JS Securities Limited – Pakistan Market Strategy 2018

Karachi, December 18, 2017 (PPI-OT): PSX’s valuations to eventually ‘trump’ politics, economic challenges

We expect market to pare most of the losses of 2017 (down 19% YTD) in 2018 by setting Dec-2018 Index target at 47,000; however the returns are likely to be skewed towards 2H2018 i.e. when we expect clarity on domestic politics and economic policies to emerge.

We expect politics to continue to dominate proceedings as we near elections, scheduled to be held around Jul-Aug 2018 period; with one eye also closely monitoring overall economic challenges, particularly the Balance of Payments situation.

We believe tracing the actual path of Pak Rupee (PKR) depreciation will be difficult as movements in the currency are not entirely market driven as the government keeps a tight check on exchange rate.

However, we expect Purchasing Power Parity (PPP) to hold in the long term, and expect PKR to completely adjust to external account imbalances by Jun-Aug 2018 period, which will coincide with the interim government setup that will be placed ahead of the general elections.

We expect PKR depreciation, rising oil prices and fiscal slippages to impact inflation. We expect 50bps increase in Policy Rate also during the Jun-Aug 2018 period and another 25bps increase towards the end of the year.

We also expect earnings announcements during the 1H2018 to be relatively less exciting, where we believe 2H2018 to garner more interest as sectors with expansions/new projects coming online in 2018/19 and sensitive to PKR depreciation and interest rates come under the spotlight.

We highlight valuations have become highly attractive at the PSX, particularly the spread of earnings yields over treasuries. The spread is at its highest in the past decade, even though risk as measured by Credit Default Swaps (CDS), Country Risk Premium (CRP) and Equity Risk Premium (EQRP) are all almost at their lowest.

The volumes have dried up, however we believe there is no lack of apparent liquidity in the market. We believe, volumes will come back, once clarity on politics and economy emerges, with Chinese likely to become strong participants in the market.

We like (1) sectors benefiting from potential PKR devaluation (E and Ps, IPPs, Textiles), (2) companies having clear leadership position to pass on PKR devaluation, and (3) banks with higher-than-peers sensitivity to increase in interest rates.

With an Index Target of 47,000, our preferred ten picks for 2018 (order with respect to their market capitalization) are: Oil and Gas Development Company (OGDC), Pakistan Petroleum (PPL), United Bank (UBL), Lucky Cement (LUCK), Engro Corporation (ENGRO), Indus Motors (INDU), Hub Power (HUBC), Bank Al Habib (BAHL), Nishat Mills (NML) and General Tyre and Rubber (GTYR).

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