Karachi, September 22, 2021 (PPI-OT): Banks: Value before growth!

We update our investment case for Pakistan Banks as we (1) incorporate gradual increase in Policy Rate, starting from 25bps increase announced this week, and taking it to 8.25% in the next one year, (2) incorporate recent tax changes announced in Budget FY22 and (3) roll over our Target Prices to Dec-2022.

We highlight the gradual increase in Policy Rate will initially result in NIMs contraction over immediate increase in cost of funds with upwards adjustment of savings rates on deposits, while re-pricing of loans may take a quarter or two. With the last leg of monetary tightening in Jul-2022, we expect complete impact of 8.25% Policy Rate to be reflected during CY23F.

With ROE inching upwards in the next couple of years, the banking sector warrants a P/B of 1.2x, close to its historical levels. As double-digit earnings growth is reflected in CY23 estimates, the sector offers a value play at current levels with current P/B at 0.7x.

Pakistan’s reclassification from Emerging Markets (EM) to Frontier Markets (FM) is expected to bring limelight to blue chips of the banking sector with HBL and MCB listed in the Simulated MSCI Pakistan Index and Simulated MSCI Frontier Markets 15% Country Capped Index, in addition to UBL in Simulated MSCI Frontier Markets 100 Index. Moreover, our workings suggest inclusion of MEBL in the Standard Index where it could either replace MCB or become the fifth constituent.

The monetary tightening cycle, along with ongoing commodity super cycle, may increase probability of higher credit costs for banks in the coming quarters. Moreover, the same is likely to shift investors towards defensive sectors and higher DY stocks, making banking stocks attractive for such investors.