THE VIBRANT STOCK MARKET
A comprehensive analysis by Elixir Securities Pakistan
Jan 10 - 16, 2005
A grand finale indeed! KSE-100 index closed 2004 at the year's peak (and all time high) of 6,218, up 39% YoY (34% US dollar adjusted). The dream run that started post 9/11, continues, with the benchmark index up 312% since start of 2001. 2004 has been an eventful year for Pakistan, be it domestic politics, local economy or foreign policy initiatives.
General Pervez Musharraf played his cards just right this year. He has managed to retain both Presidency and Army Leadership (despite stiff resistance from opposition coalitions), has his trusted lieutenant Shaukat Aziz as Prime Minister and has kept religious militancy under check. From an Army General who was uncomfortable talking politics, Musharraf now is a politically savvy leader who speaks and acts political reconciliation. It has certainly not been easy for Musharraf — both he and Shaukat Aziz have survived life attempts for their 'US inclinations' over the past 12-13 months. Fortunately, the year has ended well.
FOREIGN POLICY INITIATIVES
On Eid day this year, viewers in Pakistan saw a Bollywood movie (Yes! An Indian film) on a local satellite channel. Frankly, this would have been unimaginable some years back and speaks quite vividly of improved relations between India and Pakistan. Be it Musharraf's 'proposals' on Kashmir — identify the region, demilitarize it, and change its status — or Dr. Manmohan Singh's flexibility on 'core' issues, we certainly moved forward this year. Of course a lot more needs to be done and Kashmir still remains unresolved, but the direction is right and that's important. Moving West, Musharraf's 'honeymoon' with the White House continued. What started off as a 'you are either with us or against us' deal post 9/11, has overtime nurtured into a relationship where the US now considers Musharraf a 'friend'. Relatively seamless 'approvals' of the General's democratic inclinations (these are Pakistan's 'internal issues') and his stance on the AQ Khan issue, designation of Pakistan as a major non-NATO ally, socioeconomic assistance...there has been US support for Pakistan on all major issues. With the 'war on terror' unlikely to end any time soon, geo-politically dictated relations with the US should continue growing.
A mixed bag quite frankly. Key positives were Pakistan's re-entry into the global bond market after 6 years, pre-mature exit from IMF's loan program (more symbolic) and sustained economic growth. However, while the broader economy continued to grow, led by Large Scale Manufacturing (LSM), construction, services and agriculture, key macro variables did undergo minor adjustments this year. Pak Rupee has ended the year at Rs 59.45 to the US$, down 3.5% YoY (1st calendar year decline after 2001) and interest rates (as measured by 6-month T-Bill) are up at 3.84% versus 1.66% at start of the year. Inflation did spike up over 9% in the later half of the year and were it not for the domestic oil price cap (in place from May till Mid-December), the hike could have been more pronounced.
While Pakistan didn't break any regional records, 2004 was yet another good year for Karachi Stock Exchange. The KSE-100 Index up 39% to 6,218, market capitalization up 81% to US$ 29 billion (mainly to inclusion of Oil & Gas Development Company (OGDC) and Pakistan Petroleum (PPL) and average daily volume up 11% to 344 million shares, despite capital value tax (CVT).
KSE-100 INDEX - OIL HEAVY
Following formal listing of OGDC, KSE-100 index was reconstituted in April to include OGDC as its top representation. Oil stocks (E&P, OMCs and Refinery) now represent 32.5% of the index and given the predominant upward trend in oil prices, index's spectacular run is quite well explained.
PUBLIC OFFERINGS GALORE
A total of 17 companies (including SSGC and PIA) raised a record Rs 14.6 billion in public offerings this year, led by PPL (public offering of Rs 5.7 billion including the green shoe option). From the private sector, largest public offering was of Bank Al-Falah, worth Rs 1.2 billion.
CAPITAL VALUE TAX
Announcement of CVT did have its initial impact on the market, with the index losing 5.2% in 10 trading days and volumes subsiding significantly (Average Daily Volume of 30 days preceding FY04 Budget: 390 million shares v/s 228 million shares in 30 days after the announcement of Budget). Tough bargaining, subsequent rationalization of tax rates and most importantly, Shaukat Aziz's clear un-willingness to budge/be persuaded on the issue, has forced market players to 'live with CVT'. Looking at trading volumes at the fag end of the year, it may be said that investors are quick learners. CVT is a non-issue now.
Carry Over Trade (COT) phase-out that began in October 2004 with Southern Electric's withdrawal is to continue until June 2005, when Pakistan State Oil (PSO) exits Badla. So far 7 scrips have phased out from COT and if initial indications are to go by, the results are not that scary. But then these are hardly the typical 'punter-play'. Key test will be post February 2005 when top tier phases out. Any change brings with it uncertainty and so will COT phase-out. The fact that it has been gradual should help. The Futures Counter is expected to prove an effective substitute and eventually, investors will learn the Margin Trading way.
The year 2005 should be an eventful year for the equities markets. Transition from COT to Margin Financing, proposed privatization of Pakistan Telecommunication Company (PTCL), public offerings of government entities and monetary stance of State Bank of Pakistan are to be watched closely
The expected strong growth in LSM, agriculture and services may allow the economy to get closer to GoP's GDP growth target of 6.5%-7.1% for the current financial year. The factors having the potential to affect growth rate are inflation rate and central bank's monetary stance. The 6-month T-Bill rates move up from 1.66% at start of last year to 3.84% at 2004 end. With inflation pegged quite stubbornly at around 9% in the September-December quarter of 2004 (needs to slide to range of 6.7%-7.6% in January-June half of 2005 to meet government's target range of 7.6-8.2%). Monetary policy stance should be more aggressive. However, sharp rate adjustments appear unlikely given the government's strong pro-growth focus.
Politics should spring no real surprise. With General Musharraf retaining both Presidency and Army supremacy, things should remain under control. Law and order will be a key challenge though, given the prevailing uneasiness in Wana (area bordering Afghanistan), Balochistan and sectarian-sensitive pockets around the country. Musharraf's track record against terrorism and militancy has been good so far. But he cannot, and sure will not, underestimate the complexities and dynamics of this struggle.
On ties with India, the bar should move higher. Additional confidence building measures (CBMs) have been identified and will be implemented. If some concrete economic venture (gas pipeline, for instance) does materialize, it's going to be a new high point for sure. Kashmir will remain in focus and we will hear broad positives (with politically motivated rhetorical negatives sprinkled in). It is important for Pakistanis to understand the complexities involved.
Kashmir has forced the two countries into multiple wars with India and political governments will need time on the issue. It will be important for the two countries to continue talking.
It is expected that the US will not complicate things and the Bush-Musharraf duo would work together. While Colin Powell will surely be missed (Musharraf & Powell got on well together), Condoleezza Rice should not be a concern. The US is well aware of Pakistan's geo-strategic importance and expected to act accordingly.
2005 FAVOURS KSE
The year 2005 will be an important year for KSE as traditional Badla/COT financing will make way for Margin Financing. It is an important structural change and will bring with it pockets of uncertainty (the market has been used to the 'badla' form of leverage since decades). The regulator and the exchanges, however, have smartly phased in the change and the transition therefore should not have shock-value. Already volumes on the futures counter have picked up and barring a few glitches here or there, we should adjust well. The change is a key long-term positive.
In terms of specific events, the market will closely track progress on PTCL's proposed privatization. PTCL has been on the bloc for a long time and its strategic sell-off (a major push to investor confidence) could help re-rate market multiples. Last date for submission of EOIs was January 28, 2004 and SingTel should be a serious bidder. Amongst other strategic sell-off's, National Refinery and KESC will be on the cards.
Government's capital market divestments should continue to attract investors. Kot Addu Power Company (KAPCO) — majority government-owned and International Power operated (IPP), State Life Insurance Corporation, the country's largest private insurer), Pakistan Steel, United Bank and a secondary offering of OGDC are lined up for next year. KAPCO should be first, with its IPO scheduled for January. In terms of sectors, Telecoms, Oil, Banks, Fertilizers, Power Generation, Cements, Textiles and Gas Distribution are expected to remain under focus.
Deregulation will be the major growth theme next year with the expected entry of more private sector competition — Telenor, Warid & DV Com. Wireless (WLL, cellular) is where the real excitement is and PTCL's proposed sell-off should be the year's high point.
OIL & GAS
International oil prices and progress on new discoveries will be key themes for the E&P sector, that's rallied spectacularly at the end of 2004. We like Pakistan Oilfields. For OMCs (Shell and PSO), key will be govt's price pass-through stance. Strong LSM growth and rising demand for cars are expected volumetric positives. Based on the initial estimates, Attock Petroleum should be a good addition to the sector.
Strong growth in advances to LSM, Consumer and SME sectors are expected to drive bank earnings in 2005. Also to be closely watched will be NIT dividends that have significant earnings impact on banks like National Bank, Bank of Punjab and Faysal Bank. Union Bank, for its predominant consumer banking will also remain in focus.
Robust demand growth (on the back of improved farm economics — bumper cotton crop, high support prices and improved water availability) and benign urea prices should help manufacturers mitigate the impact of higher feedstock prices (up for revision in July 2005). Fertilizer companies are good proxies for a buoyant agriculture sector.
Year 2004 was a bad year for Hubco. Supply over-hang on the counter (after International Power's part-sell-off), generator problems (sentiment drag) and shift in investor focus towards growth, capped the stock's performance. KAPCO's listing in January should revive investor interest in IPPs. Based on our initial estimates (2004 dividend yield and EV/MW multiples), KAPCO looks attractive at Rs 30/share. From a dividend yield perspective, Hubco too holds value.
Two key events to watch out for next year would be 1) announcement of a mega hydropower project and 2) re-rating of cement capacities in mid-2005. DG Khan Cement should be able to retain market share following its planned expansion in 2007.
Opening up of markets under the WTO regime and a bumper cotton crop will drive sector growth in 2005. Most of the well managed textile companies have the infrastructure and the competitive edge needed to perform and excel in open markets.
Strong capex plans should allow SNGPL and SSGC to post decent earnings growth next year. Drags could be a tough OGRA and any sharp interest rate spike.
WHERE IS THE MARKET HEADED?
The last few years have been a pure bonanza. As a result, investors are richer and certainly more confident. They are also much more informed today, given media proliferation and its extensive coverage of financial markets. Real estate bull-run too has helped. A 40-plus man today owns a house that's probably worth twice as much as it did two years ago. He feels 'comfortable' channeling some money into equities. The mutual fund sector has more than tripled its net assets in less than 5 years and if plans are to go by, growth trajectory will continue. These are key structural changes.
Based on the estimates for next year, the index will need to move up by 15.4% (earnings growth of 8.4% and dividend yield of 7%) to maintain current market multiples. There are, however, key risks attached to multiple — maintenance. Absolutely essential for any sustained index performance is continuity of General Pervez Musharraf and his team in Islamabad. The Musharraf factor is just too strong in this entire Pakistan resurgence. Other key risks to market upside include:
•Slowdown in economic growth
•Sharp spike in inflation and therefore interest rates
•Snags in planned strategic sell-offs
•More painful-than-expected transition from COT to Margin Financing
•Broker-Regulator conflict over Demutualization/Integration
Given the index's spectacular run over the recent past, markets could see a long consolidation/corrective period before moving ahead.
WEIGHTAGES AN OF DEC 31, 2004 (%)
Pakistan State Oil
COT PHASE-OUT SCHEDULE
COT PHASE-OUT DATE
BSJS Balanced Fund
Picic Commercial Bank
Faysal Bank Limited
Union Bank Limited
PICIC Growth Fund
Fauji Fertilizer Co.
Maple Leaf Cement
ICI Pakistan Limited
Fauji Bin Qasim
Bank of Punjab
DG Khan Cement