Karachi, December 20, 2021 (PPI-OT): Pakistan Banks – what does the Smart Money say?
After underperforming KSE-100 in 2020, and so far outperforming the benchmark by 11% (on adjusted basis) in 2021, Pak banks are seen as being a defining sector for 2022. With higher rates and their positive correlation with banks’ NIMs, the stage appears set for a strong performance.
In this context, we decided to look at how the smart money is positioned on banks and also spoke to a number of money managers to better understand their outlook and positioning.
Key takeaway from our vantage point is that money managers are in agreement on fundamental positives but the fear of foreign selling and adverse regulatory measures is equally concerning – the conflicting considerations are aptly summed up in average allocation of 14 top equity mutual funds to banks standing at ~23%, in line with the sectors weight in KSE-100.
CY21: Heavyweights limit sector returns
With CY21 coming to an end, we look at how the banking sector has fared to date. After a 12% under-performance in CY20 (sector: -5%) amid steep monetary easing cycle, the sector began CY21 with attractive multiples and earnings growth on the table. The sector’s adjusted prices so far only report an 11% increase. Upon assessment of stock-wise performance, Islamic banks, banks with respective event plays and growth plays emerged as clear winners during CY21. Moreover, the key draggers have co-incidentally been the heavy-weights of the sector, which also bore their respective fundamental and/or external risks that led to limit the sector’s returns during CY21.
2022 – What’s the Smart Money doing and thinking re banks
With higher rates and their positive correlation with banks’ NIMs, the stage appears set for a strong performance. In this context, we decided to look at how the smart money is positioned on banks and also spoke to a number of money managers to better understand their outlook and positioning. Our sample of 14 top equity mutual funds in Pakistan revealed that on average the sector has allocated 23% of their fund size to banks – which is in line with the weightage of the sector in KSE-100 (i.e. 23.4%). We take a straight average of allocations to ensure that average is not swayed by differing assets sizes of funds.
Key takeaways
Positivity on structural attraction of banks is unanimous
Our sample of money managers was almost unanimous regarding the structural attraction of the sector – the sector’s forward P/B of 0.68x does not justify the recurring Tier I ROE of 22%, in addition to a D/Y of 10%. Investors are on board with steady growth in asset base, alongside NIMs expansion in banks during the next year. Moreover, the broader investor base also does not see uptick in credit cost during CY22; nonetheless, the aforementioned ROEs incorporate a higher credit cost to cover for any unforeseen deterioration in asset quality.
Foreign selling drag – is the end or reversal in sight?
The number one drag or concern of the participants is the consistent selling from foreign investors in banking stocks. The reclassification of Pakistan from MSCI EM to MSCI FM further expedited the outflow where the total net foreign selling in banks in CY21 stands at US$167mn (following on from US$168mn in CY20). Some participants also appear to be firming up their view that there are signs of the outflow stalling or reversing as we head into 2022. Despite an edgy macroeconomic picture, some investors believe Pakistan might receive some traction from foreign investors given the highly attractive multiples at present; and a chunk of those flows would likely proceed to banking sector. A key event of inclusion of Pakistan in MSCI FM 100 and MSCI FM 15% Country Capped Index is also scheduled in the first half of CY22, which can be an opportunity for Pakistan’s equity markets to tap fresh frontier funds.
Regulations and taxation policies – keeping investors tentative
Higher prospective taxes on the sector emerged as a key concern across all investor segments as the banking sector’s profits have always been highlighted when the country is looking for increase in its revenue streams. So far, the banking sector is already paying one of the highest corporate tax rates of 35%, Super Tax of 4% and has recently been penalized on lower ADR levels with higher tax charge.
On the regulatory front, recent developments such as application of the Treasury Single Account (TSA), introduction of domestic systemically important banks (D-SIBs) and a higher adequacy requirement for the same, sudden changes in corridor to compute Minimum Deposit Rate (MDR) are some of the concerns highlighted that have an effect on the investor’s comfort on the sector.
Our view: Both growth and yield on offer – limelight to rise
From our conversations we conclude that money managers are in agreement with fundamental positives but the fear of foreign selling and adverse regulatory measures is equally concerning. We believe as we head on 2022, limelight on banks will increase with allocation of funds towards banks as clarity emerges on the macro fundamentals. As and when foreign investors get interested, they are likely to tilt towards growth stories where we highlight Meezan Bank (MEBL), Bank Alhabib Ltd (BAHL) and Habib Metropolitan Bank (HMB) among the top growth plays from our banking universe that are expected to report double-digit annual book value growth in the next three years.
For investor segments that prefer D/Y to accompany the growth, where MCB Bank (MCB), United Bank Ltd (UBL) and Bank AlFalah Ltd (BAFL) stand out. The table below that lists top picks in banks from our Universe that includes their current valuations and 3-years earning CAGR capturing the attraction of the sector and the different attractive options form choose from.