- Despite foreign selling, local investors and stable policy drive Pakistan’s equities up 4pc
Pakistan Stock Exchange (PSX) weathered another volatile month, this time due to the Iran-Israel conflict, before rallying hard to post 4%MoM returns.
Daily trading activity was buoyant at US$142 million (ready plus futures). Foreign investors remained sellers, primarily in the consumer staples sector, while local individuals once again showed resilience and added to positions on dips.
Other than easing geopolitical concerns, the market was supported by the passage of a market friendly budget. This should lay grounds for improved price performance in the second half of the year (the benchmark KSE-100 index was up a modest 8% CYTD). Equities are traded at 15% discount to their long-term average – and the top-down environment is supportive.
The benchmark index had to contend with the Iran-Israel war in June, just a few weeks after the Pakistan-India conflict. Equity markets were rattled at spiking oil prices, given crude and petroleum products comprise 30% of Pakistan’s import bill or 4% of GDP).
The market was also concerned at the possible blockade of the Hormuz Strait, with Pakistan getting nearly all its oil imports through this route. Ultimately, Pakistan appears to have navigated recent geopolitical crises fairly well, culminating in a meeting between the army chief and President Trump in the White House. Details are scant but it is possible that there is follow-up collaboration on mining and minerals, together with a favorable trade deal. The feel-good factor has been confirmed by Pakistan nominating President Trump for the Nobel peace prize.
With the monetary policy committee (MPC) meeting scheduled at the height of tensions, the State Bank of Pakistan (SBP) kept the policy rate on hold at 11.0%. The SBP may also have been influenced by the current account slipping back into a deficit despite strong remittances, and some delays in new commercial borrowing (SBP foreign exchange reserves slipped to a 12-month low of US$9.1 billion). Now that the base effect is fading and inflation is on the way up (3.5% in May as against 0.3% in April), it is possible that the SBP keep the policy rate unchanged over the next few MPC meetings as well.
The FY26 Budget spared the overtaxed formal economy by marginally reducing tax rates for the salaried class and the corporate sector. It also kept the taxation structure unchanged for equities while raising tax rates for debt securities on dividends from mutual funds earning from debt, and With Holding Tax on interest on debt. The equity market cheered this.
While efforts have been made to further place restrictions on non-filers, the Budget seems to have fallen short of a meaningful push to broaden the tax net. This is a failure but, with the government having been in power for just fifteen months, analysts believe there is still a runway left to enact reforms.
The privatization of the national airline PIA will be a key litmus test in this respect, and the recent interest shown by several credible bidders such as LUCK, HUBC and FFC is encouraging.
The top-down environment looks the most settled in years. The current political configuration is looking to be durable and the economy is being run in a disciplined manner. We believe these are conducive conditions for further valuation rerating, with the KSE-100 trading at a forward P/E of 6.4x as against the last 10-year average of 7.5x. Valuation mean reversion alone can take the KSE-100 to 140,000 points.
The valuation discount is not as sharp as it was two years ago, meriting more focus on stock selection. In general, analysts suggest sectors offering swift growth prospects over the medium-term.
Cements and Oil Marketing Companies stand out in this respect, projected to deliver 3-year earnings CAGRs in excess of 15%, still trading at discounted, unlike Pharmaceuticals and Technology for instance where growth is balanced by premium valuations.
Intermarket Securities replace top picks DGKC with KOHC. As mentioned above, analysts are positive on the cement sector, but feel the likes of KOHC and PIOC offer better value for money as compared to peers (LUCK remains best in the class but is not a pure-play cement manufacturer).