Strategy and value in Pakistani shares
Pakistan now trades at 7.8 times forward earnings while EPS growth could well be 14-15 per cent next year.
By Matein Khalid Macro Idea
Published: Sun 27 Aug 2017, 3:00 PM
Last updated: Sun 27 Aug 2017, 5:04 PM
2017 has been an annus horribilis for Pakistani shares. Fears about a rupee devaluation after external accounts deteriorated, selling by offshore frontier funds after the MSCI emerging market upgrade, fear of EPS growth momentum declines, the Supreme Courts disqualification of Prime Minister Nawaz Sharif and Trump's anti-deep state Afghan speech all contributed to the 12,000 point fall from the 53127 point peak in the Pakistan Stock Exchange index. This is a 20 per cent-plus fall or a bear market, amplified by local mutual fund redemptions.
This is an opportune moment to analyse Pakistan's myriad macro, political, earnings and positioning headwinds. One, there is no doubt that Pakistan faces a balance of payments mini-crisis. The current account deficit, 1.6 per cent in fiscal 2016, is now 4 per cent of GDP in fiscal 2017. I do not need a PhD in economics to analyse the Achilles heel of Pakistan's current account malaise. Pakistan's elite has gone on a consumption binge due to the impact of a spectacular property boom (my own teenage home in Karachi's Defence Society was valued at almost $2 million, up tenfold in the past decade. This is unreal and this will not last). This is the reason imports surged by 18 per cent while exports fell 1 per cent and remittances from workers in Saudi Arabia/GCC plunged. True, the China Pakistan Economic Corridor (CPEC) necessitates a rise in machinery/energy infrastructure/capital goods imports but Pakistan imports far too many luxury goods (Benzies and Beamers a common sight in the city by the Arabian Sea) of dubious economic value. State Bank of Pakistan foreign exchange reserves have declined and the import cover is now only times. This means a devaluation of the rupee to the 112-115 range is all too possible. Pakistan also needs to repay $4.5 billion in principal and interest to external creditors in the next nine month. This is a clear source of foreign exchange rate risk to the Pakistani rupee.
President Trump's accusation that Pakistani military intelligence provides "safe havens for agents of chaos, violence and terror" will also be a deterrent to foreign institutional capital inflows. This will also inhibit foreign direct investment in the Pakistan's economy, despite its demographic windfall, scale and mineral resources. However, Trump is clearly "behind the curve" in real time since the Pakistani military launched a draconian campaign against domestic terrorists in 2012. It is no coincidence that the Pakistani stock exchange benchmark index rose 150 per cent in the past four years, Asia's best performing stock market for US dollar investors. While suicide bomb attacks and terrorist outrages still happen, thankfully Pakistan has witnessed a dramatic drop in civilian casualties. FDI is only $2.4 billion, it is the highest level since the end of President Musharraf's military dictatorship in 2008. Taliban/sectarian terrorism was a tragic chapter in the history of Pakistan that caused monumental economic and human losses. It will be a pity if Trump ignites a new round of Indian/Pakistani proxy warfare in Afghanistan.
Pakistan now trades at 7.8 times forward earnings while EPS growth could well be 14-15 per cent next year. This makes South Asia's second largest economy even cheaper than South Korea. A 10 per cent rupee devaluation could well be the catalyst to buy Pakistani equities as it will trigger offshore buyers who are waiting for this scenario. Pakistan will enter a new IMF programme after the election. Local mutual funds also hold 12 per cent in cash, dry powder for another bull run. Since 40 per cent of the index is energy and power companies with revenues in US dollars, a 10 per cent devaluation could well see a 20-25 per cent bull run on the stock exchange index.
The lessons of the nuclear test/Kargil (1998), President Bush's Afghan invasion (2001) and Musharraf's resignation (2008) stock market crashes are all historical precedents for the current financial malaise. Politics will remain a source of instability as the NAB investigates Nawaz Sharif's wealth. If the military promotes Imran Khan as the leader of a coalition government, his Mr Clean image could ignite a new bull run though his economic policy platform does not match the pro-business, reformist centre-right policies of the PML-Nawaz and Imran Khan does not command the Sharif brothers' vast political vote banks in Punjab. It is best now to accumulate defensive energy/power shares (OGDC, Pak Oilfields, Hubco), banks (Habib Bank), healthcare (Shifa, Abbot), infrastructure (KSB Pumps) and consumer shares (watch the Dalda Ghee IPO). Pakistani equities will experience a macro bungee jump once the point of maximum uncertainty on the rupee and elections passes.