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Improving Economic and Stock Market Outlook

Economy: It is a well-established fact that the Private sector is the engine of growth and economic prosperity as it plays a key role in jobs creation and income generation. As a result of successful privatization program that stated from 1980s, in Pakistan, over 90% of the commercial banking sector, 100% of the textile, cement, sugar, automobile and fertilizer industries belong to the private sector. These sectors are operating profitably, providing employment to hundreds of thousands, and contributing hundreds of billions in taxes to the exchequer. On the contrary, Public Sector Enterprises (PSE) such as Pakistan Steel Mills, Pakistan Railways, PIA, and Power Discos bleed around Rs 200 billion every year.

To put things into perspective, faced with the challenging economic environment shaped with high inflation, and large and widening Current Account Deficit (CAD), the incumbent government after coming into power in July 2018 pursued aggressive monetary tightening with sharp increase in interest rates and massive currency devaluation. Even before the Coronavirus blow, these demand compression policies weighed on the economic growth. Despite this challenging environment, the private sector has made huge investment in several sectors such as Cement, Steel, Automobile, Paper & Board, Glass, Power Generation, Refineries, and Tiles & Ceramics for capacity additions as well as Balancing, Modernization and Replacement (BMRs) (see the Table below). This in turn, is expected to enhance the potential growth rate of the economy, resulting in higher foreign exchange savings and earnings through import substitution / exports.

Capacity expansion by key sectors (2017 – 20)
Sectors Capacities Addition Current Capacity Utilization
2017 2020
Power Generation (Megawatts) 26,632 34,973 8,342 40%
Cement 46 67 20 72%
Steel (Million Tons) 0.8 1.7 0.9 48%
Glass (Thousand Tons) 633 821 188 64%
Automobile (Number in thousand) 260 271 11 41%
Refinery (Million Metric Tons) 18.8 19.4 0.6 51%

Improving economic landscape as manifested by low interest rates and benign inflation outlook, fairly valued currency & expectation of measured currency devaluation, comfortable Balance of Payment situation, bodes well for the economy. With the gradual re-opening of the economy from the Coronavirus-induced shutdown, the economic activity has started picking-up as indicated by the frequently released economic data. During June-Aug 2020 versus Mar-May 2020, cement dispatches have increased by 2%, automobile sales have witnessed an increase of 155%, and retail fuel sales volume have shown a robust growth of 36%. With sizeable available capacity, we believe that the private sector is well poised to benefit from the ensuing economic recovery.

Stock market: Despite recent correction mainly driven by rising noise in the domestic politics, the stock market is still up by 18% during the fiscal year to-date, and it has surged by 49% from its lows on March 25th. Going forward, we maintain our view that the stock market is well poised to deliver healthy returns over the medium to long-term. Our positive view on the market is supported by improving economic activity, attractive stock market valuations, accommodative monetary policy, and more importantly, controlled Coronavirus situation in the country. Despite recent increase, the active cases of Covid-19 in the country stand at around 8,800 compared with the peak number of 109,000. On the vaccine development front, researchers are testing 42 vaccines in clinical trials on humans worldwide, with eleven vaccines under large-scale efficacy test and five approved for early / limited use.

On the economic front, we anticipate inflation to moderate to 8% in FY21 after clocking-in at 10.7% in FY20. The central bank has also acknowledged that an accommodative monetary policy stance is vital for the emerging economic recovery. We expect the Current Account Deficit (CAD) to widen to a still manageable level of USD 4.4 billion (1.7% of the GDP). From the valuation standpoint, the stock market is valued at an attractive forward Price-to-Earnings (P/E) multiple of 7.6x, and Price-to-Book Value (P/BV) of 1x. The market also offers a healthy dividend yield of 5%.

Bottom Line: In our view, the stock market holds potential to deliver good returns over the medium to long-run driven by healthy expected corporate earnings over two to three years; an attractive 5% dividend yield; and some PE re-rating. Therefore, we advise investors with medium to long-term investment horizon to build position in equities through our NBP stock funds.