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Market beleaguered by negotiations with IMF, review by MSCI and facets of fy20 budget

During the week ended 10th May 2019, trading at Pakistan Stock Exchange (PSX) remained under pressure due to uncertainties emanating from negotiations with International Monetary Fund, forthcoming MSCI review and federal budget for next financial year (FY20). The benchmark index posted a decline of 3.9%WoW and closed at 34,717 points.

With the commencement of Ramadan, average traded volumes for the week plunged to 73.5 million shares, posting a whopping fall of 30%WoW. Volume leaders included: KEL, MLCF, SNGP and BOP. Leading gainers were: ENGRO, BAFL, HBL and PAEL, while laggards were: PSMC, HASCOL, MLCF and ASTL.

Key news flows impacting market sentiment included: 1) the finance division formally announcing appointment of Dr. Reza Baqir as Governor, State Bank of Pakistan (SBP) for a three-year term, 2) GoP increasing General Sales Tax (GST) and Petroleum Development Levy (PDL) rates for different products, 3) GoP deferring announcement of federal budget till 11th June, 4) provisional GDP growth data showing that country’s economy growing at a subdued 3.3%, significantly far below 6.2% target for the current financial year and 5) total foreign exchange reserves of country rising by US$230 million to US$15.972 billion during the week ended 3rd May 2019. As ambiguity clears, particularly undisclosed features of IMF negotiations with accompanying time frames could restore confidence, otherwise rattle market. With a slew of challenges ahead, Budget FY20 is likely to be a tough one, while upcoming MSCI review could be a non-event auguring well for slow consolidation in equity markets over the coming weeks.

During 1Q2019, aggregate profit of Pakistani commercial banks rose to Rs32.9 billion, up by 5%YoY. The increase was primarily on the back of 28%YoY increase in net interest income. However 6%YoY decline in non-interest income coupled with additional impact of super tax resulted in nominal growth of the sector. For analysis purpose, one of Pakistan’s leading brokerage houses has used data of listed banks that have announced their 1Q2019 financial results (excluding NBP, BoP, JSBL and BoK). Net interest income (NII) of the banks increased by 28%YoY to Rs115 billion for 1Q2019 as a result of a lagged impact of 425bps hike in policy rate during 2018 and 25bps in 1Q2019. Similarly, on a sequential basis, NII was up 17%QoQ as the lagged impact of asset re-pricing kicked in. While profit of Big-4 (MCB, HBL, UBL, ABL) was up 7%YoY), profit of mid tier banks (MEBL, BAHL, BAFL, AKBL) was up 15%. The latter have outperformed their larger peers due to better sensitivity to interest rates as well as absence of significant provision charge during the quarter under review. Non-interest income was down 6%YoY and 2%QoQ to Rs35 billion mainly due to nominal increase in fee income. Sequentially, non interest expense was up 12%YoY primarily driven by increase in operating expense. HBL continue to record expense on account of business transformation and cost relating to New York operations. Banking sector recorded net provision of rupees one billion for 1Q2019 as compared to net reversal of Rs64 million for 1Q2018. During the quarter highest provision was booked by UBL of Rs883 million followed by BAHL of Rs725 million, while highest reversal in provisioning was recorded by SNBL of Rs577 million. During the quarter under review, pretax earnings of banks rose to Rs68 billion, up 37%YoY. However, net earnings growth was restricted to just 5% due to higher effective tax rate of 52% compared to 37% for the same period last year. To note, the government in its last economic reforms package imposed super tax on banks for the year 2017 to 2020, due to which banks have recorded additional super tax (2017 annual earnings) in their 1Q2019 accounts.

 

Analysts maintain their ‘Overweight’ stance on banking sector as they expect net interest income to increase further due to the lagged impact of policy rate hikes. They also anticipate central bank to increase policy rates by further 125bps from 10.75% to 12% during 2019.

Pakistan cement industry has posted the lowest gross margins of 23.6% since 2011 for 3QFY19, amid higher input costs, lower margin on local sales and weak pricing power. Consequently, industry’s pretax earnings declined (25%YoY and 19%QoQ) during the quarter under review. The analysis of a brokerage house is based on result of 15 listed producers out of a total 17 represents 99% of total cement companies’ market capitalization.

Other companies are in losses/not actively traded. The decline in the sector’s net earnings was restricted to 10%YoY in 3QFY19 thanks to lower effective tax rate, down 15ppts to 7.7%. Substantial tax benefit to select cement producers on account of plant expansion led to lower taxes or tax benefit. Gross margins fell by 4ppts to 23.6% during the outgoing quarter. Margins contracted amid lower local demand, weak local prices and higher input costs. To note, sector’s gross margins have been under pressure since January 2017 (when CHCC’s expansion came online) and have fallen by 17ppts.

Industry volumes were down 9%YoY in 3QFY19 amid 15% decline in local sales. However, exports grew exponentially by 51%YoY thanks to 1) currency depreciation, 2) additional production from new capacities in South and 3) higher clinker sales to regional countries.

Analysts remain cautious of the industry’s performance in the short to medium term as budgetary measures in the upcoming budget and expected increase in power and gas tariffs amid IMF conditions signals further contraction in gross margins.

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