SECTORAL IMPACT OF THE BUDGET
An exclusive report from KASB
June 25 - July 01, 2001
The budget, being primarily focused on the macro picture, was generally neutral from a sectoral perspective with the notable exception of financial services (Banking, Leasing and Insurance) where banks received large cuts in their tax rate from 58% to 50%, while leasing and insurance companies had some of their tax allowances restored after having been removed last year. The equity market has been positively impacted as the budget extended the capital gains tax exemptions for a period of three years. The corporate debt market, however, was not so lucky.
There, taxes were withheld for individuals investing in corporate debt instruments. In our view, this is misguided policy that could retard the growth of the nascent corporate debt market in Pakistan, although in the short term, in a perverse sense, equities might actually benefit as a result of this new budgetary measure.
Rationale for Recommendation
Significant reduction in tax rate
High FO cost & poor demand to depress FY01 net
Budget impact neutral
Waiting for greater documentation of economy
Outlook hostage to expected fertilizer policy
Waiting for a change in return formula
Depreciation allowance reinstated allowing growth
Deregulation is great, competition is not
Paper & Board
Budget impact neutral
Better outlook but WAPDA needs restructuring
Its wireless all the way from here
Global slowdown likely to negate budget incentives
We believe that while the FY02 Budget has been mostly sector neutral in the immediate term, its macro focus on continuing the overall fiscal reform process is likely to yield longer-term positives in the context of country risk reduction. In our opinion, there is more than an even chance that Pakistan is likely to remain within the IMF ambit and successfully restructure its multilateral and bilateral external debt falling due over the next 12-24 months. If this is achieved, we feel that 1) risk of any potential foreign exchange problems should reduce; and 2) greater resources should be freed up for infrastructure development that is needed to create a conducive environment for private sector investment. Based on this premise, as well as the fact that our bottom-up analysis indicates attractive valuations, we believe that, while in the near term, the market is likely to be range-bound between the 1350 and 1450 level, by the end of 4Q01 as the above factors fall in place, there is likelihood of an upwards re-rating that could take the KSE-100 index closer to the 1600 level. Therefore, we continue to recommend Pakistan as an out-of-the-index play for 2001.
Stock market outlook
On a month-to-month basis, the KSE-100 Index has remained tightly range-bound, as market participants brace themselves for the phased commencement of the T+3 settlement system from July 2001. As a quid pro quo to the Security and Exchange Commission's desire to initiate the rolling settlement system, the stock exchanges have received permission to also start futures trading in 10 large cap, high volume stocks later this year. In this context, futures specialists were also invited from India and Japan by the KSE to make presentations to domestic stock exchange members and create awareness of key trading and settlement issues . We believe this is an important development and augurs well for the longer-term growth of the domestic stock market.
The"Futures-10" stocks are:
•Pakistan Telecommunications (PTCL)
•Hub Power Company (Hubco)
•Pakistan State Oil (PSO)
•Engro Chemicals (EC)
•Fauji Fertilizers (FFC)
•ICI Pakistan (ICI)
•Fauji Jordan Fertilizers (FJFC)
•Adamjee Insurance (AIC)
•Sui Northern Gas Pipelines (SNGPL)
•Dewan Salman Fibres (DSFL)
In our opinion, the market should have a delayed positive response to the CE assuming the position of President as it means continuity of the present technocratic cabinet team and their pro-reform policies, including accelerated pace of privatization. While we feel that foreign investor interest is likely to remain absent in the short term, or at least, until emerging markets as a whole move back into favor, domestic investor uncertainty is likely to lessen and prompt a re-entry into equities given the attractive valuations and sector and stock specific stories. At present, as per our forecasts, the Pakistan market is trading at FY01 PER of 5.85x, FV/EBITDA multiple of 2.1x, with an EPS growth of 45% and at an ROE of just under 19%. We feel these are attractive valuations both from a historic perspective as well as compared to the Asian region (ex-Japan). For domestic investors, the dividend yield on major blue chips is also at historic highs, which we believe reduces any significant downside risk from current levels.