Karachi, July 31, 2023 (PPI-OT): Comparing 47,000 of Nov-2021 vs 47,000 of today

Having gained 18% in 22 sessions, KSE-100 closed above 47,000 - first time since Nov-2021. We however highlight that KSE-100 index levels alone do not portray the whole picture and draw a comparison between the two 47,000 levels.

KSE-100 is a 'total return' index and incorporates dividends - as a result 47,000 does not correspond to stock prices having recovered to Nov-2021 levels. KSE-100 market cap is 17% lower than Nov-2021 - also partially reflected in 'price index' (KSE-30) trending 8% lower vs Nov-2021. The comparison is even more stark on P/E basis where due to consistent corporate profitability growth not being reflected in stock prices, P/E multiples are currently hovering around 3x vs 5.5x in Nov-2021.

On macro comparison, current interest rates despite near term pressures are expected to ease soon, while in Nov-2021 they were single digits; albeit ripe for an increase. Import cover, which has a strong correlation to PE has recovered to Nov-2021 levels recently with inflows from IMF and friendly countries but P/E is yet to fully reflect the same.

PSX valuations have been undisputedly attractive but lack of macro clarity has caused discount to widen - at 40% from recent and 60%+ to 10-yr mean. PSX offers material upside even in the case of just mean reversion but macro (and political) clarity remains imperative in market regaining its highs, not just in terms of symbolic index levels but also stock valuations.

KSE100 on fastest rally pace in recent times

The KSE100 Index crossed another barrier in the last trading session, closing above 47,000 level, maintaining streak of positive close since the last 7 consecutive sessions, a rare instance in recent times. The benchmark index has so far jumped 18% in 22 trading sessions from its recent low on 23rd June, and 23% from its low made in YTD CY23 on 17th January. The last rally that comes close to this pace

was witnessed during mid-2020 where KSE100 Index jumped 19%, albeit in 35 trading sessions.

The key factor supporting the rally this time has been revival of investor confidence post IMF’s new Stand-By Arrangement program with Pakistan, leading to unlocking of external funds from other lenders and resultantly taking SBP foreign exchange reserves to 2x within a month. Sectors that have outperformed during this time have been Banks, Oil and Gas Exploration, Power and Cement sectors.

Power of dividends in a total return index

While key macro indicators and market multiples vary from the last time the index was at 47,000, we also bring to notice that as KSE100 Index is a total return index and reflects dividends announced by its constituents in the index level, contrary to constituents’ prices deducting the same from its respective market capitalization. Hence, KSE100 market capitalization stood at Rs1,951bn during Nov-2021, 17% higher than today’s levels of Rs1,665bn. Some of the differences in the KSE-100 market capitalization are also driven by change in constituents and free float of constituents but the role of dividends in driving KSE-100 index is significant.

To get a better grasp of change in capital gains during this time, we take a peek on KSE30 Index’s movement during the same time as it adjusts dividends of its constituents from the index level as well. For perspective, 27 stocks from the KSE30 are included in KSE100 Index, where cumulative of those 27 stocks are 66% of KSE100’s market capitalization. While KSE100 index back to Nov-21 levels, KSE30 index is 8% lower compared to Nov-2021.

How different is it from the last 47,000 level?

The last time KSE100 was above 47,000 was back in Nov-2021 (almost 21 months ago). Every 47,000s levels, however are not the same. Back in Nov-2021, index multiples were at 5.5x, vis-à-vis 3x at present. The difference in multiples arises from growing corporate profitability over time.

Moreover, interest rates during the latter time period were at 8.75%, almost the beginning of the ongoing monetary tightening cycle, vis-à-vis 22% at present, likely towards peak of the same. With that, the market’s earnings yields, in addition to spread over respective risk-free rates also vary as show in the table on the right.

Another indicator, we have been highlighting that has strong correlation to equity market’s P/E, is the country’s import cover. We believe the correlation strengthens from the indication of country’s capacity to meet external obligations, supporting investor confidence. Pakistan’s import cover in Nov-2021 was at 2.6x, which is close to the levels we report today. As depicted in the chart on the right, the recent improvement in import cover has not completely reflected in market multiples. To note, import levels have considerably reduced of late (US$3.5bn/month), compared to Nov-2021 (US$6bn/month) as well over recent administrative measures to control FCY outflow from the country.

KSE100 still offers more room to rally

Extension of the ongoing rally would have government’s deliverables as a key moving part. This includes the sitting, caretaker and new government that takes control post Elections expected in Oct-2023. The dire need of Pakistan is to not only smoothly complete the ongoing IMF SBA, but also to ensure meeting external financing needs beyond Mar-2023 (expected expiry of the ongoing SBA), in order to keep investor confidence intact. With pre-requisites and ongoing efforts such as further monetary tightening, increase in Power and Gas costs, increasing tax measures and narrowing interbank and open market PKR/US$ rate, it is expected that all governments would keep continuation of the IMF program as a top priority.

While index multiples have reached close to 3x, they still reflect a discount of 40% from recent historical mean and 60%+ discount from 10-year average. Any further re-rating would be over and above investors pricing in upcoming corporate profitability growth.

Sectors that have outperformed in this time still have upside on the cards owing to strong corporate profitability as they remain relatively resilient to ongoing macro challenges. From sectors that have underperformed in the rally, we highlight Consumer, Pharma and Fertilizer sectors that exhibit relatively strong fundamentals, offering much room for upside from here. While Consumer and Pharma sectors trade at a deep discount of 35%+ to their average historical multiples, Fertilizer sector remains among the defensive sectors reflecting one of the highest D/Ys in the listed space.