CUT'S IMPACT ON STOCK MARKET

REDUCTION MAY BE BENEFICIAL FOR THE HIGHLY LEVERAGED COMPANIES, BUT OVERALL IMPACT MAY BE MUTED DUE TO ONGOING ENERGY CRISIS ERODING PROFITABILITY OF MANUFACTURING SECTOR.

SHABBIR H. KAZMI
(feedback@pgeconomist.com)
Oct 17 - 23, 20
11

Before examining the impact of discount rate reduction in the longer term, it may be of some interest to review the response of investors during this past week. Market experienced bullish activity during the very first trading session of the week as the daily traded volume rose to 183 million shares, which also happened to be 7-month high.

High leveraged sectors such as cement, textiles, and autos with few fertilizer companies are expected to be the prime beneficiaries of 150bps reduction in the discount rate. These sectors are expected to face relatively lower burdening financial charges, which in turn are expected to blossom their bottom lines ahead.

Surging exports up 19 per cent YoY and remittances up 25 per cent YoY during 1QFY12 provided additional support to the market. Pak-Afghan officials met US special envoy in an attempt to iron out the differences between the two countries.

Despite all the positivity, foreign flows remained in the negative zone as total foreign outflows were recorded at US$2.9 million for the week as compared to an outflow of US$2.7 million during the week.

As far as average traded value and volumes during the week are concerned, an increase of a massive 51 per cent WoW has been recorded in the average value, whereas volumes were also bolstered by a solid jump of 66 per cent WoW during week, to US$ 71 million and 125 million shares, respectively.

The benchmark KSE-100 index went up by 1.13 per cent or 134 points during the week to clock in at the level of 11,988pts. In the up coming week, market is expected to remain positive on the back of upcoming result season. Better results from oil & gas, fertilizers, cements, IPPs and telecom sectors are expected.

The State bank of Pakistan has eased monetary policy to spur economic growth but inflation threat still persists as Nepra has approved yet another hike in power tariff. Analysts strongly believe that slow growth in economic development of the country is due to supply side slippages and capacity constraint rather than high financing rate.

They suggested that the government must resolve the electricity and gas crisis at the earliest if it wants to monetary easing to yield any positive impact. Since 100bps rate cut had already been factored in, analysts expect the market to normalize gradually while inflation numbers in the coming months may set market direction for the rest of the year.

Keeping in perspective inflation for the rest of CY11 (with expected hike in electricity prices, and respite in the international commodities amid fears of another global economic recession) further rate cuts could be in the pipeline. Analysts expect market to rally on account of expectations of upcoming rate cuts in the months to come.

Conservatively speaking, analysts keep their valuations at a risk free rate of 13 per cent for now and wait for the upcoming PIB auction for more refined adjustment of valuation models accordingly. In the meantime, a decrease of a 200bps in the risk free rate leads to an average eight per cent change in the target prices of their sample companies.

Along with monetary easing, some relaxation to be given on risk-related (margin) requirements and adequate returns for financiers on the margin trading system, increased number of securities allowed for futures trading coupled with SECP's approval for short selling in the ready market, and KSE's regional attractiveness on various multiples (lowest PE at 9.3x, highest DY at 5.6 per cent) may keep equities buoyant.

However, recent strain in Pak-US ties and closure of the IMF program may impact foreign funding in the short term that may impact exchange rate and inflation with market feeling the impact in the coming months.

However, some economic analysts term this only one side of the coin and warn that the sail may not be as smooth as being portrayed by the equities analysts. They strongly believe that monetary policy easing will have a limited impact as many other factors will continue to mar the performance of the listed companies.

They believe that income of commercial banks can come under pressure because of shrinking spreads as well as growing delinquencies. Most of these delinquencies can be termed circumstantial because of prolonged outages of electricity and gas. According to an InvestCap report, the spreads during August stood at 7.59 per cent (down 29bps MoM while up 3bps YoY) as compared to 7.56 per cent during the same period last year. Spreads were highest in July this year, as they peaked to 7.88 per cent. While 'big five' may not bear the brunt in the short-term, earnings of smaller banks, which are already lean, may become leaner.

While NIMs are in for sharp compression in the near-term and earnings growth will likely decelerate in 4QCY11F and CY12, analyst believes the market is wrongly assuming that asset expansion will remain muted, asset quality improvement will occur with a significant lag and valuation multiples will fail to rerate.

In this regard, banks are effectively sitting on 10 per cent plus CRR as against a requirement of 5 per cent, suggesting an aggressive utilization of available balance sheet space can improve sector profitability by as much as 20 per cent. At the same time, the central bank data suggests the sector has added provisions of Rs9.75 billion in 3QCY11 as compared to provisions of Rs11 billion in 2QCY11.

With anticipated conversion of circular debt exposure into PIBs, asset quality improvement along with recognition of suspended markup, analyst believes banks will still close out CY11 very strongly because capital gains can surprise on the upside. While earnings growth could conservatively decelerate to single digits in CY12, this should be compensated by rerating of valuation multiples.