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Positive normalcy returns, upcoming budget will set future direction

The week ended 24th May 2019 marked substantial recovery at Pakistan Stock Exchange (PSX), with benchmark index gaining 2,537 points, up 7.65%WoW to close at 35,704 levels. The market closed positively for the first time after seven weeks. After a decade, the benchmark index posted the largest weekly gain of 7.65% or 2,537 points, the last highest gain of 9.1% was recorded in first week of April 2009. All sessions of the week closed on positive note, showing renewed optimism of investors on the back of market support fund and deferred oil facility by Saudi Arabia. Average daily traded volume during the week was up about 57% to 157 million shares as compared to about 100 million shares a week ago. Activity remained tilted towards main board, similar to that of earlier week.

Unsuccessful drilling at Khekra-1 caused a major fall at the beginning of the week. Higher than expected interest rate hike of 150bps brought interest in the banking sector (news regarding termination of compliance agreement by Federal Reserve with UBL also acted as a trigger). However, the hike remained largely a non-event for the leveraged plays that posted gains on improved market sentiments. Other news affecting the market included: 1) possible roll-back of subsidies to export sectors in FY20 budget in an attempt to meet IMF primary deficit target of 0.6% of GDP and 2) the government likely to fix PSDP target of Rs675 billion. Top performers of the week included: GWLC, PIOC, PSO, MLCF and PSMC.

While euphoria surrounding market support fund could persist in the immediate term, investors should remain wary of the fundamental weaknesses while taking exposures in certain sectors. Investors are also advised to keep a keen eye on budget related news which is expected to define market direction in the upcoming week. Further, with holiday season near, market may witness thinner volumes.

Total liquid foreign exchange reserves held by the country were reported at US$15,126.5 million on 17th May 2019. The break-up was: reserves held by State Bank of Pakistan were US$8,057.6 million and net reserves held by commercial banks amounted US$7,068.9 million. During the under review reserves held by SBP decreased by US$788 million to US$8,057.6 million due to external debt servicing and other official payments.

Topline Securities has revise down earnings forecast of Honda Atlas Cars (HCAR), post 4QMY19 financial results and revised estimates for PKR against US$. It has decrease EPS estimate of Rs22.8 to Rs16.0. To recall, HCAR posted above expectation result for 4QMY19, though EPS clocked in at Rs8.19, down 15%YoY. The decline in earnings was a result of contraction in gross profit (GP) margin by 2ppts YoY to 8% in 4QMY19.

Result has been termed above expectation mainly due to lower operating cost, down 73% QoQ which resulted in higher EPS from market expectations. Margins are likely to remain under pressure due to the rise in input cost due to significant depreciation of Pak Rupee against US$ and higher inflationary environment, which the company has not yet been able to fully pass on to the end consumers. Post IMF staff level talks, Rupee has depreciated by around 8%. It is expected to remain volatile due to IMF’s condition to have a market driven exchange rate. That will keep margins of auto sector companies mainly HCAR in check due as it is more exposed to Rupee sensitivity against US$, due to lower localization as compared to its peer companies. Removal of FED is much needed relief. It is more likely that 10% Federal Exercise duty (FED) on all cars above 1700cc would be removed as sales under this head has drastically declined; HCAR has suffered the most due to the charge of FED in the last mini budget as its 40% sales volume comes from above 1800cc segment.

 

Textile exports for April 2019 were recorded at US$1.1 billion, up 4.6%MoM but down 0.8%YoY), taking 10MFY19 exports to US$11.1 billion, remaining flat on YoY basis. Value added exports continued the sequential increase on the back of export incentives, where export sales during the month under review were recorded at US$0.8 billion. That said, 10MFY19 value added exports were recorded at US$8.4 billion. Consequently, analysts believe exporters passed-on currency devaluation benefit to final customers (unit prices were down from 3% to 20% across value added segments), a common practice aimed at augmenting sales volumes which has yielded results as readymade garments posted a volumetric increase 29%YoY for 10MFY19. The upward shift in value added exports was countered by non-value added segment decline by 8.7%YoY in 10MFY19. The largest decline was posted by raw cotton of 67.2%YoY which was on the back of depleted cotton crop.

International cotton prices have fallen back in May 2019TD so far with average prices down 7.2%MoM. Analysts believe the weaker prices could be at the back of retaliatory tariffs by China together with China’s 2019 State Reserve auction that began in early May and likely to continue until September end this year. Domestic prices are hovering at approximately Rs9,400 per 40kg, backed by a renewed interest by spinners. Cotton outlook remains weak given ample stock build-up driven by bumper crops in Brazil and increase in US production while flat production, continued reserve sales, and consumption growth in China will combine to partially absorb the higher production. A major tilt in scales could be from India where cotton imports are expected to double from a 3.1 million bales, a year ago, as the drop in production could force textile manufactures to increase overseas purchases.

Pakistan textile exports, in the short term, are likely to continue witnessing volumetric growth at the expense of absolute number growth (Textile exports have remained flat in 10MFY19 despite currency depreciation of 24.6%), where manufacturers compete on price to other international players. However, medium to long-term outlook remains bleak given lack of capacity additions and potential slowdown in the exports market whereas FTA-II with China could provide impetus to lower value added manufacturers. Possible roll-back of incentives to export sector such as subsidy on gas and electricity to fulfill IMF fiscal targets could partially negate the impact of currency devaluation on the sector. As such, analysts advise investors to balance potential one-offs through exchange rate gains with risks of negative development for the sector in the budget in the short term. Therefore, prefer composites over spinners/weavers. In the medium to long-run, we tilt our investment case towards diversified composites.

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