Pakistan Stock Market Remains Under Pressure

The benchmark index of Pakistan Stock Exchange (PSX) mostly remained under pressure as confusion is mounting amongst investors over slowdown of economy. Despite expectations of IMF negotiations to conclude soon, investors fear IMF demands including flexible exchange rate and reform agenda implementation would bring further inflationary pressure and demand slowdown. Investors remained cautious in short run as risk of further monetary tightening and inflationary pressure would keep upside in check. The remaining in limelight were Banks on interest rate hike increase, E&Ps on attractive valuations, Textiles on likely benefit from higher exports, rupee depreciation and Fertilizers on reduction in GIDC, seasonal demand, better farmer economics and supply constraints of urea.

The total liquid foreign exchange reserves held by Pakistan were reported at US$15,709.6million on 15th March 2019. The break-up of reserves was: 1) foreign reserves held by the State Bank of Pakistan (SBP) at US$8,838.7 million and 2) net foreign reserves held by commercial banks at US$6,870.9 million. During the week under review, SBP received US$1,000 million from UAE as placement of funds. After taking into account outflows relating to external debt servicing and other official payments, reserves held by SBP increased by US$716 million.

Reportedly, despite facing enormous economic challenges, Imran Khan led government seems to have gained ground. The key issues facing the government are: 1) delay in striking a deal with International Monetary Fund, 2) high inflation, rising poverty and unemployment. The factors creating hopes are improving macro indicator signifying enough political capital to initiate the reform process. It is believed that the incumbent government policy to protect the marginalized/lower income population from the price hikes has played a key role in maintaining its popularity. The prevailing conditions give confidence that the government can comfortably kick start the reform process to address key macro and energy sector challenges. From policy perspective, concrete action to tame fiscal woes remains missing, with rate hike adjustments in energy chain also falls short. With fiscal side of the equation remaining largely unaddressed, analysts expect the next policy thrust to be on the same front. Forthcoming FY20 budget would be key checkpoint in this regard. Political capital allows the government to jump start reforms and set the tone for much needed policy direction that could invigorate investor interest. 

Pricing power, margin preservation and brand premiums are auto industry terms often quoted to make the case for long term investment in Pakistan’s auto sector. Last four quarters remained a tough time for the sector, with macro dampeners and industry-centric events. In a period of rising prices, input cost pressures due to rupee depreciation and a suppressive macro backdrop.

INDU seems to be winning the battle for pricing premiums. If one assesses average pricing per unit over the last four quarters, using reported numbers, contrasting the same with simple average list price for variants (assuming all variants form equal share of sales) and sales weighted average prices (proportional to sales per variant over the period). The analysis shows that last year’s price hikes have further distorted pricing for variants. A case in point is Corolla, where top level 1.8 Altis Grande retails at a 47% premium to the entry level 1.3L Xli, when compared to 38% premium seen during July’17. Widening price distortions could have a negative impact on demand for higher-end variants, as consumer is satisfied with lower end variants, seeking a manageable price point. This relationship of marginal propensity of demand withers in the higher-end premium SUV segment. INDU seems to exercise limited pricing premium (Fortuner and Hilux contribute 18% to the sale mix).

Over July’17-Sept’18, PSMC/INDU’s average quarterly sales price per unit were at an 11% discount/1% premium to their sales weighted prices, indicating relative pricing power exhibited by INDU. This means, INDU sold more of its premium variants for each model than PSMC, a factor previously attributed as key to INDU’s ability to preserve margins. Additionally, when looking at gross margin volatility, analysts see the last quarter as a period of depleting margins for INDU/PSMC with margins slipping 220/200bpsQoQ. At the same time, for both OEMs, average sales prices grew by 25/7%QoQ, where the stark jump in INDU’s pricing sets them up for relative margin stability going forward. Since this period was also a time of major transitions for the industry as demand headed into a contractionary spell, when faced with these strains, INDU stood tall in its brand credentials. Additionally for the OEM, our results indicate a lower risk for cannibalization, while market extension to the premium 4×4 segment is margin accretive.

Given that pricing power remains the key catalyst for long term competitiveness in the auto space, a review by AKD Securities shows that successful franchises managed to: 1) extend models to multiple segments successfully, 2) retain disparate pricing for variants amongst the models on offer and 3) attract demand from premium customers. With the drastic curtailment of import of used CBU’s, analysts believe premium segment manufacturers could further attract demand from the re-sale/import market, preserving market share in the process.

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