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Rally fizzle out on FATF effects, result season; political events may creep into the limelight

During the week ended 18th October 2019, the benchmark index of Pakistan Stock Exchange (PSX) witnessed erosion of 605 points and closed at 33,870 level, down 1.76%WoW. Average daily volume also declined by 51%WoW on the back of uncertainty surrounding FATF plenary meeting. Investors remained cautious ahead of volatile result season where cement sector is expected to be a major drag. Top performers during the week were: HASCOL, EFERT, ENGRO, ASTL, and BAHL, whereas laggard were: PSO, PPL, INDU, PAEL and PIOC. Volume leaders at the bourse were: LOTCHEM, EFERT, BOP, TRG and UNITY.

Key news flows driving sentiments during the week included: 1) FATF deciding to keep Pakistan on its grey list till February 2010 and directing the government to take extra measures for the complete elimination of terror financing and money laundering, 2) IMF team holding talks on revenue collection and current account deficit, 3) FDI posting a decline of 3% during the 1QFY20 owing to lower inflows from China, the country fetched FDI amounting to US$542 million in 1QFY20 compared to US$559.4 million during 1QFY19, and 4) IMF projecting Pakistan’s primary deficit to turn positive, but likely to remain above 65% until FY24 despite continuous declines.

With earnings season remaining in full swing, companies expected to release earnings include ENGRO, MEBL, FFBL, OGDC DGKC and NML. Political developments may creep into the limelight as the JUI’s planned sit-in the capital is expected to gain steam (opposition parties remain divided on participation). The GoP’s response to FATF plenary meeting observations could mold near term investors’ sentiments.

The Financial Action Task Force (FATF) has formally announced that Pakistan will remain on its grey list for the next four months, offering a lifeline after acknowledging recent improvements. Ministry of Finance has reaffirmed its commitment to fully implement the Action Plan. While noting recent improvements, FATF has asked Pakistan to swiftly complete its action plan by February 2020. Out of 27 recommendations given to Pakistan the country has largely complied on 5, while the remaining are on varying levels. FATF decision is likely to restore investors’ confidence and help Pakistan in improving dollar inflows through Carry trades, Eurobonds and Privatization. International Monetary fund (IMF) has also kept FATF issue as a structural benchmark with timeline ending October 2019, whereby Pakistan’s AML/CFT was supposed to be strengthened. To recall, Pakistan is a member of the APG since 2000. APG is a regional body of Financial Action Task Force (FATF) and requires its members to undergo mutual evaluation on the compliance of its anti-money laundering and countering financing of terrorism (AML/CFT) framework in the light of FATF recommendations.

Pakistan completed its first ML and TF National Risk Assessment (NRA) in 2017 and assigns a national risk-rating of ‘medium’ for both ML and TF. However, the NRA lacks a comprehensive analysis of threats and vulnerabilities, and is narrow in scope with gaps in key risk areas. The ‘blacklist’ status of Pakistan would have serious implications like 1) downgrading of the overall financial system, 2) impacting trade volumes through ‘Non Tariff Barriers’ and 3) increasing country’s risk premium.

 

A year of transition both from a political and economic standpoint, FY19 turned out to be a rough year in general and difficult for steel manufacturers in particular, with the profitability of listed players declining 60%YoY. A host of factors contributed to a broad based decline in earnings including: 1) massive 24% rupee depreciation pushing input costs higher, 2) a 575bps hike in interest rate burdening leveraged players and 3) weak demand impacting pricing power. While the adjustment phase is largely over, analysts believe the earnings cycle will take some time before reversing its course, as the full impact of macro-adjustments seeps through the real economy. In this backdrop, analysts have revisited their investment case for ASTL post release of FY19 annual accounts, modeling the impact of delay in demand and margin recovery and taxation measures into the estimates. ASTL has gained 63% from its 52-week low in August 2019. While the stock offers upside potential, weak earnings outlook in the near term may inhibit further price performance.

Monthly automobile industry sales data is out, with a total of 12,083 units being sold. Out of these were 10,923 cars, 896 LCVs and 228 trucks, with an additional 3,761 tractors. In the passenger car segment, total sales of 10,923, consist of 5,793 belonging to 800CC and below segment, with Alto sales catalyzing growth, 1,781 in the 1,000CC segment and 3,349 from 1300CC and above segment. Cumulative 9MCY19 total industry sales of 157,216 units, down 21.6%YoY hindered by passenger car sales decline of 19.2%YoY, where HCAR sold 24,410 vehicles, down 39.2%YoY (undergoing its worst cumulative sales decline), PSMC sold 88,307 vehicles, down 15.4%YoY and INDU sold 39,475 units, down 18.4%YoY were the historic lows. Underpinned by wider industry headwinds, the flat-lining of sales growth in the premium 1,300CC+ segment, coupled with significant price hikes has led to ‘sticker shock’ amongst customers. Amidst wider GoP policy actions to increase documentation and grow the tax base, consumer trepidation is likely to keep sales subdued, where the ongoing 4QCY19 sales are likely to remain lackluster.

Profitability of cement sector is expected to tread into negative territory for 1QFY20 as price competition among local players is expected to weigh on margins exacerbated by increased transportation costs, FED and depressed macros. Finance cost is going to be a drag on earnings for 1QFY20 as increasing debt to finance capacity additions and working capital will take interest cover down. Leveraged players are worst placed in the current fickle environment with pricing pressure and are expected to post losses for 1QFY20.

MLCF is likely to be affected the most as it offered high discounts in the market while PIOC’s working capital woes and loss on short term investments is expected to take a toll on profitability. LUCK and FCCL stand on the other hand of the spectrum with low leverage being the saving grace for both of the companies. However margins are expected to take a beating. Analysts maintain an underweight stance on the sector.

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