Federal Budget FY22, prioritize a mix of growth and stabilization, targets GDP growth at 5.0% with tax collection at PkR5.83 trillion. Also aims at limit FY22 budget deficit to 6.3% of GDP. Incentivizing value added sector and reducing duties may prove a winner for all. GoP’s structural reforms for curing economic ills are quite visible with Refinery policy provisions and Energy sector reforms coming to the forefront. At the same time, reduction in Capital Gains Tax (CGT) for filers to 12.5% from 15% is likely to cheer the development in the coming days. Despite continued strong earnings momentum (3QFY21 earnings growth of above 90%). Budget based beneficiaries include Refineries, E&P, Cement, Flat Steel, Pharmaceuticals, Chemicals, Food, Footwear, Cables, Textiles and Autos.
Capital Market
Reduction in CGT to 12.5% from 15% is positive for the market where analysts foresee a sustained bull run in the near term. Considering the importance this budget holds, particularly in the context of presenting PTI in a favorable light before campaign trail begins by the same period next year, Budget 2022 was likely to provide incentives to industries where it has certainly delivered. Reduction of CGT, however, was a low probability event despite repeated demands of the investment fraternity. Investors are likely to cheer budgetary developments where market topping the 50,000 threshold appears a formality. The year-end target of 56,000 appears a lot more digestible now where a key check point will be GoP’s relationship with the IMF where despite being expansionary in nature, if GoP delivers on its reforms and tax collection targets, Pakistan may actually be well on a path of sustainable long term growth.
Is it all about the CGT? A definite no! Even in a hypothetical event of no CGT reduction, market was always primed for a liftoff due to 1) valuations being undemanding, 2 federal budget favoring industries and 3) return to normalcy with COVID-19 coming under control. Bullish outlook on the market has been a continuous bet on the GoP policies where the PTI led government has not disappointed. Differential between Earnings yield and sovereign rate is another indicator of continued bullish momentum. With a controlled external account (CA surplus of US$0.7 billion in 10MFY20) and consequent stable currency, analysts believe the PSX is likely to come on to foreign investors’ radar in the near term as well where foreigners have been net sellers CYTD (outflow of US$87.25 million). From overall market perspective, Budget’22 will resonate as a winner with the investment community where winners include Refineries, E&Ps, Pharmaceuticals, Food, Footwear and to an extent Autos.
Refinery Sector
Budgetary Measures Entering the Fifth Cycle Degree Rise of 10 year tax holiday for new deep conversion refineries of at least 100,000 barrels per day (bpd) for which approval is given by the Federal Government by 31st December 2021. 10 year of tax holiday on up gradation, modernization or expansion project of deep conversion refinery of at least 100,000 bpd of any existing refinery which is approved by Federal Government by 31st Dec’21. Customs duty on HSD to decrease by 1% to 10%, while for MS, customs duty is expected to increase to 10% from 3% earlier. Custom duty on Furnace Oil has been decreased to 7% from 11% earlier. Minimum turnover tax on refineries decreased to 0.5% from 0.75%. Crude oil moves from first schedule to fifth schedule of customs act and customs duty on crude oil reduced to 2.5% from 3%.
With the existing refineries requiring up gradation to improve product mix, the aforesaid income tax holiday is in a bid to incentivize refineries and is in-line with the demand of the industry players 10% duty on MS and HSD will aid refineries in improving cash flow particularly when heavy capital expenditure needs to be carried out to upgrade. With this increase in duty, effective protection on MS is expected to increase to 7.5% from 0% while on HSD it remains at 7.5%. Decrease in turnover tax will be a significant positive for the sector with gross margins remaining low due to heavy duties/taxes placed on the final product while with product mix having substantial amount of FO, low international prices of FO keep GRMs thin. Though adjustable, given that refunds have faced delays historically, application of sales tax on crude oil can result in build-up of refunds for the local refineries. The measures announced are a significant positive for the sector where analysts expect local refiners to move forward with the up gradation plans and consequent improvement of product mix is expected to result in improvement in GRMs in long term. However, increase in duties is expected to provide uplift to GRMs in near term. With BYCO’s up-gradation plan already underway, analysts expect company to be the prime beneficiary of the announced measures. However, other refiners are also expected to follow suit, with ATRL, NRL and PRL are mulling over plans to upgrade their refineries.
Steel
There has been reduction/exemption of CD, ACD & RD on import of flat rolled products of HRC and stainless steel, along with removal of 5% custom duty on HRC. FED of 17% on steel ingots, billets, ship plates, bars and other long rerolled profiles and will be charged the same under sales tax regime. Federal PSDP target has been set at Rs900 billion, up 42.9% against revised estimates of Rs630 billion for FY21 while total development budget stands at Rs2,100 billion out of which Rs1,200 billion has been allocated to provinces. Major projects in PSDP include Diamer-Basha with a cash outlay of Rs23 billion, Mohmand Dam with Rs6 billion, Dasu Hydro Power Project with Rs57 billion and Neemum Jehlum Hydropower project with Rs14 billion. Subsidy of Rs33 billion has been allocated for Naya Pakistan Housing Scheme. Removal of 5% custom duty on HRC will have positive impact on annual earnings of ISl/ASL. Moreover, a potential reduction in raw material cost of CSAP and INIL can be witnessed. Change of regime from 17% FED to 17% sales tax on billets and ingots will have a neutral impact on the sector. Higher allocation in PSDP bodes well for long steel players as demand generated via dam construction is estimated up to 4.5 million tons while demand from Naya Pakistan Housing Scheme is estimated up to 5 million tons. The continuation of construction package along with aggressive development spending will further strengthen the demand for long steel. Local players are ready to capture the market with ASTL having established excess capacity, while the expansions of MUGHAL and AGHA are set to be operational in FY22. In the backdrop of measures announced, analysts continue to remain overweight on sector, where apart from long steel players capitalizing on increasing demand, margins of flat steel players are expected to improve on account of relaxation in custom duty.
Cement
Allocation for Federal PSDP has been increased to Rs900 billion from Rs650 billion for FY21, while total development expenditure outlay stands at Rs2.1 trillion for FY22. A sum of Rs30 billion has been allocated for the subsidy under Naya Pakistan Housing Authority. An additional Rs3 billion has been allocated for Naya Pakistan Mark-up subsidy. Specific allocations have been made for big ticket dams where Rs23 billion has been allocated for Diamer Bhasha Dam, Rs57 billion has been allocated for Dasu Dam, Rs6 billion has been allocated for Mohmand Dam and Rs14 bilion has been allocated for Neelum Jehlum. The GoP has also announced its resolve to continue improving landscape for low income groups to avail housing finance and has allocated Rs1.5 billion under the Qarz-eHasna Scheme. Increase in PSDP is in-line with expectations and will further stimulate demand, especially after private sector led the demand on the back of various incentives announced by government under construction package. Moreover, any expedition on construction of Dams after the current allocation will be an upside as analysts expect the demand to grow by 10%YoY for FY22. Another demand stimulant is being provided in the shape of Naya Pakistan Housing Scheme where so far progress has been limited. However, with specific allocation being made, any progress in this regard will further improve the demand outlook of the sector. Increase in sales tax on RLNG, though adjustable, can potentially result in cash flow issues for the cement manufacturers operating their captive power plants on RLNG, mainly DKGC, FCCL. Even though no cost side relief has been provided to the sector in the budget, improved demand robustness is only going to improve pricing power of local players and consequently the margins. Cement sector has remained under pressure recently on the back of increasing coal prices after they have increased by 33% during last 4 months. Moving forward, analysts expect local manufacturers to increase cement prices further as they look to pass on the cost increase.
Automobile
The GST on locally assembled cars up to 850CC has been reduced from 17% to 12.5%. In addition to this, FED of 2.5% has been removed in the said category. The GST on imported and locally assembled hybrid electric vehicles has been reduced from 17% to 8.5% for up to 1800CC, and 425bps from 17% to 12.75% for above 1800-2500CC. The GST on imported Electric Vehicle (EV) CKD kits of small cars/SUVs with 50Kwh battery and Light Commercial Vehicles (LCVs) with 150Kwh battery has been exempted till 30th Jun 2026. The GST applicable on sale of locally manufactured Electric Vehicles (EVs) has been set at 1% till 30th June 2021. The VAT has been exempted on cars up to 850CC and Electric Vehicle (EV) CKD kits and CBU units for small cars/SUV’s and Light Commercial Vehicles (LCVs) till 30th Jun 2026, However, the tax benefit on 2-3 wheeler EVs will expire on 30th June 2025. Incentives in form of tax relations were expected for local manufacturers of auto parts in order to increase the level of localization which ceases to exist. The demand for passenger cars has shown a strong rebound in FY21 after a dreadful FY20. The passenger car sales in 11MFY21 were reported at 139,613 units as compared to 89,133 units, up 57% YoY. Going forward, analysts expect a healthy growth in medium to long term. However, the supply chain disruptions are expected to hamper the pace of production in outgoing calendar year. The monthly average passenger car sales of PSMC in 5MCY21 have cloaked in at 7,974 units as compared to monthly average of 4,355 units in CY20, a growth of 83%. The reduction of GST and removal of FED and VAT on small cars as well GoP’s “Meri Gaari Scheme” on small cars is expected to drive the sales of PSMC. Reduction of GST on imported hybrid electric vehicles is expected to increase the imports of Japanese used cars under this category thereby increasing competition for local 1300CC+ premium sedan segment. However, the quantum of importing cars is still anticipated to be low due to operational difficulties in importing cars in Pakistan. Nevertheless, analysts continue to like local OEMs in premium 1300CC+ segment where prompt upgrades are expected to support the sales momentum in medium to long term. Analysts maintain a positive stance on PSMC and INDU in our coverage, though the possibility of HCAR outperforming cannot be ruled out as the new model Euphoria is yet to be introduced.
Textile
Reduction in RD, CD, and ACD on import of raw materials include: synthetic filament yarn, man- made filament yarn, woven fabrics, and artificial staple fibres. These include removal of 5% regulatory/custom duty on import of polyester yarn, reduction in tariffs on cotton, polyester and man-made fiber value chain. Minimum turnover tax reduced to 1.25% from 1.5%. Tax payable by cotton ginners on their income shall not be more than 1% of their turnover. Normalization of sales tax on raw cotton and ginned cotton to 17%also bodes well. Minimum wage is proposed to be Rs20,000. Reduction in RD, CD, and ACD to enhance export competitiveness of local players. To highlight, value-added segment consists of up to 75% of overall textile exports. Reduction in duties on yarn imports is negative for spinners while materially positive for mid-to-end textile chain players. Cotton ginners should rejoice budget with cap on tax expense. Increase in sales tax on cotton to 17% from 10% could translate into lower refund accumulation for spinners. After covid-19 spillovers, the situation has improved significantly for the exporters following easing in lockdowns globally and diversion of orders from regional countries (i.e. Bangladesh & India). Most of domestic players are scaling up their productions to pre-COVID level. Order book is once again strong with local players capturing US textile imports from China after order cancellation from Xinjiang, allowing manufacturers to work at full capacities. Older cotton inventories benefit local manufacturers in streaming through the recent bull cycle in commodities, translating into higher margins while massive lockdowns in India and other major cotton exporting countries opening up opportunities for local manufacturers.