Interview with Mr Basharat Khan — Executive Director & Head of Equities Din Capital
Mr Basharat Khan is currently working as Executive Director & Head of Equities at Din Capital, a corporate brokerage house on Pakistan Stocks Exchange (PSX). Prior to joining it, he worked at Askari Investment Management as Chief Investment Officer and before that he was associated with Arif Habib Investments for 8 years where he served on various positions-head of research, head of equity funds and CIO.
PAGE: YOUR VIEWS ON CHINESE INVESTMENT IN PAKISTAN STOCK EXCHANGE:
BASHARAT KHAN: Selling of 40% holding to a strategic investor should pave the way for bringing overall change in the working of PSX. First of all, brokers will see windfall gains on their stake in PSX shares, enabling them to strengthen their capital base.
Pakistani market is perhaps amongst a few in the world where activity on the exchange is restricted to the ready-counter only as introduction of new derivative products such as margin financing and options got delayed repeatedly. Now after this change, it is expected that new products will be introduced which will help in enhancing trading volumes and reviving trading activities.
This change should also lead to coming in of foreign brokerage houses (perhaps a few Chinese brokerage houses) to Pakistan, thus enabling the exchange and its listed companies to attract more international exposure and foreign investment.
At present, PSX is valued at Rs22 billion ($213 million) only after the selloff of 40% stake at Rs28 per share. This is very attractive valuation for the exchange despite lower earnings presently. Price may look expensive on multiples but we shouldn’t ignore the fact that Pakistani market capitalization has reached closer to $100 billion where even smaller companies have bigger market cap than the value of country’s monopoly stock exchange. When PSX goes for IPO, we are likely to see higher demand and price is expected to surge above the price at which 40% shares were sold to strategic investor.
PAGE: WHERE DO YOU SEE PSX MOVING IN FUTURE?
BASHARAT KHAN: Pakistani equities have done exceptionally well in the second half of 2016 and have performed well above consensus expectations since November despite strong foreign selling. On valuation basis, some sectors in general and few stocks in particular have become relatively expensive as the rise in their share prices not fully supported by changes in fundamentals.
We need to look carefully whether the rise in share prices is due to some major change in fundamentals or is driven by speculation. Therefore, we might see overvalued stocks taking correction if earnings growth couldn’t meet expectations. Overall, broader market is trading around 14x multiple on 2016 earnings with some relatively small float stocks trading in very high multiples.
Market has been factoring in CPEC related developments/optimism which should help in big way for reviving domestic demand and pushing GDP growth higher. At the same time, prevailing low interest rates have started to attract savers and retirement funds towards equity linked mutual funds.
In 2017, one other factor which will have marked influence on the market is Pakistan joining MSCI Emerging Market Index. Till now, we are seeing outflow of foreign investors which has picked up pace since November (after Donald Trump win in US elections), however, expectations are that foreigners should increase their allocation once Pakistan formally joins MSCI-EM. But it shouldn’t be perceived as a foregone conclusion as emerging market flows are dependent on a wide array of factors and major one will be how the new US administration under President Trump comes out with new policies with the rest of the world.
PAGE: WHICH SECTOR MAY PERFORM WELL ON PSX DUE TO THE FOREIGN STRATEGIC INVESTMENT?
BASHARAT KHAN: Sectors performance will be primarily influenced by sector specific expectations and developments.
CPEC related progress has led to great surge in share prices of stocks in sectors such as cement, steel and autos. However, recent few months’ increase in share prices is perhaps driven by strong domestic liquidity push rather than any major shift in expectations.
Based on basic valuation parameters such as price earning multiple, price to book value or price to sales; levels have reached historic high.
In the case of large market cap sectors such as oil and banks valuations may not look that expensive but they are certainly in expensive territory for some stocks in sectors such as pharma and auto in particular.
Pakistani oil exploration companies have crawled back closer to levels when oil prices were in $80-100. This rebound in stock prices has outpaced the core fundamentals of these companies therefore for prices to sustain either oil prices have to rise or companies will have to show much improved production numbers.
Cement companies are experiencing the best times ever, never seen before in history, they are making exorbitantly high gross margins in excess of 40% with net margin in the range of 20-25%. Almost all major players have announced expansion with capacity likely to be increased by almost 50% from 45m tons to 65m tons over the next three to four years.
Pakistan which has one of the lowest per capita cement usage is all set to witness growth in coming years amid heavy infrastructure spending and housing boom. Key risks which the industry could see is the decline in margins going forward as prevailing levels are too high to be sustained for long.
Recent past history has shown that cement manufacturers have played their informal cartel arrangement against threats very effectively. All these basic industries such as cement, steel etc are prime beneficiaries of boom in housing and infrastructure spending in any country.
In Pakistan, these basic industries have been provided with excellent protection in the form of barriers against imports through higher tariffs which has in fact insulated the industry from external threats. Higher profits have enabled these companies to expand and in the case of cement almost every manufacturers has announced expansion.
While domestic demand should continue to remain strong, industry will face a lean time post 2018 when most new expansions will come online which will lead to oversupply situation thus exerting downward pressure on margins.
Banking stocks which had underperformed in the first half of the year have bounced back strongly since July. While concerns remain on lower profitability of banks due to lower interest margins, banks became a preferred choice for investors (primarily foreigners) as downward interest rate cycle has come to an end amid expectations of revival in GDP growth.
Overall banks are expected to outperform the market and will have major impact on KSE-100 performance given the highest weight of the sector on index.
PAGE: HOW WOULD YOU COMPARE PSX WITH INDIAN AND CHINESE EXCHANGES?
BASHARAT KHAN: During past 12 months, KSE-100 Index is up 60% as against 15% increase in Shanghai Composite and Bombay Sensex rise of 13%.
This huge increase has re-rated the market by almost 40% during last year with price earnings multiple now average around 14x on 2016 earnings.
Strong domestic liquidity has played a major role in pushing the market higher largely supported by lower interest rates, positive news flow on CPEC and improvement in Pakistan sovereign credit rating. The strength of the market as it makes new highs can be judged from the fact that index has refused to take even minor correction.
While individual stocks in various sectors have gone through varying degree of price correction and witnessed volatility, index on the other hand has been showing steady rise. Why is the market so different this time around? Yes positive expectation is one factor but it is actually the diversion of domestic liquidity which has pushed prices so high.
These domestic inflows mostly originated from high net-worth individuals and mutual funds have been chasing stocks nonstop. Earnings multiples have somewhat taken a back seat as companies are being valued on assets and market capitalization basis.
Foreign investors have been net sellers during 2016 with selling intensifying after Donald Trump election in the US. At this stage the quantum of leverage as shown in futures and MTS is too small to give us any idea that there is a bubble in the making.
As long as interest rates stay lower and there is no major upheaval in global markets, valuation may continue to stay higher compared to historic levels, with market giving very few bargain opportunities as used to be the case in the past. At the same time, only chasing momentum and pushing fundamentals to the sideline is certainly not the approach one should be pursuing at this stage.