Karachi, July 01, 2022 (PPI-OT): Jun-2022: Macro headwinds continue to dampen sentiment
Nascent positives outweighed; KSE100 falls 4% in Jun-2022
The KSE100 Index witnessed a news flow heavy month where key highlights were Federal Budget FY23 and its subsequent amendments, progress with the IMF and development on FATF’s front. The budget with a heavy IMF tinge and pronounced additional taxes outweighed positive developments on FATF and progress on IMF deal. KSE100 Index resultantly ended the month down 3.6%, closing 2QCY22 down 7.5% and 1HCY22 down 6.9%. Continuation of PKR depreciation, with some respite towards month end dragged Jun-2022 returns to -6.4% in US$ for KSE-100. Decrease in confidence was also reflected in leaner market activity as volumes dipped 16% MoM.
IMF conditions create concerns on inflation
While the IMF program remains critical, the conditions leading to a successful IMF Staff level agreement are inflationary in nature, leading to FY23’s estimated CPI to average over 18%. These include resumption of PDL and GST on POL products, rationalizing electricity and gas tariffs and further monetary tightening. These steps could also trim margins of some sectors, subject to the extent of bargain power corporates would hold amid potential slowdown in economic activity. We highlight, OGRA has recently approved c. 45% increase in gas rates for gas network companies, partially addressing rationalizing gas tariffs in the system.
Budget FY23 – not too PSX friendly
A government facing elections in maximum of 18 months and looking to resume the IMF program, as soon as it can, was faced with the unenviable task of drafting Federal Budget FY23. While revenue target announced seem aggressive, we believe the target can be met even with relative slowdown with support from (1) growth from additional taxes announced on the elite and retailers, (2) PKR depreciation increasing duties and GST on imports and (3) better management of retail fuel prices, under IMF program.
On sectors, the overpowering measure announced has been the one-time 10% Super Tax, followed by an indefinite 4% annual Super Tax (with annual income +Rs300mn/annum). This has jolted the smart money over impact on corporate profitability, in addition to further taxes on banks that is among the largest holdings of many sizable investors.
Outlook
Incorporating all taxes and higher energy prices in FY23, PSX forward earnings yield are still at 25%, towering above prevailing 12M bond yield of 13%+, an unusual phenomenon for Pakistan in our view, which last faced similar spreads during the Global Financial Crisis (2008-2009). The current concerns over inflation and lack of clarity on IMF deal, seem to be playing a major role driving the widening of this spread. We believe a decision on the same holds key to contraction in the spread, as clearer CPI outlook will contain the rise in yields, where 12M PKRV is already pricing in ~100 – 150 bp increase in the Policy Rate, where we also expect a 100bp increase on July 7.
As we have highlighted the strong relation of market multiples with import cover, approval of Federal Budget FY23 unlocking IMF and other flows and will hence beef up the import cover providing a trigger to multiples and valuations. Another key area of respite could emerge from softening global commodity prices over inflation suppressing global demand.