Pakistan Market CY14 Review and Outlook

pakistan-flagDespite a rise in political noise and militant backlash following a major military offensive, the KSE-100 Index rode the wave of macro rerating to gain 27% (31% in US$ terms) during CY14, bringing 3-year aggregate gains to 183%.

Pakistan market in terms of US$ returns ranked as the third best equity market in the world by Bloomberg. While politics/law & order brought the eye-catching headlines, the underlying economy kept humming, underpinned by foreign exchange reserves by State Bank of Pakistan (SBP) rising to US$10.4 billion, with external account comfort dovetailing with single-digit CPI to result in monetary easing.

Going forward, with political temperatures coming off from peak and lower global crude oil prices positively impacted the external account, the economy should enter a sustained growth phase with interest rates poised to further come off in 2015.

This should enable the Pakistan Market to continue its valuation rerating drive where the forward P/E multiple has risen to 8.5x (vs. 6.9x prior to the May’13 general elections), but is still lower than the 10-year average P/E multiple of 9.1x. Analysts retain June’15 Index target of 35,000 points.

The key developments during the year included: 1) rise in political noise, 2) escalation in law and order concerns and 3) continued macro improvement. Politics effectively led to CY14 being a year of two halves as 1HCY14 return was reported at 17% followed by returns of just 8% in 2HCY14 as the PTI/PAT’s Islamabad sit-ins rocked investor confidence.

At the same time, military operation in the northern areas resulted in militant backlash culminating in the tragic Peshawar school attack during December’14. Nevertheless, Pakistan Economy continued to depict incremental improvement, underpinned by SBP-held FX reserves rising to US$10.4bn (privatization/3G auction, Saudi Arabia grant, IMF tranches and Eurobond/Sukuk issue). As a result, the PkR appreciated by 4%YoY.

Despite some foreign selling pressure in December’14 (net outflow of US$49.5 million), Pakistan attracted net FPI inflow of US$382.5 million in full-year CY14 (US$700 million including privatization proceeds). This was supported by Pakistan’s weight increase in the MSCI FM Index, up 8% as compared to 4% a year ago.

While overall volumes declined by 6%YoY to 209 million shares, average daily traded value rose by 24%YoY to US$93 million. Volumes could see an uptick going forward, following the addition of 5 equity listings in the outgoing year (EFERT, SPWL, EPQL, AVN, HASCOL) with 2 more anticipated listings in January’15.

Profitability of Pakistan’s leading brokerage house AKD Securities declined to 12%YoY in 9MCY14 (fall in Telecoms & Textiles), most sectors managed to post robust price performance in CY14. Within the mainboard sectors, outperformance was posted by Autos (up 137%YoY on higher margins on weaker JPY), Pharmaceuticals (up 84%YoY on anticipated annual drug price increase), Cements (up 65%YoY on higher margins amidst strong demand), Chemicals (up 34%YoY led by EFERT), Electricity (up 32%YoY on higher load factors), and Banks (up 29%YoY on PIB shift). On the flipside, Oil & Gas (down 19%YoY on lower global crude oil prices) and Telecoms (down 21%YoY on ICH withdrawal/PTC VSS) were key laggards. In doing so, Banks have now overtaken Oil & Gas as the largest sector by market capitalization.

With political temperatures coming off from peak and lower global crude oil prices, positively impacted the external account, the economy should enter a sustained growth phase with interest rates poised to further come off in 2015. This should lead to sustained valuation rerating where the market’s forward P/E multiple of 8.5x can potentially rerate to 9.0x-9.5x to drive the Index to our Junuary’15 target of 35,000 points.

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