Markets to perform choppy; cements and banks in the limelight
The week ended 7th December 2018 was another difficult one as the benchmark Index of Pakistan Stock Exchange (PSX) closed at 38,562 points, down 4.8%WoW. Unexpected interest rate hike of 150bps to 10.0% by the central bank caught investors off guard and coupled with Rupee depreciation triggered across the board selling. Oil prices receded 2.4%WoW in the run-up to the OPEC’s meeting as non-OPEC producers expand production, with pressure being exerted by OPEC’s decision to delay a final decision on output cuts, awaiting support from non-OPEC heavyweight Russia. Consequently, Oil & Gas sector lost 5.7% of its market capitalization during the week. The negatives overshadowed the improving relationship of Pakistan with the US, with the latter coming for assistance in negotiating settlement of the Afghan War.
While volume leaders for the week were: KEL, BOP, LOTCHEM, MLCF and PAEL, laggards included: APL, HASCOL, PIOC, PSO and PSMC. Importantly, foreign selling subsided during the week under review week with FIPI declining by US$2.5million as compared to a fall of US$51.1million a week ago.The next week is likely to be dominated by the same preoccupations. Final OPEC decision on production cuts would set the tone of the market for the upcoming week. Market performance could remain choppy where investors are likely to shift funds to fixed income in the aftermath of latest rate hike and uncertainty remains on external funding.
Troubling macro backdrop stifled investor sentiment, pulling the PSX benchmark index down 2.8%MoM, to close at 40,496pts at November 2018, marking a period of consistent softness in equity markets. Absence of concrete developments with regards to arranging external finances (bi-lateral or with the IMF), coupled with PKR weakness, MSCI rebalancing and rising cost of borrowing (425bps hike CYTD) rattled investors. The shaky end of November 2018 brings macros back to center stage, where the 150bps hike (higher than consensus of 100bps) coupled with PKR volatility (touching 143 but closing at 139.05 against US$ on Friday) will impose fundamental economic indicators (SPI, CPI, trade figures, credit offtake) on all aspects of capital markets.
Somewhat encouraging are recent policy shifts which aid the Government of Pakistan (GoP) in mending fences with the IMF, as the pace at which macro-adjustments are to be made was the major point of contention in reaching the staff-level agreement, where analysts expect monetary tightening to continue (150bps hike during CY19), though at a slower pace. Dampeners aside, upsides over the medium term is likely to be event-driven in nature, with positive developments on foreign funding (oil funding arrangement with UAE, Chinese investments materializing), IMF negotiations and GoP policy plan implementation (energy sector payment, tax reforms) could continue bearish sentiment.
Pakistan’s banking sector is better placed around this time with asset mix tilted towards investments, whereas economic growth is expected to remain around 4.8% as compared to 0.4% in CY09. Additionally, at that time, Textile sector led asset quality depletion in which global economic scenario played its part. Current market capitalization implies a sector ROE of 12.3% as compared to an expected 13.1% in CY19F. ROE is forecast to recover from 10.3% (CY18) led by interest rate gains (CY19 NIMs: forecast at 3.9% as compared to 3.4% for CY18). While the recent pace of interest rate hike is likely to result in higher provisioning cost, concerns over deteriorating asset quality are unfounded.
Short-termism has routed the power chain, where reactionary measures burdening the working environment include: 1) closure of FO generation base leading to inventory pile ups at refineries, 2) RLNG supply under debate with possible extension of supplies to households and 3) continuing buildup of circular debt where clearance measures are yet to be enacted. Analyzing CYTD HSFO and HSD cracks to Brent, analysts highlight the lack of movement in HSD prices relative to Brent illustrating expanding premium, whereas HSFO trades at discounts, limiting its feasibility for export. In short, deviations in cracks could limit refined fuel price movements for local oil marketing companies. RLNG has expanded its footprint in the country’s energy mix with quantum of imports rising 92%YoY, as shipments on spot basis through PLL have reduced the overall LNG DES price slope to 13.02% as compared to 13.37% under long term agreement, translating into saving of US$34.3million FYTD, all the more meaningful as policy measures to expand supply beyond power and industry inevitably raise losses.
Crude benchmarks in the run up to OPEC’s recent meeting indicate softness, as non-OPEC producers expand production, indicating a possible break in the cartel’s hold on global crude prices.
A deterioration of fundamental business dynamics is expected where rising costs (PKR devaluation, gas and power price hikes) coupled with supply side inflationary burden on consumers and slowing industrial activity, make for hampered pricing power, hurting profitability over the medium term. Declining profitability is expected to deplete the capacity of companies to disburse monetary payouts, where downside to dividend is expected, particularly from rising finance costs and debt servicing outflows. This convergence of ‘bottom-up’ negatives accompanied by slowing volumes and general decline in market activity, could relegate companies to augment non-cash payouts when faced with cash flow pressures, particularly in the form of stock bonuses.
Already, CY18TD total stocks issuing bonus shares has climbed to 43 from 25 in CY17, where the reduction in tax on bonus shares has been the major catalyst, while total issuance remains below 52 of CY13. Even so, bonus shares can be seen to have a limited impact on market capitalization while remaining extremely difficult to forecast, analysts highlight the extended role they may play in keeping index heavyweights Banks and Cements in the limelight.