Looking into the bullish case for Pakistan's Habib Bank

Dubai - I believe Habib Bank is on the precipice of a valuation re-rating.

Habib bank is one of Pakistan's oldest, biggest retain/corporate banks, now privatised last year with a 51 per cent controlling stake held by the Aga Khan Fund for Economic Development. Its recent price fall from Rs240 to Rs172 is a compelling opportunity to own an undervalued, well managed proxy for consumption and credit offtake in a 190 million population country now at one of history's significant political and financial inflection points. With a market cap of a mere $2.4 billion, a price/earnings ratio of 7.4 per cent, a price/book value of 1.3 and a dividend yield of eight per cent, I believe Habib Bank is on the precipice of a valuation re-rating that could turn this bank's shares into a frontier market money gusher for us. Why?
One, Pakistan's GDP growth has begun to revive to 4.5 per cent, largely boosted by consumption and a revival in business confidence/capex. The $6.6 billion IMF loan package has been a macro stabiliser and the fall in crude prices has enabled Pakistan to boost its foreign reserves to above $20 billion. Nawaz Sharif's pro-business PML government has also embraced the restructuring and privatisation of state owned enterprises.
Two, Pakistan's past "decade of terror" exacted a tragic toll in human lives and led to a fall in the loan/GDP ratio from 27 per cent to a dismal 15 per cent as capex plummeted. Loan/GDP is 30 per cent in both Bangladesh and Sri Lanka. Yet the Pakistan Army's offensives against the Taliban in South Waziristan have been hugely successful and improved the security/counter-terrorism climate. In fact, the Afghan President has even requested for Pakistani military strikes against the Taliban on the Durand Line.
Three, Pakistan will enjoy both a peace and demographic dividend in the next three years if the TTP and sectarian terrorists are vanquished. Two-thirds of its 190 million citizens are below the age of 30.
Four, while Praetorianism and serial military coups were a recurrent theme in Pakistan's post Partition history, the PPP government of Asif Zardari completed its term, as will Nawaz Sharif's PML as well as adhere to the IMF loan program. Pakistan is unique in international politics as the only state that has a geopolitical "too big to fail" put option underwritten by Washington, Beijing, Riyadh and Abu Dhabi.
Five, after a horrific year for emerging markets, Pakistan trades at a valuation of eight times earnings despite a systemic improvement in its political/financial (interest rates are at 43 year lows) and fiscal risk. I remember Pakistan equities traded as high as 13.8 times earnings during the bull market in the General Musharraf-Shaukat Aziz era and Pakistani banks traded at 2.6 bull market peaks. Habib Bank Limited seems inexpensive and unloved to me despite its central role in the $46 billion China economic corridor, its 22 per cent return on equity and 17 per cent capital adequacy ratio. The enforcement order from Uncle Sam against the bank's New York branch has led to offshore fund manager selling and is an ideal entry point to accumulate its shares.
Six, Habib Bank has a Rs2.2 trillion balance sheet and current accounts rose 15 per cent to Rs600 billion in 2015. These constitute 37 per cent of the bank's 1.6 trillion deposit base and the domestic CASA ratio has improved to 85.6 per cent from 80 per cent. These are dream metrics for an investor in international banking.
Seven, while the bank has high non-performing loans that must be managed, I am optimistic that management slashed coverage at the last earnings conference call by CFO Raymond Kotwal (who I remember as a Grammarian six pointer in his Cambridge "O" levels in the lost world of Z.A Bhutto's Karachi!). True, first quarter earnings were a disappointment due to flat net interest rate margins and mediocre capital markets/fee income growth, but these are short term setbacks. The real silver lining is the 74 per cent sequential decline in provisions and the stellar 90 per cent coverage ratios. Low cost deposits, economies of scale, an Islamic/international/investment/mobile banking franchise all mean Habib Bank's return on equity could easily rise to 25 per cent in the next three years. This means a valuation re-rating is inevitable, ceteris paribus-though all else rarely remains the same in Pakistan. Dr. Johnson said patriotism is the last refuge of the scoundrel but he forgot to mention deep value investors can also succumb to this emotion!