BULLS STAGE COMEBACK OVER SC VERDICT; BANKS’ EARNINGS LIKELY TO SUPPORT
The week ended on 28th July 2017 will be marked in the history of Pakistan due to the Supreme Court’s verdict leading to the disqualification of incumbent Prime Minister Nawaz Sharif and dissolution of the cabinet. Passing through a rough patch marred by political uncertainty and a spate of largely unsatisfactory results announcements, market witnessed high volatility last week. Despite all odds the week closed at 45,912 points, up 1.4%WoW.
News flows impacting the market included: 1) Pakistan’s foreign exchange reserves declining to US$20.4 billion, 2) ENGRO’s Thar coal‐fired power project likely to commence commercial operations by Jun’ 2019, about four months ahead of its official deadline, 3) NEPRA scaling down the tariff for electricity supply from the new Thar coal‐fired plants by 18.51% because of falling production costs and 4) urea off take during Jun’17 soaring to 1.06 million tons, while DAP offtakes climbing to 112,000 tons. While the gainers included: EFOODS, HUBC, POL, MLCF and INDU; the laggards were: PSMC, LUCK, ASTL, APL and MCB. Average daily traded volumes rose by 48%WoW to 198.35 million shares with volume leaders being: ANL, EPCL, TRG, KEL and ASL. Foreign interest remained weak with net outlows of US$13.15 million against net outflows of US$2.00 million in the preceding week. Panama Papers case verdict is likely to affect investors’ sentiment.
According to a report by one of Pakistan’s leading brokerage house Topline Securities, the collective production of exploration and production companies (E&Ps) operating in the country grew by three percent to 88,189 barrels per day (bpd) during 2016-17. Temporary shutdowns affected production of some of the major oil companies at the beginning of 2017. As a result, oil production averaged 95,000 bpd initially. Oil production went up 10%YoY to about 91,000 bpd during June. However, on MoM basis, it was up 11%, owing to the low-base effect. Nashpa field, which accounts for 26% of Pakistan’s total oil production, experienced a brief shutdown in May. Although, the country’s oil production growth in 2016-17 was 3%, major listed E&Ps registered an increase of 9-11 percent. Additional output from the developed fields and commissioning of some new projects lifted the oil production of Oil and Gas Development Company (OGDC), Pakistan Petroleum (PPL) and Pakistan Oilfields (POL).
Engro Fertilizers (EFERT), Pakistan’s second largest urea manufacturing company is scheduled to announce its 2QCY17 financial results on Friday, 4th August, 2017. According to a report by AKD Securities, the Company is forecast to post profit after tax of R3.19 billion (EPS: Rs2.40) for the quarter. The significant increase in earnings is expected on the back of: 1) strong growth in topline to Rs17.49 billion resulting from higher urea offtake to 550,000 tons and 2) a 18%YoY decrease in finance cost on account of swift de-leveraging and low interest rate environment.
On a cumulative basis, the brokerage house expects EFERT to post Rs4.84 billion (EPS: Rs3.64) net profit for 1HCY17 as compared to Rs2.79 billion (EPS: Rs2.10) for 1HCY16, up 73%YoY. Along with the result, the Company is also expected to announce an interim cash dividend of Rs2.25/share.
United Bank of Pakistan (UBL) posted a consolidated profit after tax of Rs13.2 billion (EPS: Rs10.81) for 1HCY17, down 9%YoY. Sequentially, there was a 24%QoQ decline in earnings on continuation of super tax. Alongside, the result, UBL also announced the second interim dividend of Rs3.0/share taking half year payout to Rs6.0/share. Key highlights of 1HCY17 result included: 1) net interest income (NII) declining by 5%YoY can be attributed to lower interest rates, 2) asset quality continued to improve with the Bank marking reversal of Rs192 million during 1HCY17 as compared to Rs1.5 billion for the corresponding period last year, 3) non-interest income declined by 13%YoY due to a 16%YoY reduction in capital gains and 5%YoY decline in fee income and 4) along with this there was a 4%YoY increase in expenses.
The income of commercial banks has to be watched closely and minutely, because they are the biggest investors in government securities. In the recent past, profitability of banks has remained under pressure due to low interest rate environment and shrinking spreads. Banking spreads remain at their multi-year lows. In addition, the continuation of super tax also erodes profitability of the banks. These factors are likely to manifest in the upcoming 1HCY17F results where analysts expect earnings to decline by 9%YoY. Positive surprise can come from higher utilization of capital gains and lower than expected credit costs. While CY17F is being termed a sluggish year, earnings can rebound going forward, led by the interest rate recovery and likely higher loan growth.
As a group, the Big-6 banks are expected to post a combined net profit of Rs58.5 billion for 1HCY17F as compared to Rs64.4 billion for 1HCY16. Net interest income (NII) is likely to decline by 6.4%YoY as yields on the earning assets continue to decline, because of shrinking banking spreads and PIB substitution. A 6%YoY drop is anticipated in non-interest income on lower realization of capital gains. Sequentially, earnings drop of 22%QoQ is more on account of 4% super tax to be charged on CY16 taxable income.
In the backdrop of soft CY17 earnings outlook along with interest rate reversal expectations in 1HCY18, analysts remain skeptical about the banking sector performance. That said, long-term triggers remain firmly in place with monetary tightening likely to commence in 1HCY18. Investors should focus on banks with an aggressive plan regarding: 1) a growing proportion of current account deposits, 2) a strong non-interest income profile, 3) ability to reach and capture CPEC led growth and 4) ample capital adequacy.