Pakistan Market Strategy Market Fall Provides Selective Entry Point Select Stocks Warrant Attention

Transcription

1 Pakistan Equity Strategy October 19, 2018 Prices as of October 17, 2018 REP-057 Pakistan Market Fall Provides Selective Entry Point Select Stocks Warrant Attention Best Brokerage House 2018 Topline Research Tel: , Ext: 133 Topline Securities, Pakistan Best Local Brokerage House Brokers Poll , Best Local Brokerage House

2 Market Now Trades at Forward PE of 7.3x (5-Year low) The benchmark KSE -100 Index has fallen by 7.0% (23% in US$) in 2018YTD to 37,647 index levels and is down 29% (44% US$) from its peak of 52,876 on May 24, Pakistan equities have been under pressure since its peak in May 2017 on the back of 1) economic concerns, 2) political upheavals and 3) net foreign selling. Pakistan s fiscal and external imbalances (FY18 fiscal deficit at 6.6% vs. 5.8% last year and FY18 current account deficit at 5.8% vs. 4.1% last year) continue to expand that has now led the new govt. to the familiar path of International Monetary Funds (IMF), where a fund program is expected to be in place within the next few months. The IMF program will be accompanied by further 1) currency devaluation (Rupee has already devalued by 21% in 2018YTD), 2) hike in interest rates (policy rate up 2.75% in 2018YTD) and 2) increase in energy prices to name a few. In anticipation of the tough economic measures and expected slowdown in economy (FY19 GDP growth expected at % vs. FY18 GDP growth of 5.8%), the market has been embroiled with negative sentiments and is currently trading at forward PE of 7.3x compared (close to 5 -Year low) to market 10 -year average PE of 8.5x. The disqualification of former Prime Minister (PM) Nawaz Sharif in July 2017 led to increased political uncertainty and subsequent clash with the state institutions, which at one time also had led to assertions that the July 2018 elections could be delayed. However, the timely elections and a new govt. has to some extent allayed political noise. There had been across the board sell -off in emerging markets lately, on the back of U.S. trade war with China and country specific issues that led to weakening of emerging market currencies against dollar. To note, Morgan Stanley Capital International (MSCI) Emerging Market (MSCI EM) index is down 15% in 2018YTD. This also had a spillover effect on Pakistan s market which has seen net foreign selling of US$375 in 2018YTD. 2

3 Select Stocks to Act as Defensive Plays Pakistan market s recent decline has led to inordinate fall in across the board listed stocks. We have identified following select stocks that warrant investors attention based on certain valuation matrix: Engro Corporation (ENGRO), Indus Motors (INDU), Oil & Gas Development (OGDC), Nishat Mills (NML), D.G. Khan Cement (DGKC), Nishat Power (NPL), Pakistan Telecommunication (PTC), Pak Elektron (PAEL) and Habib Bank (HBL). To remain diversified in our selection criteria, we have picked one stock each from Autos, Banks, Cement, Consumers, Exploration & Production (E&Ps), Fertilizer, Power, Textile and Telecom, which in our view are likely to act as defensive plays in deteriorating macroeconomic situation. These companies, in our view, either have significantly fallen in their stock prices or are attractively placed on our valuation matrix. The valuation matrix we which have used to screen -out companies are Price to Earnings (PE), Price to Sales (PS), Dividend Yield (DY), Price to Book Value (PBV), Net Cash Position and Business Model. Pakistan Stock Market: Key Numbers 2016A 2017A 2018E 2019F 2020F PE Earnings Growth* -3% 12% 5% 14% 14% Earnings Growth (ex -Oil & Bank) 3% 6% -1% 3% 11% PBV Dividend Yield 6% 5% 6% 6% 7% ROE 15% 13% 13% 15% 16% *Adjusted for outliers 3

4 Our Top Picks Engro Corporation Indus Motor Oil & Gas Development Nishat Mills DG Khan Cement Nishat Power Pakistan Telecommunication Pak Elektron Habib Bank Market Honda Atlas Strategy Cars (HCAR) 4

5 Engro Corporation (ENGRO) Engro Corporation is currently sitting at net cash balance of Rs118/sh, which the company has invested in short term securities yielding 9-10%. In rising interest rates scenario (interest rates are up 2.75% in 2018YTD), these investments are likely to provide higher interest income. The stock is trading at an attractive forward earnings multiple of 7.8x (cash adjusted PE of 5.7x), which is much below its historical P/E multiple of 11.6x. Among its existing portfolio companies, EFERT and EPCL are performing well, former due to better urea prices and latter due to 1) lower breakeven point of US$175/ton vs. US$450/ton earlier 2) upcoming expansion of PVC and 3) entrance into hydrogen per oxide segment to cater southern region of Pakistan. On the other hand, ENGRO is evaluating around 15 projects to park its surplus cash, of which M&A s in listed companies cannot be ruled out. In addition to Engro, its parent company Dawood Hercules (DAWH) is sitting at cash of Rs11bn (Rs21/sh) as its recent tower deal was cancelled due to pending regulatory approvals. Incorporating ENGRO SOTP, DAWH is currently trading at discount of 41% to its SOTP of Rs170. Further cash adjusted P/E of DAWH for 2019E is at an attractive 6.5x. Valuation Matrix (2019E) PE (x) 7.8 Net Cash Adjusted PE (x) 5.7 PS (x) 1.2 PBV (x) 1.1 Dividend Yield 8% Net Cash/sh 118 Net Cash % of Mkt Cap 40% SOTP Discount to Mkt 27% ENGRO vs KSE-100 Index ENGRO KSE % 8% -3% -15% 5

6 Indus Motor Company (INDU) Indus Motors (INDU) has fallen by 27% compared to 7.0% fall in KSE -100 index in 2018YTD. The company s business is cyclical in nature and hence as economy slows down, INDU s performance will take a hit. However, even after incorporating the challenging business environment, investors have overreacted, in our view. Even in the worst case scenario, INDU depicts a 2019E PE multiple of 11. Moreover, the company has a net cash per share of ~Rs334/sh. If we were to adjust our earnings estimate for cash in the base case scenario, the 2019E PE multiple comes out to be an attractive 7.2x. Moreover, timely and appropriate price hike has enabled the company to pass on the impact of currency devaluation (PKR depreciated 21% in 2018YTD) which has also been reflected in its recent quarters margins. The pricing power of INDU can be judged from the fact that it recently halted the booking of its cars to gauge and pass on PKR depreciation impact. The power originates from cultural acceptance of the company in Pakistan where it is the largest player in Sedan market and also due to easy availability of its spare parts throughout the country which makes it popular in rural areas as well giving it a diverse clientele. Valuation Matrix (FY19E) PE (x) 7.5 Net Cash Adjusted PE (x) 7.2 PS (x) 0.6 PBV (x) 2.2 Dividend Yield 9% Net Cash/sh 334 Net Cash % of Mkt Cap 30% INDU vs KSE-100 Index 25% INDU KSE % -3% -17% -31% -45% 6

7 Oil & Gas Development (OGDC) We like OGDC based on its cash rich book and attractive valuation. The company holds cash & equivalents of Rs37/share on net basis, which is 25% of its market capitalization. The company is trading at FY19E PE of 6.2x (oil prices assumption of US$70/bbl), while it s cash adjusted PE is at lucrative 5.2x, making it the cheapest among its peers. Moreover, OGDC is the beneficiary of higher oil prices and currency devaluation (PKR depreciated 21% in 2018YTD). Arab light oil prices in 2018YTD have risen to 27% to US$81/bbl (up 50% YoY in 1QFY19) on the back of looming USA sanctions on Iran. The recent spat of USA with Saudi Arabia over the disappearance of a Saudi journalist has further fueled speculations in the oil market. Even if oil prices fall by 30% from here, OGDC will still trade at FY19E PE of 7.6x (net adjusted PE of 6.5x). An opportunity exists for E&Ps to explore hydrocarbon reserves as the new Govt. has shown willingness to issue more exploration licenses. This is to boost indigenous oil & gas production to curtail dependency on imported oil (oil bill is 30% of country s imports). Valuation Matrix (FY19E) PE (x) 6.2 Net Cash Adjusted PE (x) 5.2 PS (x) 3.1 PBV (x) 1 Dividend Yield 5% Net Cash/sh 37 Net Cash % of Mkt Cap 25% OGDC vs KSE-100 Index 20% OGDC KSE % 10% 5% 0% -5% -10% 7

8 Nishat Mills (NML) NML is one of the largest exporter of value added textile in Pakistan and with new Govt. s ambition to enhance exports coupled with rupee devaluation of around 28% since Dec 2017 is likely to boost companies margins and earnings going forward. Currently the company is using blend of RLNG and Natrual Gas (72:28) for its power generation need. Recently, the new government has offered Punjab based textiles to reduce their RLNG cost. In this scenario, NML will be biggest beneficiaries. In addition to subsidized RLNG cost, new government has also assured textile companies for timely release of their drawback/incentive funds coupled with decline in electricity tariff in line with their manifesto of providing incentives to exporters. This will enhance cash flows of the company and will allow it to improve its working capital management, which is currently managed through short term borrowings. NML has diversified exposure in cement, financial, and power sector of Pakistan. Further, the company has also announced to enter into auto sector of Pakistan in collaboration with Hyundai Motors of Korea. Currently, NML is trading at discount of 23% to its SOTP value of Rs171 with PBV of 0.7x. Valuation Matrix (FY19E) PE (x) 6.9 PS (x) 0.5 PBV (x) 0.7 Dividend Yield 6% SOTP Discount to Mkt 23% NML vs KSE-100 Index 30% NML KSE % 10% 0% -10% 8

9 DG Khan Cement (DGKC) Cement stocks are under pressure on the back of higher input costs (FOB coal prices up 18% YoY to US$103/ton 1QFY19) and weak pricing power given dull demand outlook. Sector gross margins are now hovering at 6 years low of ~27%. As a result, cement sector is down 26% in 2018YTD. However, DGKC has underperformed the sector by 13%, which in our view is unjustified, given its Sum -Of -The -Parts (SOTP) valuation of Rs130/share, which includes portfolio value of Rs63/share. On the flip side, DGKC s cement business is trading at an attractive FY19E PE of 3.3x, making it the cheapest cement company in our Universe at current levels. We have excluded portfolio valuation of Rs27.5bn (Rs63/sh) from the company s market capitalization to arrive at cement operation PE. In worst case scenario, if DGKC s FY19E earnings decline by 40% from our base case estimates, the company s cement business still trades at PE of 5.5x. The company also trades at lower EV/ton of U$74 (cash & investments adjusted EV/ton of US$39). Valuation Matrix (FY19E) PE (x) 9 PE* (x) 3.3 PS (x) 1.1 PBV (x) 0.5 Dividend Yield 6% SOTP Discount to Mkt 37% *Cement business (ex port. value) DGKC vs KSE-100 Index 25% DGKC KSE % -1% -14% -27% -40% 9

10 Nishat Power (NPL) NPL has lost around 58% of its value since its peak in Jan 2017, underperforming market by 33% despite sovereign guarantee and 22% rupee devaluation YTD. Currently overdue receivables of the NPL are Rs27/share (higher than its current price), which are backed by sovereign guarantees. NPL is currently trading at PBV of only 0.5x. With likely resolution of circular debt (which is currently under radar of new Govt.), NPL can release its skipped dividend amounting to Rs6-7/share coupled with special dividend of Rs5/share, we believe. Valuation Matrix (FY19E) PE (x) 2.7 PE* (x) 2.1 PS (x) 0.5 PBV (x) 0.5 Dividend Yield** 7% * Net Receivables Adjusted ** excluding special/skipped Chances of resolution of circular debt are bright as it falls under structural reforms of IMF program. The Govt. prior to the 2013 IMF program paid a sum of Rs480bn to settle the energy sector circular debt. Nonetheless, the new Govt. is all set to increase energy tariff in Pakistan that will reduce the increase of circular debt in the economy. As a result, IPPs will have better cash flow management going forward. NPL vs KSE-100 Index 30% NPL 10% -10% -30% -50% KSE

11 Pakistan Telecommunication (PTC) PTC, the leading national telecom operator is meeting our valuation matrix criteria as the stock has been one of the underperformers lately, down 19% in 2018YTD, underperforming the benchmark index by 11% and warrant attention, we believe. The company has one of the highest dividend yields of 17% average in last 3 years in our sample stocks while it stands favorably at PBV of 0.6x. The underperformance of the stock is despite its cash rich book with net cash of around Rs4/share, which is 37% of its market capitalization. The company is trading at cash adjusted FY19E PE of 7.5x. PTC is undergoing a comprehensive network transformation to upgrade its existing infrastructure. As per the management, this will help the company to achieve reduced customer complaints, better Average Revenue per User (ARPU) and increased revenue in upgraded exchanges. A growth area for the company is the untapped market for Microfinance. PTC holds microfinance bank Ubank through its subsidiary Ufone. Ubank posted profits of Rs33mn in 2017 vs. loss of Rs161mn last year. In 1H2018, the bank s revenues grew by 71% YoY. The acquisition of 45% stake in Telenor Microfinance Bank by Ant Financial (the parent company of Alipay and the financial services affiliate of Alibaba) at an investment of US$184.5mn in Mar 2018, also highlights the growth potential of Microfinance. Valuation Matrix (2019E) PE (x) 8.7 PE* (x) 7.5 PS (x) 0.3 PBV (x) 0.6 Dividend Yield 10% Net Cash/sh 3.57 Net Cash % of Mkt Cap 37% PTC vs KSE-100 Index 20% PTC KSE % 0% -10% -20% -30% 11

12 Pak Elektron (PAEL) Pakistan s leading appliances and power equipment manufacturer has substantially underperformed, down 49% in 2018YTD. The stock is down 79% from its peak of Rs124 in May PAEL is trading at an attractive FY19E PS and PBV of 0.4 and 0.5, respectively. Compared to this, Arcelik (Turkish firm) acquired 100% stake in Dawlance (45% market share in refrigerators that time) for US$258m in Nov 2016 at PS of 1.17x, which indicates significant upside potential for PAEL from these levels. Furthermore, PAEL offers dividend yield of 7% at its current price. The company is going through a rough patch due to competition from Chinese brands as well as row with one of its largest distributors that affected the company s appliances sales. On top of this, the recent increase in commodity prices and currency devaluation has limited the company s ability to pass on higher input costs that led to decline in margins in recent quarters. However, due to its strong positioning as a household brand, there should be a turnaround in PAEL s appliances sales while margins should normalize once currency stabilizes. The company is also introducing new products (LED TV and semi automatic and fully automatic washing machines) in appliances space that should diversify its sales going forward, we believe. The company also manufactures power transformers and distribution equipments, which is about 25-30% of the company s sales. Valuation Matrix (2019E) PE (x) 6.0 PS (x) 0.4 PBV (x) 0.5 Dividend Yield 7% PAEL vs KSE-100 Index 20% PAEL KSE-100 0% -20% -40% -60% -80% 12

13 Habib Bank Limited Habib Bank Limited (HBL), the largest deposit franchise in Pakistan, is trading at a PBV of 0.9x, which is ~5 year low. Furthermore, Bank has fallen 21% in 2018YTD and underperformed both the market and the Banking Sector that have declined 7.0% and 3.8% in 2018YTD, respectively. The bank maintains its leadership position in deposits, where its deposits stand at Rs2.0tn (as of Jun 2018), leading the next big player by Rs100bn. It also has the largest branch network in the country at 1,751 branches (as of Jun 2018). Moreover, as monetary tightening continues, the bank will see its net interest income expanding, growing the bottom -line. The bank has been significantly de -rated post US$225mn penalty by New York State Department of Financial Services (NYSDFS), which dampened investor confidence in the stock. This was compounded by adverse decision in a pension related case which further weakened the Bank s earnings. However, there is little chance of further action on the company from its international operations as well as little chance of further significant pension charge. Thus, given historically low valuations, and favorable macroeconomic environment in the shape of tightening monetary policy, we see significant potential re -rating in HBL. Valuation Matrix (2019E) PBV 0.9 PE 7.8 ROE 12% Dividend Yield 5% HBL vs KSE-100 Index HBL KSE % 19% 8% -3% -14% -25% 13

14 CONTACT US Mr. Mohammed Sohail CEO Dir: +92 (21) Research Team: Mr. Saad Hashemy Chief Economist & Director Research Dir: +92 (21) Mr. Nabeel Khursheed Senior Research Analyst +92 (21) Mr. Shankar Talreja Research Analyst +92 (21) Mr. Syed Daniyal Adil Research Analyst +92 (21) Mr. Fahad Qasim Manager Research +92 (21) Mr. Asif Habib Database Officer +92 (21) Equity Sales Team: Ms. Samar Iqbal Head of International Equity Sales Dir: +92 (21) Mr. Umair Naseer Senior Manager Equity Sales Dir: +92 (21) Mr. Muhammad Hammad Aman Senior Manager Equity Sales Dir: +92 (21) Mr. Rai Omar Basharat Senior Manager Equity Sales Dir: +92 (21) Corporate Office: 508, Continental Trade Center, Block-8, Clifton, Karachi, Pakistan Tel: Fax:

15 Analyst Certification and Disclosures The research analyst(s), denoted by an AC on the cover of this report, primarily involved in the preparation of this report, certifies that (1) the views expressed in this report accurately reflect his/her personal views about all of the subject companies/securities/sectors and (2) no part of his/her compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this report. Furthermore, it is stated that the research analyst or its close relative have neither served as a director/officer in the past 3 years nor received any compensation from the subject company in the past 12 months. Additionally, as per regulation 8(2)(i) of the Research Analyst Regulations, 2015, we currently do not have a financial interest in the securities of the subject company aggregating more than 1% of the value of the company. Rating System Topline Securities employs three tier ratings system to rate a stock, as mentioned below, which is based upon the level of expected return for a specific stock. The rating is based on the following with time horizon of 12 -months. Rating Expected Total Return Buy Stock will outperform the average total return of stocks in universe Neutral Stock will perform in line with the average total return of stocks in universe Sell Stock will underperform the average total return of stocks in universe For sector rating, Topline Securities employs three tier ratings system, depending upon the sector s proposed weight in the portfolio as compared to sector s weight in KSE -100 Index: Rating Sector s Proposed Weight in Portfolio Over Weight > Weight in KSE -100 Index Market Weight = Weight in KSE -100 Index Under Weight < Weight in KSE -100 Index Ratings are updated daily to account for the latest developments in the economy/sector/company, changes in stock prices and changes in analyst s assumptions or a combination of any of these factors. Valuation Methodology To arrive at our 12 -months Target Price, Topline Securities uses different valuation methods which include: 1). Present value methodology, 2). Multiplier methodology, and 3). Asset -based methodology. Research Dissemination Policy Topline Securities endeavors to make all reasonable efforts to disseminate research to all eligible clients in a timely manner through either physical or electronic distribution such as , fax mail etc. Nevertheless, all clients may not receive the material at the same time. Disclaimer This report has been prepared by Topline Securities and is provided for information purposes only. Under no circumstances this is to be used or considered as an offer to sell or solicitation of any offer to buy. While reasonable care has been taken to ensure that the information contained therein is not untrue or misleading at the time of publication, we make no representation as to its accuracy or completeness and it should not be relied upon as such. From time to time, Topline Securities and/or any of its officers or directors may, as permitted by applicable laws, have a position, or otherwise be interested in any transaction, in any securities directly or indirectly subject of this report. This report is provided only for the information of professional advisers who are expected to make their own investment decisions without undue reliance on this report. Investments in capital markets are subject to market risk and Topline Securities accepts no responsibility whatsoever for any direct or indirect consequential loss arising from any use of this report or its contents. In particular, the report takes no account of the investment objectives, financial situation and particular needs of investors, who should seek further professional advice or rely upon their own judgment and acumen before making any investment. The views expressed in this report are those of Topline Research Department and do not necessarily reflect those of Topline or its directors. Topline as a firm may have business relationships, including investment -banking relationships, with the companies referred to in this report. All rights reserved by Topline Securities. This report or any portion hereof may not be reproduced, distributed or published by any person for any purpose whatsoever. Nor can it be sent to a third party without prior consent of Topline Securities. Action could be taken for unauthorized reproduction, distribution or publication. 15