Pakistan Stock Exchange closes above 43,000 levels

Delivering persistent returns despite the recent spate of foreign selling (outflow of US$125.7 million since November'16), the benchmark Index of Pakistan Stock Exchange grew 0.63%WoW, gaining 271pts closing at 43,271 points. Supported by OPEC's decision to restrict crude output and resulting movement in global benchmarks (Brent/WTI gained 11.8/8.4%WoW), upstream Oil & Gas climbed higher.

Key news flows during the week were: 1) CPI for November’16 was reported at 3.81%YoY compared to 4.21%YoY in October'16, implying sequential increase of 0.21%MoM, 2) deregulation of 95 and 97RON MOGAS affirmed by Minister stating that 92RON would replace the 87RON previously being supplied, 3) Finance Minister announcing increase in price of petrol and diesel, 4) GoP releasing Rs248.1 billion for various development projects under public sector development program (PSDP) under the current financial year as against a total allocation of Rs800 billion during the previous year and 5) Pakistan Stock Exchange (PSX) scheduled to open bids on Monday, December 5, 2016 submitted by foreign strategic investors and local institutions to for acquiring 40 percent stake of the bourse. Key gainers at the bourse during the week were: EPCL, MTL, ICI and ENGRO, whereas laggards were: NCL, NML and HCAR. Average traded volumes were highest for: BOP, PACE, ASL and WTL. Approaching end of the year holiday season, foreign participation is expected to take a back seat as local funds and institutional investors, favoring blue‐chip plays offering value. Rise in local oil prices have further fueled expectations of a bottoming out of the monetary atmosphere keeping commercial banks in the spotlight.

Gaining 6.9%MoM in November'16, PSX‐100 index stood its ground in what was an eventful month for the world; while global equity markets struggled (MSCI EM/FM down 5%/2%MoM) on policy uncertainties post Donald Trump's election as US President. This was despite persistent foreign selling where outflow for the month rose to US$117.05 million ‐ the highest in CY16. While the entire main-board posted positive returns, Cements led the board returning 15.9%MoM (on anticipated strong growth in dispatches and reversal in coal prices after a short lived rally) followed by Textiles (+9.7%MoM due to anticipated pressure on local currency amid strengthening US$) and Chemicals (+8.0%MoM on reduction in gas prices for industries). Going into December'16, the market is likely to look towards the following, taking direction accordingly: 1) oil price trend in the light of OPEC's production cut agreement and the stance adopted by non‐OPEC producers following the decision, 2) FOMC meeting on December 13‐14 where any potential rate hike can continue prompting outflows and 3) on‐going Panama papers related hearing keeping political pressure intact.

To stimulate growth, news flows have disclosed that the ECC has approved a 33% reduction in gas prices exclusively for industries, bringing down prices to Rs400/mmbtu. As an official notification by OGRA is still pending, lack of clarity remains on the inclusion of certain heads in the concession to be availed. It is general understanding that the gas price reduction extends to general industries that utilize gas as a fuel source including Steel, Glass, Fertilizers (concession available on fuel stock only) and Textiles. While benefiting industries by and large, Fertilizers, the largest industrial consumer of gas, stand to benefit the most followed by Steels and Textiles. Cements, on the other hand, are likely to remain unaffected unless the concession is also extended to captive power generation‐ gas tariff for which is determined under a separate head. In this backdrop, while the Fertilizer sector might enjoy a short‐term rally, a weak demand outlook and depressed international pricing dynamics can continue restricting price performance.

Pakistan stock market continues upward move

Benchmark Index of Pakistan Stock Exchange continued its upward move and touched a high of 43,000 points for the week ended 25^th November 2016. The gain of 625 points (1.59%WoW) was primarily led by E&P companies (on the back of 4.25%WoW increase in crude oil price), cements (on receding coal prices and expectation of robust dispatches) and textiles (on expected announcement of incentive package for the industry).

Average daily traded volume inched up by 4%WoW to 475 million shares where volume leaders remained second tier scrips such as PACE, BOP, PIAA, SMBL and ANL. Leaders during the outgoing week included NCL, NML, HASCOL, ASTL and EPCL, while laggards included SSGC, MEBL, INDU, AKBL and HBL.

Following were the key developments during the week: 1) ECC approving reduction in gas prices for industrial consumers by Rs200/mmbtu, 2) PIA concluding a financing facility of US$130 million, 3) T‐bills yields in the recent auction remaining flat, 4) Pakistan securing an additional US$8.5 billion of investment from Beijing as part of the countries' joint energy, transport and infrastructure plan and 5) Summit Bank Limited announcing to initiate due diligence of Sindh Bank Limited for potential merger/acquisition.

The market is expected to remain volatile, taking direction from the following events in the upcoming week: 1) Panama case hearing scheduled on 29^th November, 2) Monetary policy Statement to be issued on 26^th and 3) OPEC’s meting by the end of this month to finalize output deal where inability of the producers to reach an agreement can keep Oil & Gas sector under pressure. Additionally, the recent trend of rising coal prices may keep cements under pressure while textiles are expected to remain in limelight upon expected announcement of the export incentive package.

After touching the year's high last month (4.2%YoY), CPI inflation is projected to revert back, coming in at 3.82%YoY during this month, implying a limited 0.21%MoM increase owing to muted rise in food inflation (0.2%MoM) and a high base effect. On the other hand, NFNE Core inflation is expected to inch up slightly to 5.3%YoY compared to 5.2%YoY in October this year. Consequently, 5MFY17 CPI/NFNE Core inflation average is expected at 3.91%YoY/4.87%YoY compared to 1.87%YoY/3.79%YoY in the corresponding periods last year. Inflation is expected to tread higher during the rest of the fiscal year, with projection for FY17 CPI inflation at 4.8%YoY, which eliminates room for further rate cut in the upcoming MPS. Moreover, rapid deterioration in current account strength (up 63%YoY in 4MFY17) and rising concerns on global front in the form of dollar and crude oil prices gaining strength are expected to keep the central bank cautious.

Inching up, current account deficit for October’16 was recorded at US$381 million as compared to US$174 million for September'16. Resultantly, 4MFY17 deficit accumulated to US$1.76 billion, higher than US$1.08 billion for the same period last year. The weakness has been led by slowdown in remittance flows and rapidly expanding trade deficit. Foreign investment dynamics have been unpromising so far in FY17, where FDI net inflows were reported at US$316 million ‐ half of US$610 million in 4MFY16. Relief has come in the form of the recent US$1.00 billion Sukuk issue, which has taken 4MFY17 total foreign investment to US$1.4 billion as compared to US$0.95 billion. Going forward, current account weakness is expected to continue where analysts reiterate their projection for deficit at 1.7% of GDP driven by trade deficit and slower remittance inflows.

Following below expected 3QCY16 earnings, AKD Securities revisited its investment case for national Bank of Pakistan (NBP), revising projected CY16/CY17 earnings down by 8.2%/7.6% on account of a higher than expected sequential downtrend in the bank's income streams, both funded and non‐ funded. While interest income was understandably lower on account of PIB maturities during the quarter, brokerage house has expressed its concerns regarding the decline in non‐interest income that was down 20%QoQ despite higher gains utilization. In this regard, fee income was down 28%QoQ followed by 34%QoQ decline in other income. While still appreciative of the bank's concerted efforts in improving its asset quality, higher provisions during the quarter were on account of changes in regulations on consumer financing by SBP (Rs783 million booked in this regard) along with seasonal impact of agri‐financing. Gaining 27%CYTD, the market has been quick in acknowledging the bank's fundamental turnaround. Valuation set is attractive and has room to expand once sentiments further improve on: 1) interest rate cycle reversal drawing close and 2) multiple re‐rating upon formal MSCI inclusion.

OGDC achieves record crude oil production per day

It is not a secret that Pakistan is highly deficient in indigenous energy products. Import of crude oil and POL products eats up billions of dollars every year. On top of that extensive gas and electricity load shedding keeps capacity utilization of industrial units below optimum capacity utilization. The prevailing situation demands accelerating activities of exploration and production (E&P) companies. Pakistan meets around 12 percent of its oil requirement from indigenous resources.

The state owned largest E&P, Oil & Gas Development Company (OGDC) claims it is making extra efforts and one tends to agree with the statement partially. Its latest announcement says that the Company has achieved a record production of 50,172 barrels per day (bpd) of crude oil. By international standard the number may look dismal but for Pakistan it looks enormous, 57 percent of the country’s total crude oil production estimated around 88,000 bpd.

The information disseminated indicates that the Company is all set to inject about 4,000 barrels of additional oil per day, 100 million cubic feet per day (mmcfd) of gas and 400 tons of liquefied petroleum gas, starting with fewer quantities in the first week of December and then gradually going up. This addition would come from Kunar Pasakhi Deep field in Sindh which had been held up due to disputes and court cases.

Pakistan inching towards acute shortage of POL products

I am a great fan of Dawn newspaper and Khaleeq Kiani. The story published on Monday Pakistan's fuel reserves fall below strategic levels highlights a few points. These include: 1) Prime Minister and Ministers don’t have time to focus on strategic issues of national importance, 2) they are also devoid of acumen required for strategic planning and 3) bureaucracy, picked up by politicians also tows the lines of their big bosses.

Knowing Khaleeq, I will not mince my words and say without hesitation that this story should have appeared much earlier. International price of crude oil took a nosedive in 2014 and since then has been hovering around less than USD50 per barrel. This provided an excellent opportunity to Pakistan to 1) construct additional storage facilities and 2) build strategic reserves. However, the policy planners and decision makers failed on both the fronts miserably.

Some time back I had posted a blog that a few refineries were busy in creating facilities to add their production and broaden product mix. Lately, I also posted a blog highlighting acute shortage of HOBC. Even at that time I was fully convinced that refineries were operating below optimum capacity utilization and country’s dependence on imported white oil products were on the rise.

This reminds me that at one stage three new refineries were on cards but even PARCO deferred it Khalifa point refinery. This clearly showed ‘confidence deficit’ and I could not resist from saying that if local investors are shy the country should not expect foreign investment.

Please allow me to say that the worst hindrance in establishing of energy and power generation companies in Pakistan is ‘circular debt’. Following policies of international donors blindly has put the cart before the horse. Added to this is failure of the government to contain blatant pilferage of electrify and gas. The menace prevails due to the absence of political will and inefficient regulatory and legal framework.

The incumbent government, since coming into power has been issuing new/revised deadlines for getting rid of load shedding, I often fear that it is hoping against the hopes. The reason is simple, unless the government makes required structural changes, stopping pilferage is almost impossible. Besides this, the government has to prove by act that is serious in overcoming pilferage and recovery of outstanding dues. Else be ready to face even the worst conditions.

State of Pakistan Economy

Pakistan’s central bank, State Bank of Pakistan (SBP) has recently released its Annual Report for the financial year ended 30th June 2016. The Report is full of praises of the economic managers for achieving targets under prevailing difficult circumstances. However, it also highlights the serious problems facing the country. The bottom line is that unless right structural reforms are undertaken the country may once again plunge deeper in serious crises, worst being balance of payment crisis. I would talk about praises later as I consider it my ardent duty to first highlight the problems facing the country.

Notwithstanding these positive macroeconomic stability gains, the Report highlights some challenges as well. Firstly, the current level of private investments and savings in the country needs acceleration to keep pace with required investible resources. Secondly, structural issues in the export industry need to be resolved. Thirdly, the reliance of the tax system on stop-gap measures is creating distortions in the economy. Finally, the country needs to spend more on social sector development to address social issues.

The Report, considers Pakistan to be well positioned to address these challenges. It anticipates all-important support coming from a stable macroeconomic environment and growing investments in CPEC-related projects. These would help improve the existing infrastructure and power supplies to businesses. Some analysts don’t agree with this rationalization.

The Report recognizes the positive impact of improved macroeconomic environment, better energy supplies, and subsiding security concerns. The central bank believes that in addition to CPEC, economic activity would benefit from pro-growth policies. It specifically says that the current policy rate, at a historic low of 5.75 percent has made funding easier for businesses and consumers. Similarly, growing development spending, despite a planned reduction in budget deficit, would continue to support infrastructure-related industries. One also tends to disagree with this because bulk of the deposits are being invested by commercial banks in government securities rather than extended to private sector.

The Report further explains that though some macroeconomic indicators were short of targets, they still posted better performance over the last year. For instance, real GDP growth of 4.7 percent during FY16 was below its target, but nevertheless higher than the growth achieved a year earlier. Meanwhile, the accumulation of the country’s foreign exchange reserves reached an all-time high level at end FY16; the exchange rate remained stable; and CPI inflation fell to only 2.9 percent during the year. Similarly, fiscal consolidation remained on track, and the budget deficit was reduced to 4.6 percent of GDP – the lowest since FY07. All this is not due to any good policies adopted by the government but lower international prices of crude oil.

The government envisages a GDP growth of 5.7 percent for FY17. The current account deficit is likely to stay in the range of 0.5 – 1.5 percent of GDP during the current financial year. The Report draws attention to the IMF program’s contribution in restoring macroeconomic stability and confidence of international creditors. Crucially, it maintains that the reform process – related to energy-sector, loss-making PSEs (like PSM, PIA), and business-friendly regulations – must continue after the IMF program’s completion.

Finally, the Report reiterates that without private sector participation, it will be hard to achieve a higher and sustainable growth that is built on the pillars of entrepreneurship, innovation and competitiveness.

The detailed Report is available at SBP website www.sbp.org.pk

Pakistan Stock Exchange witnesses 7 percent decline in average daily trading volume

During the week ended 18^th October, Pakistan Stock Exchange remained under pressure due to external and internal pressures. While India continued medium and heavy artillery shelling across the line of control (LoC), Panama case hearing added more confusion rather than providing clarity. As a result the benchmark Index closed 1.2%WoW lower at 42,325 points. Daily average trading volumes also declined 7.1%WoW to 458.6 million shares. Top gainers for the week included: HASCOL, EPCL, PIOC, CHCC and NCL; while losers were: INDU, ICI, ASTL, SSGC and DAWH.

Major news flow for the week included: 1) GoP rejected bids worth Rs113 billion (against a target of Rs50 billion) for this month’s auction of Pakistan Investment Bonds (PIB) as banks sought higher interest rates, 2) SBP reduced SLR for Islamic banks and banking branches by to 14% to induce liquidity near Rs225 billion Bai‐Muajjal maturity, 3) Vitol announced plans to acquire another 10% stake in HASCOL exercising its call option that would take cumulative holding to 25 percent, 4) Oman Telecommunications’ Chief reiterated plans to sell the company’s controlling stake in WorldCall Telecom, 5) Lucky Electric Power Company revised proposal for its planned 660MW power plant following a shift in fuel source to local coal with the EPC arrangement expected to be finalized by before 2016 and 6) SECMC expects to begin commercial operations for its 660MW Thar coal‐fired power project by June’19.

With room for escalation in political tensions on developments on Panama case, delayed till 29^th November, market is likely to remain lackluster. Moreover, futures rollover next week along with possible continuation of foreign outflows is likely to keep market under pressure. Anticipations regarding this month’s monetary policy statement are expected to remain in favor of a status quo, giving support to banking scrips. Continued weakness in coal prices (a decline by almost 18%WoW) can propel price performance in the cement sector while volatility in crude prices ahead of OPEC meeting scheduled on 30^th November may prompt higher activity in energy stocks.

According to AKD Securities, 9MCY16 earnings performance of Bank Alfalah (BAFL) was laudable on a number of counts, especially in terms of improvement in asset quality and effective Current Account mobilization. Flagging NPL ratio of 5.4% ‐ the lowest among ‘Big-Six), the bank's provisioning charges have come down by a sizable 79%YoY to Rs267 million, while coverage has increased to 83.1% in 9MCY16. Gaining confidence from the same, the brokerage house is now more comfortable on the bank's asset quality metrics and has lowered its provision charges. In turn, the bank's CASA hiked to 79% as compared the same period last year, lowering cost of funds. The brokerage house believes there are chances for further trimming, where apart from the aforementioned factors, CAR enhancement to 14.1% and ADR in excess of 50% depicting bank's push for loan growth are additional positives.

Lack of encouraging news flows, following a shift in policy for coal fired power plant (refusal to allow imported coal projects), lack of headway on circular debt clearance and privatizations have weighted on the energy sector companies, with HUBC and KAPCO posting a decline of about 12 and 13 percent FYTD. The impact on future growth projects (limiting of size and scale of planned expansions) from an adverse policy environment may be sizeable, holding down valuations and profitability in the long run.

According to the monthly automobile sales and production data, total vehicles sold reached 16,330 units (down 1.5%MoM and 17.2%YoY) during October this year. The sale comprised of 14,796 passenger cars (increasing 1.2%MoM but down 5.8%YoY) and 1,534 LCVs (falling 22.2%MoM and 61.8%YoY). The halving of GST on tractors allowed sales to climb by 46.3%MoM/93.2%YoY to 4,642 units. Monthly numbers point to a systemic consolidation in unit sales as consumers adjust buying behavior to accommodate for new models, while OEMs phase out models (Hilux by INDU and possibly Cultus by PSMC). Buying behavior is expected to ramp‐up in the beginning of CY17 with newly registered automobiles experiencing an increase in demand, additionally, auto sales growth is expected to normalize in 2QFY17, where the high base of the Rozgar scheme sales normalizes.

Pakistan inching towards balance of payment crisis

Remittances to Pakistan have been on a decline (down 3.8%YoY in 4MFY17), where recovery following the sharp dip in July16 (-20%YoY) has been slow to materialize.

 Driven by weak global macro dynamics and depressed crude oil prices the trend remains similar to other regional countries (Bangladesh/India down 9%/14%YoY in CY16TD) which are also considerably reliant on remittance flows.

 Going forward, we expect seasonal recovery to keep remittances marginally higher in FY17. With effects from current trends lingering we project remittance growth to remain in low single digits over the medium term.

 In this context, we highlight room for greater BoP volatility on weaker trade dynamics. Nonetheless, support to external account is expected to come in the form of higher foreign debt inflows (multilateral and bond issuances) driving exchange rate stability and consequently keeping depreciation pressures on the Pak Rupee limited.

 Pakistan emerged more vulnerable in the region due to a weak global macro outlook impacting remittance flow adversely, with major impact on South Asian countries that share reliance on remittances (avg. Remittance/GDP ratio: ~10%) for foreign inflows.

 Depressed crude prices affecting labor dynamics in GCC region has been a key driver in this regard where the region receives ~63% (2015 est.) of all GCC-sourced remittance. Consequently, Bangladesh and India have seen sharp decline in remittances with flows contracting 9%YoY and 14%YoY in CY16 so far respectively.

 Though initially sturdy, Pakistan is also witnessing a slowdown in remittances with 4MFY17 inflows declining by 3.8%YoY, where inflows from the GCC region declined 4.6%YoY in the same period.

 However, analysts take it as a bigger concern for Pakistan compared to regional peers in the backdrop of worsening trade dynamics (trade deficit up 11%YoY in FY16) compared to Bangladesh/India that contracted trade deficits by 9%YoY/10%YoY in FY16. With oil prices unlikely to mark a sharp recovery in the near-term and slow global demand recovery (UK/European economies), outlook for remittances remains tepid, where the WB has projected a dip of 2.3% in 2016, followed by moderate recovery in 2017/18 (2.2%/2.3% growth).

 Similar to the region, outlook for remittance to Pakistan remains subdued where analysts expect flows to stagnate around US$20 billion. Though currently on a decline, they see room for seasonal recovery near the end of FY17 - with flows increasing marginally for the year.

 Going forward, effects of low oil prices are likely to linger over the medium term, strong correlation of GCC remittance and oil price decline. On the other hand, recent dip inflows from US on account of higher transfer costs is expected to normalize.

 In aggregate, remittance growth is projected to remain in single digits over the medium term. However, key risks remain in the form of further slowdown from UK/EU region on account of Brexit and concerns emanating from recent US elections.

 Going forward, expanding trade deficit (FY17F: 14%YoY) amid weak remittance outlook remains a major risk to BoP stability, where analysts see current account deficit rising to 1.7% of GDP as against 1.2% for FY16).

 That said, concerns on exchange rate stability remain limited, where analysts derive comfort from expected foreign debt inflows (multilateral commitments and another bond issue planned) keeping foreign exchange reserves position stable.

This remains a key positive for exchange rate strength, where stronger foreign exchange reserves position will provide room to counter current account weakness.