Daily Call November 17, 2017

Transcription

1 REP- 300 Market Strategy BAML Conference: Opinions Remain Mixed Equities Return (USD) CY17TD May-17TD FY17 MSCI Emerg 30.5% 11.9% 21.2% MSCI World 17.8% 7.1% 16.5% MSCI Develop 16.3% 6.5% 15.9% Pakistan -15.3% -19.6% 23.1% USD mn Gross Buy Gross Sell Net Buy / (Sell) Oil & Gas Marketing Food Producers Textile All Others Sectors Power Gen (6) Telecom (7) Fertilizer (14) Commercial Banks (59) Cements (60) Oil & Gas Exploration (75) Total 2,038 2,219 (180) Source: Bloomberg, *31-May-17 to 16-Nov-17 Source: Bloomberg, AHL Research Analyst Samiullah Tariq sami.tariq@arifhabibltd.com Market Return - MSCI vs Pakistan Source: Bloomberg, MSCI Barra 160% 145% 130% 115% 100% 85% 70% 55% Sector-wise Foreign Portfolio Investment* Nov-16 Dec-16 Jan-17 Relative Performance Feb-17 MLCF UBL KSE100 Mar-17 Apr-17 May-17 Jun-17 Jul-17 HUBC MCB Aug-17 Sep-17 Oct-17 Mixed Views about Pakistan The Bank of America Merill Lynch organized a MENA Conference in Dubai this week where we highlight participation from UBL, MCB, HUBC and MLCF from Pakistan amongst 70 other global corporations. Over the course of 2 days and given interaction with various prominent names in the international community, we have amassed insights on the foreign sentiment towards investment in Pakistan. The participants general consensus about Pakistan s shift to the Emerging Markets was that it has not been a very smooth one as the KSE-100 index has tumbled by 19.6% post the transition to EM. However, a similar trajectory was witnessed in case of several other upgrades from frontier to emerging and from emerging to developed markets. Consequences have visibly been decline in market capitalization as well as reduction in volumes and liquidity. Meanwhile political uncertainty, timing of elections and fears pertinent to Rupee devaluation compared to Egypt were key investor concerns. Some participants were also of the view that materialization of CPEC projects was essential for Pakistan in order to enhance its exports as without power, roads and ports, no manufacturing enterprise can ship goods efficiently and effectively. Moreover, we observed a certain shift in investors focus from likelihood of materialization of CPEC projects to the timing of their completion, impact on EBITDA, total debt, financing cost and bottom-lines of respective local companies. They also enquired about the cost at which debt was being granted to companies by Chinese banks. On a positive note, investors remained cognizant of the improved law and order situation on ground in Pakistan. New Investors Now Considering to Take Exposure in Pakistan New investors have started looking at Pakistan as a perspective market for investment after re-classification into the Emerging Markets as their mandate only allows them to find opportunities in the EM space and not in the Frontier Markets. Albeit, the timing of investment remains a topic of debate as the domestic equity bourse has been on a roller coaster ride since its inclusion in the MSCI EM. Political Uncertainty Deterring Investors The prevailing political uncertainty since the removal of ex-prime minister Nawaz Sharif from his post has been a major deterrent for foreign investors. Resolution or clarity on the political front can potentially increase investment flows into Pakistan. Concern Regarding the PKR Over-valuation Investors in general expressed concern about overvaluation of the Pak Rupee and compared the Pakistani economy with Egypt; the latter has devalued its currency by 0.5% during the past one year and as a result, its economy has responded well to the change. We view the uncertainty regarding performance of PKR against the USD a continuous hindrance to investment. Further to this, we highlight the key themes picked up from interaction with the management of the respective companies: United Bank Limited: The management of UBL provided details of the favorable macroeconomic landscape whereby interest rates are one of the lowest in the history of Pakistan as a consequence of low inflation caused partly by lower oil prices. The GDP grew by 5.3% during FY17 which was the highest growth achieved during the past decade. To recall, during , interest rates were high at around 12% - 13% along with low GDP growth of 2.8%. Successive governments ran significantly higher fiscal deficits encouraging the banks to run a CASA - Treasury bills strategy. Most banks focused on collecting low cost deposits and investing them in low risk government securities thereby earning a decent spread income. This resulted in a low ADR. Moreover, since 3rd quarter of 2013, the SBP 1

2 introduced a Minimum Deposit Rate for saving deposits whereby the rate of saving deposits moved along with the change in discount rate. This has squeezed the spreads of the banks considerably. Regarding recent pressure on foreign exchange reserves, the bank stated that the government intends to issue Euro bonds and sukuk which will increase the import cover from present 3 months. In addition, receipts from the Coalition Support Funds will also help alleviate pressure on the foreign exchange reserves. Moreover, the government does not intend to import inflation with a sudden depreciation of PKR against USD. To conclude, the management informed investors that despite challenges, the present macroeconomic environment in Pakistan has been the most favorable since the past 10 years. Citing recent political uncertainty which commenced in May 17, the management believed that it further gained traction post disqualification of the ex-prime Minister Nawaz Sharif. This has also slowed down the progress on key reforms. However, management expects the political fog to clear out with the organization of elections where the ruling party PML (N) is expected to be re-elected to power with a different leadership. The ruling party has delivered on its promises of reviving the power sector and has been pro-investment. Casein-point: the barometer for economic performance has been visible improvement in automobile, motorcycle and cement sales. The management contended that the perception is worse than the real economic situation where if you exclude the performance of the stock market and the external sector, the economic situation on the ground is healthy. With regards to the exchange rate, the management said that the PKR seems overvalued by 5% and can adjust accordingly. While responding to another question regarding inclusion of Pakistan in Fragile 5 by S&P, the management stated that dysfunction in the policy leads to increased economic uncertainty. With revival of the power sector, the government now needs to focus on promoting exports via increasing subsidies and rebates or via reducing utility rates. The management while providing the background of UBL since privatization stated that the profitability of the bank has grown significantly subsequently. The domestic franchise continues to dominate the bank and contributes around 80% of assets while the international operations are around 20% of total assets. Investment in technology differentiates UBL from other banks as its branchless banking initiative Omni is ahead of all other banks. The branchless banking now has 45k agents which have a significantly higher penetration than the bank s branch network which stood at 1,359 branches at the end of CY16. Through this business model, the bank can provide cash management services to merchants as well as compete with microfinance banks without incurring the cost of building up the dedicated infrastructure. The branchless banking will increase customer touch points and financial inclusion while also serving the unbanked population. The profile of the bank s loan book includes 90% corporate portfolio and 10% retail and SME. The public sector and government guaranteed portfolio comprises 50% of the corporate loan book whereas the private sector contributes the remaining 50%. The public sector portfolio has a lower risk weight and provides higher spreads and is therefore more attractive for the bank; it contributes significantly to the bank s portfolio as after 2008, a lot of business groups in Pakistan went bust and therefore, the bank took exposure in the public sector. The corporate loan book growth is being driven by growth in infrastructure loans. The outstanding portfolio is dominated by the power sector (~19%) followed by the textile sector (~14%) and whole sale retail trading sectors. The circular debt continues to prevail at high levels where the bank s management believes that the privatization of discos remains the key to resolve the problems of the power sector. The management cited the example of KEL in which the incoming management turned around the utility and resolved majority of the problems of the city. Commenting on the Non-Performing loans portfolio, the management stated that less than 10% of NPLs originate from the public sector. For the past 3 quarters, the domestic NPL formation has been below 30bps. The domestic coverage stands at 87% while the bank level coverage stands at ~84%. The UAE loan book has been under stress as it is 2

3 dominated by contractors and wholesalers. These sectors are facing headwinds due to different stages of economic cycles. Historically, the bank has focused on SMEs in UAE and not on corporates as the bank has a relatively smaller presence in UAE compared to other banks operating in this market. Some provisions are expected in the upcoming quarter on the UAE business. The infection ratio for the UAE business stands slightly above 10%. UBL has an independent franchise in UAE which is not dependent on Pakistani business. The consumer portfolio is not more than 6% -7% of the total loan portfolio. In order to avoid the outcome of 2008 for consumer financing, the bank has not only increased the security checks through screening of potential customers via ECIB and development of own scoring system and the requirement to have a valid bank account but has also improved the collection system. Auto financing has been growing consistently by 20-30% however, its share in total loan book stays low. Regarding deposits, the management stated that their domestic CASA is 84% and has been consistent at this level in recent times. However, the percentage of Current Account has been increasing and currently stands at ~40% which is the highest for any bank. The major banks including HBL and NBP are facing problems which will affect their risk bearing capacity benefitting UBL in competitive positioning. The management expects retail banking to benefit with the appointment of the new President who spearheaded the segment in HBL. Commenting on the investment book, the bank stated that UBL holds a PIB portfolio worth PKR 600 bn, which has an average yield of 8.8% and an average maturity of 2.5 years. 20% of PIBs will mature next year. The compression in Net Interest Margins, which the bank is facing right now will be countered by higher Non-Funded Income. The bank expects the NFI to grow by 7% next year. The management stated that the bank has a capital adequacy ratio (CAR) of more than 15% at the end of 3Q17. However, it is looking to issue additional tier 1 capital which is a newer concept and has been utilized by two other banks including BAFL and BAHL. As the CAR requirements increase, the management prefers to have a buffer of 3%. The bank does not plan to cut the dividends nor does it plan to issue any right shares. The bank does not face any compliance situation like HBL. However, it has been further de-risking its international operations. MCB Bank Limited: The management reiterated that MCB Bank continues to remain amongst the top four banks in terms of assets and deposits, however, it holds the highest market capitalization after the recent decline at the index of other banks (including HBL due to compliance issues). The bank has historically maintained the highest ROE and ROA in the banking industry but has recently faced pressure on its margins due to decline in interest rates and maturity of PIBs (Pakistan Investment Bonds). MCB had the lowest cost / income ratio among all banks and counts cost controls as one of its greatest strengths. The management also highlighted that the banks majority shareholder i.e. the Nishat Group, is actively involved in its decision making. The bank s deposit mix is focused towards low cost with total CASA around 93% and current accounts standing at 38%. The cost of funds for the bank is lowest at 2.9%. Reason for this is a wider foot print of the bank in Pakistan s rural areas. With regards to the merger of NIB with MCB, the management stated that the primary objective was to recover the investment via recovering non-performing loans of NIB Bank. The cost / income ratio of the bank has gone up after the merger as the SBP has restricted MCB not to terminate the employees of NIB bank for a period of one year. Total assets of NIB Bank will be lower than 10% of MCB Bank s assets. The bank plans to transfer 100 branches into the Islamic banking subsidiary of MCB Bank. While informing the investors about its investment portfolio, the management specified that the PIB portfolio of the bank (having an 11% yield) will mature by Dec 18, while reinvestment of the proceeds into Treasury Bills is being done at approximately 6%. The 3

4 bank also expects an increase in interest rates from Jun 18. Commenting on its strategy to counter the prevailing lower interest rates, the management focused on increasing the share of Current Account Deposits. The bank did not participate in CPEC projects as it believed that the prevailing circular debt will continue to hamper the performance of the power generation sector. The bank believed that without privatizing the discos, performance of the power sector will not reach its full potential. The bank was of the view that the PKR is overvalued against USD by 10% and interest rates will move up, increasing the net interest margins of the bank. Hub Power Company Limited: The company s strategy for growth revolves around 3 major projects including 1) 1,320MW imported coal-based power plant with $ based IRR of above 17%, 2) 330MW local coal-based power plant with $ IRR of above 20%, and 3) coal mining facility of ~3.7mn tons per day. Pertinently, for the equity contribution of these projects, HUBC is planning to finance these via debt alongside internal cash flow generation. Hence, payout ratio of the company during this phase may curtail to 50% - 70% (81% in FY17). The outstanding challenge for materialization of these projects remains the execution as the financing has almost been completed. For coal project 1, which is the 1,320MW imported coal fired plant, the management disclosed that all financing documents are ready and approvals have been received and they are in the process of meeting CPs (Conditions Precedent) for the financial closure; USD 1.5bn debt has been secured for the project. While commenting on the mix of debt between Chinese and Pakistani banks, the management informed that Pakistani banks have virtually no exposure in the project s debt financing as HUBC is leveraging its own balance sheet to inject equity into the project. Therefore, debt from Pakistani banks will only be utilized for injection of equity and meeting requirements of working capital. If the company keeps its share at 26%, the equity contribution will amount to USD 130mn and it has the option to increase it to 46.5%. The company has given the notice to the other shareholder regarding increase in its share, however, that process will take time. The financial close of the project is expected by Dec 17 and the COD is scheduled by Aug 19. Describing the Thar Coal project, the management stated that Thar Energy Limited will setup a mine mouth coal fired plant (330 MW) at a cost of ~USD 500mn. HUBC will own 60% of the project, while the Fauji group will have a stake of 30% and the remainder (10%) will be owned by CMEC (China Machinery and Engineering Corporation). Total equity contribution in said project is expected at USD 125mn whereas HUBC s contribution is estimated around USD 65mn. With the financial closure expected in Mar 18, the project is likely to commence operations by Jun 20. Regarding the sale of HUBC s shareholding by the Dawood Group to KAPCO, the management stated that the strategic direction of the company is locked with the completion of these new projects and the change in shareholding will not affect it. On the Narowal demerger front, HUBC s 100% owned subsidiary - Narowal Energy Limited - is expected to benefit from the debt being raised for the equity portion of growth projects. While speaking of the O&Ms, HUBC s management disclosed plans for major overhaul of its 4 boilers at Hub plant and how negotiations with GE have been initiated to fund the replacement of boilers and share additional fuel savings in the ratio of 45% : 55% (GE:HUBC). Maple Leaf Cement Factory: The Company management shared optimism on the local cement demand and expects it to grow by 8% in the medium term. Moreover, the company estimates double digit local demand during FY18 as economic activity is expected to remain buoyant in the election year. Regarding exports, the management believes that post commissioning of new capacities, manufacturers are expected to start focusing on export markets. Adding details, management suggested that from FY18 onwards, players in the southern market will try to maximize their exports in order to maintain utilization levels. Discussion on pricing revealed that the management expects price 4

5 reversal from 2H in the north region as current domestic prices in said region are deemed unsustainable in the longer run and a rebound is expected henceforth. Furthermore, the company s view on the expansion outlook is that ~16.2mn tons of capacities (North 8.6mn and South 7.6mn) will come online by FY20 and total utilization levels will not drop below 73%. The brownfield capacity expansion of 7,200tpd by MLCF is projected to come online by end of Mar 19. In addition, the new line is expected to have a flexible pet coke usage (to the extent of 75% - 95%), which is anticipated to be over 20% more cost efficient in contrast to coal. Plus the company is also planning to augment utilization of pet coke by up to 50% on its line-ii. Lastly, the company expects saving of ~PKR 3.8/kWh through its 40MW coal-based power plant which commenced commercial production in Oct 17 and dependency on national grid is now around 5% only. Outlook for investment Although the market observed a recent net outflow of foreign investment (CY17TD and FY18TD net outflow of USD 440mn and USD 107mn, respectively), given our interactions, we remain positive that there will be a trend reversal in the near future, which could lead to further equity gains. Pakistan s equity market is currently trading at a forward PER of 8.0x versus regional PER of 14.2x, (a discount of 44%). On dividend yield basis, KSE-100 offers a decent 6.4% versus DY of 2.4% in regional markets. 5

6 Analyst Certification: The research analyst(s) is (are) principally responsible for preparation of this report. The views expressed in this research report accurately reflect the personal views of the analyst(s) about the subject security (ies) or sector (or economy), and no part of the compensation of the research analyst(s) was, is, or will be directly or indirectly related to the specific recommendations and views expressed by research analyst(s) in this report. In addition, we currently do not have any interest (financial or otherwise) in the subject security (ies). Furthermore, compensation of the Analyst(s) is not determined nor based on any other service(s) that AHL is offering. Analyst(s) are not subject to the supervision or control of any employee of AHL s non-research departments, and no personal engaged in providing non-research services have any influence or control over the compensatory evaluation of the Analyst(s). Equity Research Ratings Arif Habib Limited (AHL) uses three rating categories, depending upon return form current market price, with Target period as June 2018 for Target Price. In addition, return excludes all type of taxes. For more details kindly refer the following table; Rating BUY HOLD SELL Description Upside* of subject security(ies) is more than +10% from last closing of market price(s) Upside* of subject security(ies) is between -10% and +10% from last closing of market price(s) Upside* of subject security(ies) is less than -10% from last closing of market price(s) * Upside for Power Generation Companies (Ex. KEL) is upside plus dividend yield. Equity Valuation Methodology AHL Research uses the following valuation technique(s) to arrive at the period end target prices; Discounted Cash Flow (DCF) Dividend Discount Model (DDM) Sum of the Parts (SoTP) Justified Price to Book (JPTB) Reserved Base Valuation (RBV) Risks The following risks may potentially impact our valuations of subject security (ies); Market risk Interest Rate Risk Exchange Rate (Currency) Risk Disclaimer: This document has been prepared by Research analysts at Arif Habib Limited (AHL). This document does not constitute an offer or solicitation for the purchase or sale of any security. This publication is intended only for distribution to the clients of the Company who are assumed to be reasonably sophisticated investors that understand the risks involved in investing in equity securities. The information contained herein is based upon publicly available data and sources believed to be reliable. While every care was taken to ensure accuracy and objectivity, AHL does not represent that it is accurate or complete and it should not be relied on as such. In particular, the report takes no account of the investment objectives, financial situation and particular needs of investors. The information given in this document is as of the date of this report and there can be no assurance that future results or events will be consistent with this information. This information is subject to change without any prior notice. AHL reserves the right to make modifications and alterations to this statement as may be required from time to time. However, AHL is under no obligation to update or keep the information current. AHL is committed to providing independent and transparent recommendation to its client and would be happy to provide any information in response to specific client queries. Past performance is not necessarily a guide to future performance. This document is provided for assistance only and is not intended to be and must not alone be taken as the basis for any investment decision. The user assumes the entire risk of any use made of this information. Each recipient of this document should make such investigation as it deems necessary to arrive at an independent evaluation of an investment in the securities of companies referred to in this document (including the merits and risks involved), and should consult his or her own advisors to determine the merits and risks of such investment. AHL or any of its affiliates shall not be in any way responsible for any loss or damage that may be arise to any person from any inadvertent error in the information contained in this report. Disclosure required under Research Analyst Regulations, 2015: In order to avoid any conflict of interest, we hereby disclosed that; Arif Habib Limited (AHL) has shareholding in MLCF. 6