The lack of dynamism in the economy has snipped earnings in the bud
By Khurram Baig
Jan 12 - 18, 1998
The last year has not been very good as far as corporate earnings are concerned and there was no significant growth in earnings. The trend does not appear to be changing and most analysts do not expect any better growth in 1998.
The year has started on a dull no and the expected Ramzan rally or the arrival of fresh foreign funds as is usually expected at the start of the year are both conspicuous by their absence. The rally prior to the start of the last quarter of 1997 has fizzled out badly and investor confidence is shaken. This is for a variety of reasons like the political crisis and then the lack of growth in the industry. Economic growth is just not there, the manufacturing sector is slowing down, and this lack of hectic activity in the industrial sector has had its effect on the financial sector as well.
With the slump in the stock market which has once again gone to the levels when the present government had taken over has affected the health of the mutual fund and the investment banking industry.
At the start of the present government's tenure the country was very bullish and the market reacted in kind, with the stock index jumping substantially to about 2100 points before it once again started to slide. This happened at the start of the last quarter of 1997 and the slide is still continuing with a fall below the 1500 point level expected.
Earnings and their importance
Earnings have a very vital role to play in the development of the market and it is only positive earnings growth that can stimulate this development. Unfortunately as we have already said, for one reason or the other, earnings have not been able to grow at a satisfactory rate. The fact that the Pakistan market has a low P/E is not because earnings are good but because share prices are low. And if we were to compare this to India we will see that because of good earnings growth, shares of multinationals listed on both exchanges are considered buys there at P/Es several times that in the Pakistan market. The same scrips at less than half the prices here are considered expensive because earnings growth is not there. We mentioned multinationals simply to explain the comparison and not to in any way hint that they have less than satisfactory earnings growth. It is with this factor in mind that we have compiled the earnings of select 100 companies from various sectors to judge the slight overall fall in earnings across the board.
Analysts predict that the situation will be a little worse of 1998 before any improvement.
The yield on the KSE-100 has dropped from 4.46% in 1994 to 1.72% in 1995 and then went up slightly to 2.47% in 1996 which is still very low. Now it is reasonable compared to the dividend yields in most other emerging markets but it becomes meaningless when weighed against factors like the exchange risk and inflation. Also, the dividend yield on the whole market is much lower. It was 1.3% in 1994, moved up slightly to 1.8% in 1995 and is not expected to be more than 2% for 1996. The worrying factor here is that the index and share prices of the market in general, have fallen substantially during this period. The index at the end of 1994 was 2049 points, 1498 at the close of 1995 and just 1338 at the close of 1996. In this case, with falling stock prices, two figures should definitely have improved. They are the market price to earning ratio (P/Ex) and dividend yields. This has failed to happen. As we have already mentioned, dividend yields have gone down since 1994 and have been more or less stagnant from 1995 to 1996. The market P/Ex has remained almost unchanged also. As we did for dividend yield, if we look at the KSE-100 stocks, it was 10.71 in 1994, 11.39 in 1995 and 11.05 in 1996. Now we know that the share prices have fallen. So unless earnings have fallen also, the P/E should have come down. In the same way, since prices have fallen, unless dividends have become smaller, dividend yields should have improved tremendously.
The result is quite clear, earnings have been falling, in fact earnings growth was 13.1% in 1994, and just 1.5% in 1995. With falling dividends, even if some share holders have been looking for steady earnings from dividends, the disappointment performance has forced many to either take their money out of the market into fixed income securities or foreign currency holdings or they have shifted their focus to liquid stocks which offer the chance of capital gains.
The yields in 1995 for most emerging markets were definitely more impressive than the yields for Pakistan. Hong Kong had a dividend yield of 2.7% in 1995 which is very impressive considering the low inflation of 6.3% and the average annual currency appreciation of 0.1%. Hong Kong also has a Foreign Currency Debt Risk Rating of A compared to B+ for Pakistan. Malaysia had a dividend yield of just 1.3% in 1995 but it has very low inflation at 3.5%, an average annual currency appreciation of 1.5% and a Foreign Currency Debt Risk Rating of A+. Then there is Singapore which has a slightly higher yield of 1.6% coupled with some very impressive economic indicators. Inflation is an extremely low 1.2%, the Debt Risk Rating is AAA and the annual average currency appreciation is just under 5%.
When one compares these figures to Pakistan the contrast is almost shocking. We have a dividend yield of 1.8%, inflation of 10.5%, an average currency depreciation of 8.3% and a Debt Risk Rating of B+ which stands every chance of being lowered because Pakistan is staring at default straight in the face. The fact that Pakistan's market is composed of hundreds of small illiquid companies, with most of the shares held by sponsors, makes it all the more difficult for it to develop at a decent pace. Foreign fund managers need some room to play in and while they can get it in markets like Hong Kong, Malaysia, Indonesia, India, Singapore and even Thailand and the Philippines, Pakistan is more often than not too small to bother with. Except for half a dozen scrips like Pakistan Telecommunication Company Limited (PTCL), Hub Power, Fauji Fertiliser, ICI Pakistan, Dewan Salman and maybe a couple of other scrips, there just is not enough floating stock in the market for it to be worth the foreign fund manager's time.
It is expected that in coming years earnings will go up because of the long line of privatisations in the offing. But it is not clear when exactly we will see this privatization become a reality. And at the same time a number of major companies like Pakistan Telecommunication Corporation Limited (PTCL), Hub Power Limited and Pakistan State Oil Limited (PSO) are looking at a flat trend with no real growth in earnings.
There is no real expectation from the two gas companies, Sui Southern and Sui Northern while the fertilizer companies, Fauji Fertilizer and Engro Chemical are looking at stagnant markets with little or no growth.
MCB is looking at good growth but among the prominent blue chips it is one of the few exceptions. There is no real growth expected in Packages and Lever Brothers and the pharma companies have been going through a lean period as well.
The bottom line is that we cannot expect earnings to go up until there is growth in the manufacturing sector. There is no stimulus in the economy and thus there is no real possibility of sustained earnings growth in the short term or medium term.