
• Pakistan market’s recent decline has led to inordinate fall in across the board listed stocks. We have identified following select stocks that warrant investors attention based on certain valuation matrix: Engro Corporation (ENGRO), Indus Motors (INDU), Oil & Gas Development (OGDC), Nishat Mills (NML), D.G. Khan Cement (DGKC), Nishat Power (NPL), Pakistan Telecommunication (PTC), Pak Elektron (PAEL) and Habib Bank (HBL).
• To remain diversified in our selection criteria, we have picked one stock each from Autos, Banks, Cement, Consumers, Exploration & Production (E&Ps), Fertilizer, Power, Textile and Telecom, which in our view are likely to act as defensive plays in deteriorating macroeconomic situation. These companies, in our view, either have significantly fallen in their stock prices or are attractively placed on our valuation matrix.
• The valuation matrix we which have used to screen-out companies are Price to Earnings (PE), Price to Sales (PS), Dividend Yield (DY), Price to Book Value (PBV), Net Cash Position and Business Model.