Karachi, December 28, 2021 (PPI-OT): Pakistan Market Strategy CY22
61k or Bust!
Boom or Bust: Afridi is on the pitch. Anything can happen. A six and the match is won; a wicket and it’s all over. An apt metaphor for Pakistan market. Afridi is the government (and I’m not even making the Pathan connection here). Pass the mini budget, get the IMF on board, and despite a few difficulties and off days (dot balls in cricketing analogy), the match is won and you’re looking forward to KSE-100 at 61k+ for CY22. Unable to get the IMF for whatever reason (or even a delay) and expect a total meltdown with the KSE-100 unable to even sustain 40k. It’s a coin toss between bulls and bears where this poor soul is betting on bulls (base case at least), though trajectory is unlikely to be linear.
The pitch for Pakistan equities: Why we believe the market should perform is quite simple actually. It’s a 180 degree turn from the situation in CY21 i.e. i) the IMF will come back eradicating the main uncertainty that plagued CY21, ii) commodities will likely come down but in a tempered way, providing the external side with much needed space and iii) interest rate hikes will be measured, whereby making it easier for the market to absorb. Add to that, earnings yield (E/Y) currently stands at 23% versus 10 year PIB yield (risk free rate) at 11.8%, signaling a clear and aggressive ‘Buy’ here.
Valuations are attractive while the worst of economic pitfalls is behind: The KSE-100 currently trades at an undemanding P/E of just 4.3x, similar to the level witnessed during the peak of Covid. Instead of reminiscing over mean reversion to historic avg. P/E, investors would be better served making a case for valuation expansion due to a strong/improving outlook. P/E and the market rebounded during Covid because the economic tide turned (Economic stimulus package et al), otherwise an ever lower P/E would have been a certainty instead of mean reversion to historical average. Similarly, P/E today should increase for the simple reason that outlook remains strong where despite disaster mongering, the worst of economic pitfalls is behind. Our outlook is corroborated by expectations of i) managed interest rate increases (125bps spread throughout Cy22), ii) controlled CAD (which has been the major point of concern) at US$15bn for FY22 and US$10bn in FY23 and iii) relatively stable currency moving ahead.
Market may replicate 2005-08 move: Of particular prominence for the KSE-100 is a throwback to the period 2005-08, where SBP aggressively moved interest rates to 9% from 7.5%, with measured and spread out increases thereafter, eventually reaching 10.5% by Jan’08. Despite rate rises, the KSE-100 returned 112% during the period, crossing 14k level in the process, having fallen to below 7k level following the initial aggressive rate rise. We think a similar performance beckons where, while not as great as during 2005-07, economic numbers remain manageable and are likely to improve moving ahead, a contrast to when numbers began slipping beginning 2008.
The Risks – Fed move, commodity swings and Afghan situation: The risks obviously include rate rises in the US which could act as a double edged sword considering favourable commodity versus PkR/US$ moves. At the same time, geopolitics will continue to have reverberations across our economic spectrum particularly Pakistan’s relationship with the Biden administration in the aftermath of Afghanistan developments. Moreover, the financial crunch and humanitarian crises in Afghanistan needs to watched out for and managed carefully so as to not have any spillover effects in Pakistan.
Market Strategy – targeting 61.5k: Main themes for CY22 include commodity play where focus comes to Cements (LUCK, MLCF, FCCL – lower coal prices) and Steel (MUGHAL, ASTL – strong local demand), ii) interest rates – impact of already increased 275bps and a further 125bps hike meaning Banks come into play (MEBL, MCB) and iii) re-entry of IMF program which should be broader positive. We also like Tech – valuation play (SYS, TRG, AVN), Autos (Indus – yield and cash rich balance sheet), Textiles – strong exports and yarn margins (NML, IMAGE, NCL) and Foods (UNITY, PREMA, TOMCL on business outlook). We also like EFERT for yield.