PAKISTAN EQUITY STRATEGY 2015

FIRST CAPITAL

EQUITIES

Strategy | Pakistan

January 2015

PAKISTAN MARKET STRATEGY

Table of contents Market - All set to achieve new target Pakistan equities yielded 27% gain in 2014

KSE vs Key Events

Dec-2015 Index target of 40K

Market catalyst in 2015

KSE: Quarterly return pattern

Shift to top-down approach

KSE - At Glance

Economy - Consolidating the recovery A glimpse into past

Gathering momentum

Key Indicators

Politics - Stable & Improving

Key Calls

Engro Corporation

Nishat Mills

DG Khan Cement

Pakistan State Oil

United Bank

Bank Alfalah

Habib Bank

Strategy| Pakistan January 2015

First Capital Equities Ltd

2

All set to achieve new target Pakistan equities yielded 27% gain in 2014

• Despite heightened political noise, Pakistan equities once again emerged as one of the best

performing market of the world by generating 27% (US$ 33%) gain in CY14 mainly on account of improving macros & increased market visibility to international investors.

• As expected, the pro-business PML(N) Govt dealt effectively with the economic challenges that

improved the macros significantly. In its economic reforms program the govt implemented tax reforms, kick start of privatization process (transactions of UBL, ABL & PPL), 3G/4G auction made successful re-entry in global bond market (Euro bond issue of US$2.0bn & Sukuk of US1.0bn) which subsequently improved forex reserves position, stabilized exchange rate, controlled government local borrowing & increased investors’ confidence.

• The macro level optimism mainly inspired more than half of the return in CY14 as heightened

political noise in the wake of dharna (sit-ins) initiation by PTI & PAT coupled with tensed Govt-military relations were largely offset by strengthening macro position.



3

Source: MSCI & FCEL Research

KSE vs MSCI EM/FM

MARKET

Key data

KSE-100 Index 33,786

52 week High/Low 33,786/25,478

Market cap (US$ bn) 77

Market cap/GDP (%) 30

1-Yr Avg. daily Vol (US$ mn) 95

Free float (%) 29

Valuation analysis 2014A 2015E

PE (x) 9.9 8.5

PBV (x) 2.1 1.8

Div Yield (%) 5.0 6.0

ROAE (%) 21 21

ROA (%) 4 4

‐5%

5%

15%

25%

35%

MSCI FM ‐ 100 MSCI FM MSCI EM KSE 100

‐4

1

6

11

16CY 14 Return YTD return PE (RHS)

Source: KSE & FCEL Research

All set to achieve new target KSE vs Key Events



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MARKET

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ar‐1

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15

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000Volumes KSE100 Index

DR drop by 50bps

Cut in DR

SBP reserves slip to 13-year low

Operatiion Zarb-e-Azb launced

PTI calls off dharna

MSCI doubles Pakistan weight to

8.4pc

FY15 budget announced IMF sucessful

review

CGT releif package

Higher earnings & single digit DR

Favourabe resolution of CGT

Positive CPI readings

Positive outcome on caretaker Govt

General ELections

Partial resolution of circular debt Moody's changes

outlook for five bank

PTI & PAT sit in started

GIDC ordinance signed by President

Improved Pak-US relations

Opening of Nato supp & CSF flows

Ramzan effect & reversal in DR

EU-GSP plus

SC's verdict; 18th ammendment

APS attack in Peshawar

All set to achieve new target Dec-2015 Index target of 40k

• We opine, the bull run at Pakistan market to extend in CY15 too with strong outlook to generate another double-digit gain in CY15.

• The Pakistani market is currently trading at PE of ~8.50x or 35% discount to the regional average whereas it appears more attractive on dividend yield basis which shows a discount of 42% to the regional average.

• The a) continuation in economic recovery, b) privatization/PSE’s sell-offs, c) nations’ unity over anti-terrorism policy leading to increased military offenses d) improved & stable political situation d) double digit earnings growth e) increased weight in MSCI Index & f) room for further cut in interest rate, exhibit a strong case for Pakistan stock market to generate another handsome return in CY15.

• A 14% EPS growth in 2015E suggests market could touch 38.5k during CY15 without any re-rating (i.e, forward PE of 8.5x).

• That said, at a target PE of 9.5x and expected dividend yield of 6%, we arrived at end-Dec 2015 KSE-Index target of 40k.

• The theme of valuation re-rating to remain intact given the notable fall in political uncertainties, rising macro, net beneficiary of oil price plunge, higher weight in MSCI index.

• In our view, the Pakistan equity market is one amongst very few markets around the world looking poised to advance on a long-term bull phase over the next several years.

• We opine that investors should keep the strategy based on growth stocks. The overall investment theme may remain focused on growth stocks, however, segments which are likely to receive benefits of declining cost should remain on top in the criteria of stock selection.



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All set to achieve new target Market catalyst in 2015

Below we have discussed key triggers for KSE in 2015:

Economy: From recovery to growth phase

• With Pakistan under an IMF Extended Fund Facility (EFF), the financial assistance from IMF has trigged much needed economic reforms while the ensuing dollar inflows have provided a cushion for the vulnerable FX reserves in terms of currency.

• The sudden fall in international oil prices further supported the recovering growth and helped in improving the balance of position of the country while providing the support to the exchange rate.

• The improving macro economic indicators and stability at the political front has significantly reduced the country’s risk profile, we believe.

• Pakistan’s qualification for the sixth tranche of IMF after meeting the quantitative performance criteria underscores the improving economic outlook.

• Going forward, progress on energy and fiscal reforms would further support the equity prices in CY15.

• These include efficient use of energy resources by cutting untargeted subsides, overcoming energy power shortages, power tariff rationalization, liberalize trade regime, privatization of public sector enterprises, withdraw tax exemptions, improving tax administration and allowing SBP to follow an independent monetary policy.

Political stability

• We anticipate 2015 to be a year of relatively improved & stable political scenario where the opposition party (PTI) calling-off its dharna (sit-in) politics & pledged not to revert to it again while



MARKET

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All set to achieve new target the security scenario (increased military offense in the wake of nation’s unity over stiff anti-terrorism policy following Army School massacre) is also likely to remain much more controlled than previously.

Privatization

• The continuation of privatization process along with the planned capital market transactions is likely

to remain the key trigger for the market during CY15. In line with its economic ideology, the PML-N government pledged to sell govt stakes in state-owned companies. Key capital market transaction to watch is HBL sell-off which is estimated to fetch US$1.2bn in 1HCY15.

Corporate earnings growth

• The corporate profitability trend is likely to remain on upward trajectory & would show further

improvement in 2015 due to better expectations from the core growth of Cements, Fertilizer, Textile & Banking sector companies. The high earnings growth on the corporate side will keep Pakistan market’s attractiveness despite 27% rise in equity prices.

Liquidity – Equities to attract more flows

• We believe that in the absence of other viable investment options, the market would keep attracting

domestic liquidity. Meanwhile, besides better domestic liquidity, the fundamental recovery would also attract foreign investment.

Pakistan’s weight in MSCI Frontier Index to rise

• In its upcoming index review, any positive outcome with respect to weight increase of KSE in MSCI FM or up-gradation to MSCI EM status, would successfully increase the visibility of Pakistan to foreign fund managers. The continuous out-performance of KSE vs its MSCI FM peers along with bearish stock performance of oil exporting countries should support in attracting off-shore fund managers’ attention & their resource allocation.



MARKET

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All set to achieve new target Shift to top-down approach

• Despite muted economic growth in recent years, Pakistan market’s return exceeded the GDP growth in real terms where it mainly tracked the earnings growth momentum. Therefore, a ‘bottom-up’ investment strategy was best suited.

• However, for CY15, the strengthening overall economic scenario in the wake of strong expectation of rising GDP growth is likely to fuel corporate earnings growth during the year. Considering this, an investment strategy of ‘top-down’ approach appears suitable.

• With resurging growth, reduction in political noise, benefits of falling oil prices, lower inflation rates, strengthening external position, stable exchange rate & easing monetary policy are the factor that is likely to lend support to the bullish spell across the board.

• In this regard, we highlight sectors (like Cements, Fertilizer, Textile & Banks) estimated to put-perform (volumes + margin gains) the GDP growth hence appear ideal to outpace overall market return.

• We expect the economic growth to support higher volumes while the lowering cost (falling fuel & inflation) is likely to magnify the impact of higher revenue on the bottom-line of the companies. It indicates a handsome increase in the profitability going forward. With profitability improvement on track, stocks are likely to perform better.



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All set to achieve new target KSE: Quarterly return pattern

• The analysis of last fifteen years data (2000-2014) reveals an interesting observation related to

Pakistan market’s performance in the opening quarter (Jan-Mar) of the calendar years.

• Barring 2001 & 2011, the market has yielded exceptionally higher returns in 1Q. Even in the periods

of ultra instability, 1Q returns have remained in the positive zone. For instance, MS Bhutto was assassinated on Dec 27, 2007.

• On average basis, the market’s 1Q return in last 15 years arrives at 15% versus 1%, 3% and 7% in 2Q,

3Q and 4Q, respectively. Whereas, in last 10 years (2005-14), 1Q average return was 13% compared to respective 2%, 3% and 3% in 2Q, 3Q and 4Q.



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KSE: Last 10‐year Avg Return

0%2%4%6%8%

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KSE - At Glance


Dec-2014 Index Target


Avg. Daily Activity


Market Capitalization (US$ bn) - Avg

Source: NCCPL & FCEL Research

Nt. monthly Foreign Port Invt. (US$ mn)

Source: KSE, SBP & FCEL Research

KSE vs Discount Rate


100-Index Annual Return

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05,00010,00015,00020,00025,00030,00035,000

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KSE100DR

‐5,000

10,00015,00020,00025,00030,00035,00040,00045,000

Jan‐12

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May

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May

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Jan‐15

May

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Sep‐15

End‐Dec CY14: 32,131

40k

Consolidating the recovery

A glimpse into past

• FY14, was marked as the first year of completion of PML-N led government. The government

overcame the stiff challenges successfully posing on both internal and external fronts during the year. Building-up of forex reserves, appreciation & stability in exchange rates, significant decline in CPI readings, successful re-entry in Global bond market & reduced number of terrorists attacks to name a few.

• During FY10-14, average GDP growth was recorded at only 3.6% - well below average of 5.4% for the

preceding 5 years.

• Alone in FY14, GDP growth increased slightly to 4.1% from 3.7% a year earlier. This mainly ensued

from heavy weight services sector that grew by 4.3%. Encouragingly, the industrial sector also depicted improved performance in the wake of pickup in manufacturing activities which grew by 5.8% during the year.

• On the demand side, the overall consumption depicted an improvement (up by 0.35% of GDP to

reach 92%) albeit at low pace as a result of fall in private consumption (down by 0.7pps to 80% of GDP) and increase in public consumption (up by 1.0pps to 12% of GDP) during the year. Contribution of net exports to GDP was maintained at minus 6% of GDP (down 0.2pps). Fixed investment weakened further to 12.4% of GDP as private investment dropped to only 8.9% of GDP.

• Average CPI dropped down to single digit from 11% in FY12 to just 8.7% on the back of improved

supply situation & declining global commodities prices.

• Surpassing the initial target of 6.5%, fiscal deficit of FY14 settled at 5.5% of GDP primarily due to

rationalizing revenue & expenditures coupled with the provincial budget surpluses.



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Key Macro Indicators

FY13A FY14 Target FY14A

Real GDP 3.7 4.4 4.1

Agriculture 2.9 3.8 2.1

Industry 1.4 4.8 5.8

Services 4.9 4.6 4.3

Consumption 4.6 6.0

Investment 1.3 0.2

CPI inflation 7.4 8.0 8.6

US$ bn

Fiscal balance (8.2) (6.3) (5.5)

Public debt 64.8 61.3 64.3

Current account balance (1.0) (1.1) (1.2)

Source: SBP

Remittances 13.9 15.1 15.8

Exports (fob) 24.8 26.6 25.2

Imports (fob) 40.2 43.3 41.8

as percent of GDP

growth in percent




ECONOMY

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Consolidating the recovery • Given the raising concerns of reversing inflationary pressure on account of high growth in monetary

aggregates & rise in power prices during 1HFY14, SBP changed its stance from accommodative to tight policy which resulted in cumulative 100bps increase in policy rate during the half.

• However, later on, due to reduced risks of inflationary pressure, the central bank adopted neutral

stance & kept the policy rate constant in the second half of FY14.

• Meanwhile, the realization of higher remittances (US$15.8bn) and lower services deficit arrested the

current account slippages and remained successful in maintaining the ratio close to 1% of GDP. That said, the CA deficit numbers of FY14 were recorded at US$3.0bn (1.2% of GDP) versus that of US$2.5bn (1.1% of GDP) - a slight increase of 10bps.

• FY14 concluded as another year of double digit growth in Foreign Direct Investment (FDI) where the

account posted an increase of 14% YoY. Improvement on domestic & external fronts remained the major factors that boosted the investors’ confidence towards Pakistan.

• On a positive note, net foreign inflows under the head of international bond issues, gift money,

privatization proceeds, receipts from multi lateral & bilateral sources along with international institutions (IMF, World Bank, ADB) rose the foreign reserves sharply to US$14.1bn from the level of US$7.9bn in Jan-14 and US$11.0bn in June-13.

• Extreme volatility was witnessed on the exchange rate front. That said, the rupee made high of

PRs109.5/US$ and low of PRs96.9/US$ during the year. This sharp depreciation in the currency was observed during the initial half of the fiscal when receipt of US$1.5bn gift from Saudi Arabia, nearly a billion dollar collection from 3G/4G licenses auction and receipt of external loans improved the situation & brought the exchange rate back to the level as it was at the start of year. The rate then resided in the stable range of PRs98-100/US$.



ECONOMY

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Gathering momentum

• In continuation of it’s briefly spelled out ‘economic revival’ program the government strived

sincerely to implement its economic agenda in order to put the economy back on track.

• Consequently, the reforms initiated by the government produced positive results and turnaround the

economic health of the country significantly.

• This is reflected from resurging foreign exchange reserves from drastic levels, appreciation &

stabilization of exchange rate in relation to dollar, handsome industrial growth on the back of improved energy supply, contained inflation to single digit, continuous increases in foreign worker remittances, stock market marking new highs, successful re-entry in global bond market & auction of 3G/4G licenses.

• Moreover, the international financial institutions like ADB & IMF also acknowledged the measures taken by PML(N) Govt. and appreciated the desired positive improvements in national economy.

• In line with the plan, government successfully launched its privatization initiative and divested its holdings in UBL, PPL (part) and ABL which raised a sum of US$689mn. The major portion of which was subscribed by international investors.

• However, the unfavorable oil market dynamics restrained GoP from conducting the SPO of its OGDC stake and the transaction was postponed. In addition, the offloading of HBL stake has been scheduled in later half of the fiscal.

• After the successful re-entry of Pakistan in global bond market, CY15 is likely to see inflows from privatization drive. In this regard, the Govt has scheduled a number of equity sell-off transactions in the 2HFY15.



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Consolidating the recovery • To maintain the improvement in external accounts, fiscal imbalances and growth, the government

would continue to receive financial support from International Monetary Fund (IMF) & other lending agencies.



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Selected Economic Indicators

1QFY14 1QFY15 FY15 Target

growth in percent

Real GDP NA 4.0 5.1

LSM 6.6 1.9 4.0

CPI 8.1 7.5 8.0

Private sector credit (0.5) 11.0 NA

Money supply (M2) 0.2 0.2 NA

US$ bn

Total liquid reserves 9.8 13.5 NA

Worker remittances 3.9 4.7 16.7

Direct investment in Pakistan 0.2 0.2 2.0

C/A balance (1.2) (1.3) (1.1)

percent of GDP

Fiscal bal. as % of GDP (1.1) (4.8) (4.9)

Source: SBP & Planning Commission

Consolidating the recovery • We believe the government would remain successful in obtaining financial aid including project &

program loans from the international lending agencies given the successful IMF reviews amid strict adherence to the targets set by the agency.

• Based on government’s estimates for external loans, grants & repayments along with the expected

current account deficit of US$2.9bn in FY15, the foreign exchange reserves of the country may touch US$17.0bn - a growth of 27%.

• This would resultantly improve the import cover level to over 3.0 months, thereby, putting the

balance-of-payment position in much comfortable zone & would keep the exchange rate stable.

• The financial assistance from IMF has trigged much needed economic reforms while the ensuing

dollar inflows have provided a cushion for the vulnerable foreign exchange reserves in terms of currency.

• We firmly believe that the economy of Pakistan has recovered strongly and would continue to show

notable improvements going forward. Pakistan’s qualification for the remaining IMF tranches & successful inflows from planned stake sell-offs and bond issues remain crucial in achieving the target full year recovery.

• The macro theme for FY15/16 is primarily based on pick-up in manufacturing activity amid reducing

power shortfalls & enduring single digit interest rates environment.

• As per general perception, the pace of economic activity during the first half of the ongoing fiscal

should have remained muted as the public demonstrations, worsening security condition, floods & legislative hurdles in implementation have halted the government’s operation which resultantly slowed down the reform process.



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• However, the scenario may have dented the confidence level but the initial estimates indicate a nominal impact of the same as strong private credit growth (Nov 2014: 9.0%), inflows from sell-offs, encouraging inflation numbers (Dec CPI: 5.8%) & falling central bank financing for fiscal operations have largely compensated for the slowed activity.

• The release of fifth & sixth tranches amounting US$1.05bn following successful Fourth & Fifth reviews of IMF further endorses that the macro benchmarks were largely met with nominal impact from the aforementioned political & natural mishaps noted.

• The recent dip in political noise in the wake of winding up of ‘dharna politics’, solidarity of all sections of the society over elimination of terrorism provide government with an opportunity to shift its focus back to the repair process.



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Projections for Major Economic Indicators

GoP Annual Target IMF Forecast SBP Forecast FCEL Estimate growth in percent

GDP 5.1 4.3 4.0 - 5.0 4.5

CPI inflation 8.0 7.9 6.5 - 7.5 6.0

Money supply (M2) NA 12.4 11.5 - 12.5 11.0

US$ bn

Worker remittances 16.7 17.3 16.5 - 17.5 17.0

Exports 27.0 25.3 25.4 - 25.9 25.0

Imports 44.2 44.2 43.9 - 44.7 45.0

Current account balance (1.1) (4.0) (1.0) - (2.0) (3.5)

percent of GDP

Fiscal balance (4.9) (4.8) (5.0) - (6.0) (5.5)

Source: SBP, IMF & FCEL Research

Consolidating the recovery • Reportedly, the Govt. has reaffirmed its commitment to achieve its program targets and has started

addressing policy shortfalls.

• Amid expected recovery in manufacturing sector’s performance and continued improvement in services sector, Pakistan economy is likely to perform better in FY15 with our growth expectations of 4.5%.

• The government’s GDP growth target for FY15 has remained quite optimistic as it expects a growth of 5.1%. Whereas, IMF has remained conservative & estimate the growth to inch up to 4.3%.

• Despite stringent measures taken & planned by the government, following restart of the reforms, the probability to achieve growth target of 5.1% set for FY15 remains low, in our opinion.

• However, if reforms remain on track (easing fiscal adjustments & structural improvements in energy sector, privatization of PSEs & improved investment climate) the growth rate may surpass 5% mark in medium-term but not in CY15.

• The contained budgetary borrowing & single digit interest rate environment would primarily keep the private credit growth on upward trajectory. Moreover, government‘s efforts to cope the power shortage in the country, would further facilitate in picking up the industrial activity.

• Therefore, the manufacturing segment is anticipated to depict decent recovery during the ongoing fiscal. The services sector, the largest contributor to the GDP, is also anticipated to retain its better performance in FY15.

• On average basis, the trade deficit has been hovering around 6.3% of GDP in past five years. During 1HFY15, trade deficit arrived at US$12.13bn or 4.7% of GDP — up 34% YoY. It is expected to show improvement in the remainder half of the fiscal and is likely to settle at 7.7% of GDP by end Jun-15.



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Consolidating the recovery • We opine this on the back of drastic fall in international oil prices that should restrict the rising

import bill while higher utilization of GSP plus status in the wake of improved power related woes would lift the exports figures.

• Additionally, the current account posted a deficit of US$2.3bn in 5MFY15, against deficit of US$2.1bn in 5MFY14 primarily on the back of higher trade deficit & partly compensated by worker remittances. The full year numbers are expected to show further weakening and would conclude the year at 1.5% level of GDP.

• Workers’ remittances in 1HFY15 increased to US$8.9bn - an increase of 15% over 1HFY14. Meanwhile, Pakistan received FDI of US$422mn in the first five months of FY15, around 19% higher flows versus US$355mn in the corresponding five months of the preceding fiscal year.

• The strong performance of capital and financial account could not be maintained in the initial half of the fiscal due to the postponement of privatization deals, Sukuk transaction & lesser multilateral disbursements.

• We expect better prospects of capital & financial accounts in upcoming quarters as substantial financial inflows are scheduled from a) remaining CSF (~US$720mn) b) International debt issue (US$1,500mn) and c) privatization (US$1.0bn) in second half of FY15 — a relatively calmed political space where PTI has called off its ongoing protest.

• While, the bulk of the IMF loan repayment has already been made (IMF exposure to Pakistan has fallen to roughly US$3.0bn), the country still has to service approx US$1.3bn scheduled for FY15.

• With the expectation of strong foreign inflows, the balance of payment position is likely to remain in comfortable zone and the future successful reviews of the IMF would pave way for the inflows from World Bank, ADB and IDB.



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Consolidating the recovery • Overall, we project the current account deficit to reside in the range of 1.25-1.50% of GDP in FY15.

Nonetheless, unforeseen lower realization of foreign financial inflows may harm the reserves position and increase pressure on the exchange rate.

• During 1HFY15, fiscal deficit was recorded at 2.4% of GDP. This improvement occurred mainly due to tax collections remained in line whereas the shortfalls were adjusted by limiting capital expenditure.

• For FY15, the government has set fiscal deficit target at 4.9% of GDP, slightly lower than the 5.5% level recorded in FY14. Meanwhile, IMF has projected the deficit at 4.5% of GDP. We do not see any risk of slippages in the target deficit set by these entities.

• The receding inflationary trend continued in the first half of FY15. That said, the average CPI reading settled at 6.1% in 1HFY15 versus the full year target of 8.0% and last year average of 8.6%.

• Besides plummeting oil prices, improved food supplies containing the prices of perishable items, limited impact of floods & significant base effect contributed favorably in bringing the CPI reading down.

• Nonetheless, the full impact of floods & political uncertainties have raised concerns regarding full year inflation figure but its impact is assessed to be nominal as the due support to the remainder CPI readings from the tumbling oil prices would appear in the second half of the fiscal.

• Despite risks of reversal in inflationary trend on account of scheduled hike in power tariffs, levying GIDC & sustainability of perishable items, sluggish global oil & commodity market coupled with improvements on fiscal imbalances reinforced the positive inflation outlook for FY15.

• Resultantly, SBP has changed its monetary stance from neutral to accommodative. This resulted in 50bps reduction in policy rate in Nov-14 (DR @ 9.50%).



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Consolidating the recovery • The strengthening expectation of lower oil prices for at least medium term and continuation of

favorable global commodity market with no threats of immediate reversal in-sight, the CPI readings are likely to show flat-falling trend in the remainder period of the current fiscal.

• That said, we expects FY15 to conclude the year at 6.0% CPI. Consequently, we may see another

50bps cut in policy rate during 2HFY15.



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Pakistan Macro Indicators FY11 FY12 FY13 FY14 FY15E

Real GDP growth (%) 3.7% 4.4% 3.6% 4.10% 4.50%

Macro Agriculture (%) 2.0% 3.5% 3.3% 2.10% 3.00%

Manufacturing (%) 4.7% 2.7% 3.5% 5.80% 4.50%

Services (%) 3.9% 5.3% 3.7% 4.30% 5.10%

Tax Revenue (PRs bn) 1,699 2,053 2,199 2,564 2,700

Fiscal Tax/GDP (%) 9.4% 9.9% 9.6% 10.10% 10.30%

Fiscal deficit (PRs bn) 1,194 1,761 1,834 1,388 1,442

Fiscal deficit as % of GDP 6.6% 8.5% 8.0% 5.50% 5.50%

Exports (US$ bn) 25.4 24.7 24.8 25.2 25.0

External

Imports (US$ bn) 35.8 40.4 40.2 41.8 45.0

Trade Bal. (US$ bn) (10.4) (15.7) (15.4) -16.6 -20.0

Trade Bal. (% GDP) -4.9% -7.0% -6.5% -6.10% -7.70%

Remittances (US$ bn) 11.2 13.2 13.9 15.8 17.0

Current account (US$ bn) 0.2 (4.7) (2.5) -3 -3.5

Current account as % of GDP 0.1% -2.1% -1.1% -1.20% -1.35%

CPI (%) 13.7% 11.0% 7.4% 8.6% 6.0%

Monetary M2 growth (%) 15.9% 14.1% 15.9% 12.5% 11.0%

Total FX Reserves - (PRs bn) 18.2 15.3 11.0 14.1 16.5

Exchange Rate (period avg.) 86 89 97 103 101

External Debt (US$ mn) 57,897 55,862 50,176 54,793 57,096

Domestic Debt (PRs bn) 6,012 7,638 9,521 10,907 10,747

Total Debt as % of GDP 61% 62% 63% 63% 63%

Debt

ECONOMY

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23

Economy: Key Indicators

Source: SBP, Ec. Survey & FCEL Research

GDP Sub-Sec Performance


Supply-side contributions to growth


GDP Composition (FY14)


Inflation (% YoY)


Fiscal deficit as % of GDP


Quantum Index on LSM (YoY % Chg)

‐6.0%‐4.0%‐2.0%0.0%2.0%4.0%6.0%8.0%

FY09 FY10 FY11 FY12 FY13 FY14 FY15E

GDP AgricultureManufacturing Services

0%

1%

2%

3%

4%

5%

6%

FY10 FY11 FY12 FY13 FY14 FY15E

Agriculture Industry

Services GDP

Services , 58%

Agri , 21%

Industry, 21%

‐0.1

‐0.05

0

0.05

0.1

0.15

Jul‐1

0

Jan‐11

Jul‐1

1

Jan‐12

Jul‐1

2

Jan‐13

Jul‐1

3

Jan‐14

Jul‐1

4

2

5

8

11

14

Jul 12

Oct 12

Jan 13

Mar‐13

Jun‐13

Sep‐13

Dec‐13

Mar‐14

Jun‐14

Sep‐14

Dec‐14

General FoodNon‐Food Core

0%

2%

4%

6%

8%

10%

FY06

FY07

FY08

FY09

FY10

FY11

FY12

FY13

FY14

FY15

E



24

Economy: Key Indicators


Exports performance (US$ bn)


Trade Deficit (US$ bn)


Current Ac. Bal (US$ bn)


Monthly Remittances (US$ mn)


External debt as % of GDP


Exchange Rate vs Foreign Reserves

‐5%0%5%

10%15%20%25%30%

FY11 FY12 FY13 FY14 FY15E

05101520253035Export (US$ bn)

Growth %

0%

2%

4%

6%

8%


0

5

10

15

20Trade Deficit as % GDP

‐30‐20‐100

102030


Inc. (Nt) Ser (Nt)Cr. Trans . (Nt) Trade BalCA. Bal

40

45

5055

60

65

FY10 FY11 FY12 FY13 FY14 FY15E

0%

10%

20%

30%

40%External debtAs % of GDP

0

5

10

15

20

25


75

80

85

90

95

100

105FX Res (LHS)PKR/US$

0500

1,0001,5002,000

Jan‐

10Ju

n‐10

Nov

‐10

Apr

‐11

Sep‐

11Fe

b‐12

Jul‐1

2Dec

‐12

May

‐13

Oct‐1

3M

ar‐1

4Aug

‐14

Stable & Improving • After the successful & historic transition of power from one democratic government to another, the

incumbent ruling set-up of PML(N) enjoyed notably stable and smother period than any other democratically elected political government of the country.

• This provided decent time to the new government to brainstorm much needed prompt measures &

strategies to counter prevailing economic and security challenges being faced by the country.

• While the new government was busy in addressing the crucial economic & security challenges, the

announcement of ‘Dharna politics’ (initiated by the country’s third largest political party, Pakistan Tehreek-e-Insaaf—PTI) changed the face of domestic political arena.

• Later on, the announcement of Pakistan Awami Tehreek’s (PAT) similar protest & rising civil-

military tension further aggravated the ground situation.

• Consequently, the situation turned chaotic & posed question marks over government’s ability to

complete its five year tenure, thereby, pushing the political temperature to new highs.

• However, recently, the unfortunate incident of Army School attack that killed 132 school children,

favorably brought all the major political parties as well as army, religious entities & other notable segments of the society together on single platform where they all expressed their condemnation & solidarity with the government in tackling the menace of terrorism.

• That said, setting all the political differences aside, PTI chief, Imran Khan, called-off his long placed

dharna (sit-in) and pledged its support to the Govt in establishing counter terrorism measures by appearing in the APC called by the Prime Minister Nawaz Shareef.

• The unfortunate army school incident happened to be a “blessing in disguise” for the ruling set-up as



POLITICS

25

Stable & Improving it closed the civil-military ties & prompted PTI to withdraw from its dharna politics. This manifest that the PML(N) government is now in much more comfortable ruling position.

• The situation provides a legitimate consensus to the government in building a national narrative on

terrorism and implementing strict security measures while helping in pursuing a combined (military and non-military) approach to counter terrorism.

• Moreover, Govt has also gained some breathing space to restart the abandoned economic reforms

programs i.e. (tax & power reforms, privatization etc), through its strategies and policies where it restrained itself from taking un-populist/strict measures during the sit-in span.

• Moreover, the unity in standing against the terrorism has also provided much need support to the

ongoing “Zarb-e-Azab” military operation where its scope has now been expanded beyond Northwaziristan region and surgical operations against terrorist in the metropolitan cities of the country have also been included in the plan.



POLITICS

26

2013 2014 % Chg

Bomb blasts 574 388 -32

Suicide Attacks 43 25 -42

Fatalities

Civilian 3,001 1,781 -41

Security forces 676 533 -21

Terrorists 1,702 3,182 87

Falling wave of terrorism

Source: SATP

Stable & Improving • In our opinion, the new comprehensive & collective counter-terrorism policy is very much likely to

help the government in restricting the menace of terrorist attacks as regional (Afghanistan meeting) & international (US & other allies) support in stepping-up security & offensive measures against terrorists has also been received in this regard. There will be a significantly improved internal security situation by the end of 2015, we believe.

• It is important to mention that the restart of PTI & PAT’s street agitation over the lingering

differences of tribunal commission is not expected to weaken governments position as the ruling set up has already gained the experience of dealing with this type of situation, secured across the board support of political parties inside parliament & successfully improved its relation with military.

• On a positive note, PTI chief Imran khan has recently pledged not to revert to its sit-in politics &

reaffirmed its support to the present government in tackling terrorism from the country. This is a huge positive for the prevailing set-up we believe.

• We envisage total political chaos as a low probability scenario at this point.

• In addition, the ECP is likely to hold Senate elections in the first week of Mar-15. We opine that the

case for PML(N) to emerge as a winner appears strong. We say this on the back of its existing strength in the Punjab and Balochistan Assemblies along with notable presence in the federal capital and KP provincial assemblies. This will provide notable strength to the government in the upper house also.

• We foresee the government enjoying imminent strength, essential for crucial parliamentary

approvals going forward.



POLITICS

27



28

Key Calls

Engro Corporation • Engro Corporation Limited offers an ideal investment exposure in the consumer segment of an

economy that hosts the world sixth largest population cluster.

• The key to ECorp’s diversification activities is its focus on such segments that are highly un-penetrated yet stable i.e. Food, Chemical, Power and Fertilizers.

• During last year, the share price of the stock has rallied exceptionally (up 39%) mainly owing to improved business performance of fertilizer segment. While the performances of other business segments remained decent during the year.

• The continuation of feed gas supply (diverted from Guddu thermal plant) to its old plant enabled EFERT to register 24% (9MCY14 YoY) higher production volume as well as speculation of charging discounted gas price on its Enven plant remained prime triggers of such notable price run-up.

• We expect the performance of fertilizer segment to remain upbeat in CY15 also, assuming both plants operational & charging concessionary gas price for 10 months period, the production volume is likely to depict 10% YoY growth while profitability to grow 38% YoY.

• In the wake of improved cashflows (also complemented by lower finance costs due to restructuring and falling interest rates) the segment is all set to commence its dividend payout from this year.

• Efoods business is also expected to depict handsome earnings recovery in CY15. The profitability growth of 236% is primarily estimated on the back of notable margins & volumes gains during the year. That said, the resolution of distribution network issues would help in achieving higher sales while higher domestic milk prices coupled with falling prices of international milk powder (down over 40%) would provide boost to the margins of EFERT at gross levels.

• Strong growth in EFERT & EFOOD’s earnings and persistent & compelling financial performance by other subsidiaries, 2015 is likely to be another year of strong earnings growth for Engro Corporation with its bottom-ling depicting 167% growth at PRs16.76bn (EPS PRs32.1) as against PRs6.29bn (EPS PRs12.01) in 2014E.

• With fair value based on SOTP at PRs300/share, we consider Engro amongst the best investment opportunities available in Pakistan Market.



29

Key data

Stock Price (PRs) 258.13

Target price (PRs) 300.10

Upside 16%

Bloomberg Code

52 week High/Low (PRs) 258/157

Market cap (US$ mn) 1,326

1-Yr Avg. daily vol (US$ mn) 7.19

Free float (%) 44

ENGRO PA

Valuation analysis 2014E 2015F

EV/Sales (x) 1.2 1.0

EV/EBITDA (x) 7.3 4.9

P/Bv (x) 2.5 2.0

ROE (%) 12 25

ROA (%) 8 13

PE (x) 21.5 8.1

40%

60%

80%

100%

120%

140%

Jan‐14

Feb‐14

Mar‐14

Apr‐14

May‐14

Jun‐14

Jul‐1

4

Aug‐14

Sep‐14

Oct‐14

Nov

‐14

Dec

‐14

Jan‐15

ENGROKSE

Nishat Mills • Nishat Mills, flagship textile arm of Nishat group, one of the largest industrial groups in Pakistan,

remains our preferred pick in domestic textile space.

• Given its strong presence in European market, the company is identified as the major beneficiary of the Generalized System of Preferences Plus (GSP-plus) status awarded by the European Union.

• The fruits of GSP Plus status have now finally begin to appear as witnessed from the recent export numbers of the country where the value added textile segment have registered 10% YoY growth in the first five months of current fiscal.

• The implementation of GSP plus scheme & the economic recovery in EU region is anticipated to boost the NML’s sales performance going forward. The said measure will also enhance the attractiveness of the company’s products in the EU region (EU share is 33% in total exports revenue during FY14).

• Significant boost to margins are also anticipated as the bumper cotton crop, in nearly all cotton producing countries, have resulted in lower cotton prices (down 26% to PRs4,900/maund from last year avg). Moreover, the record fall in FO prices & cut in domestic power tariffs further adds charm to the margin story.

• That said, we expect the margins of NML to show 210bps & 390bps improvement in FY15 and FY16, respectively from prevailing levels of 14% (FY14).

• Envisaging this GSP plus opportunity, the company has invested heavily in capacity enhancements program by installing additional looms and replacing few old ones (to increase efficiency).

• The expansion program of NML appears to continue as it further plans to add a new spinning unit (28,800 spindles) in 2015. In addition, the garments facility to produce approx 4.8mn garment pieces p.a, is also planned to come online in 2HFY15.

• We anticipate underlying profit of the company to depict 4% increase at PRs5.7bn (EPS PRs16.3) during the prevailing fiscal. The earnings growth momentum is expected to continue with 3-year EPS CAGR of 13%.

• NML holds a healthy investment portfolio with exposure in banking, power and cement sector of Pakistan. The market worth of NML investment portfolio has reached to PRs58bn or PRs164/share.



30

Key data



Upside 12%

Bloomberg Code NML PA


Market cap (US$ mn) 462


Free float (%) 50

Valuation analysis 2014A 2015F


PE (x) 8.4 8.1

Div Yield (%) 3.2 3.7

ROE (%) 9 8

ROA (%) 6 5

PBv (x) 0.7 0.7

40%

60%

80%

100%

120%

140%

Jan‐14

Mar‐14

May‐14

Jul‐1

4

Sep‐14

Nov

‐14

Jan‐15

NMLKSE

DG Khan Cement • DGKC is the third largest cement producer in Pakistan with production capacity of approx. 4.2mn

tons per annum.

• Apart from its cement business, DGKC has also invested a notable sum in the formation of a investment portfolio with exposure in banking, textile and insurance sector.

• The reducing cost pressure (falling international coal prices, cut in power tariffs & declining interest rates) has improved the margins & earnings prospects of the company notably. The impact of the same is likely to appear from 2HFY15.

• The theme of domestic demand revival, strong margins amid sustainable pricing and easing cost pressures would help DG Khan to post substantial improvement in the profitability.

• We expect DGKC to register local volumetric growth of 5% during FY15-17F. Despite subdued performance of export market, we expect the rising local sales to lift the capacity utilization of the company from 94% in FY14 to 104% in FY17F.

• Strong cash flow generation has facilitated DGKC in strengthening its balance sheet in recent times That said, LTD reduced to PRs1.2bn from PRs9.4bn in last 2-3 years.

• Following debt retirement, DGKC decided to invest its residual-cash in cost reducing measures. That said, the company has announced to install a coal-fired power plant at its existing site to reduce its reliance on expensive power (i.e. from National Grid, FO & Gas) while ensuring uninterrupted power supply. Our back of the envelop calculations suggest an annual savings of PRs500mn to the company from this project.

• The market worth of DGKC investment portfolio has reached to PRs37bn. This translates into per share worth of PRs84/share for the company.

• Our target price of PRs133 is based on a sum-of-the-parts (SOTP) valuation methodology. This includes PRs72/share for cement operations and PRs61/share for portfolio value.

• The scrip is currently trading at FY15 PE, EV/EBITDA and EV/ton of 7.9x, 4.8x and US$116/ton.



31

Key data



Upside 12%

Bloomberg Code DGKC PA

52 week High/Low (PRs) 119.2/72



Free float (%) 55



PE (x) 8.7 8.1

Div Yield (%) 2.6 3.4

ROE (%) 10 10

ROA (%) 8 8

PBv (x) 0.8 0.8

40%

60%

80%

100%

120%

140%

Jan‐14

Feb‐14

Mar‐14

Apr‐14

May‐14

Jun‐14

Jul‐14

Aug

‐14

Sep‐14

Oct‐14

Nov‐14

Dec‐14

Jan‐15

DGKCKSE

Pakistan State Oil • PSO ranks as the leading oil marketing company (OMC) in Pakistan. With its largest pan-country

distribution network of 3,700 outlets, the company handles nearly 62% of country’s total petroleum demand & is well positioned to reap the benefits of rising POL demand.

• The investment case of PSO has strengthened recently in the wake of likely improvement in liquidity overhang, improved demand prospects of POL products, higher margins & investment in LNG import business.

• Recent fall in international oil prices has resultantly reduced the power generation cost thereby narrowing the tariff-cost differential of the sector. As the widening gap of power tariff & cost were the main cause of receivable build-up for PSO the emerging scenario is expected to ease the liquidity situation of the company notably.

• In addition, the reduction in domestic POL prices has also faded the charm of domestic CNG consumption thereby brightening the demand prospects of white oil sales. We expect the sales of white oil to revive amid further shrinkage in CNG-POL price gap. The increase in higher margin (fixed in rupee term & unaffected from falling oil prices) white oil sales is likely to increase its contribution in overall earnings going forward.

• The halted power sector reforms are likely to resume shortly with the easing political temperature following winding up of sit-in by PTI. This has provided an opportunity to the government to once again focus on its power reforms program (privatization of DISCOS & reducing line loses) as committed with IMF. The reforms are likely to address the receivable accretion issue of the sector in general and PSO in particular.

• The new business venture of LNG import business is likely to support the earnings growth of the company while enabling it to reduce its exposure from circular debt.

• Furthermore, debt burdened PSO is likely to benefit from the probable cut in interest rates.

• At current price, PSO is trading at PE 6.45x on FY15 estimates. This reflects significant discount of over 30% from market, peers & its historical levels. The wide gap provides a decent space for multiple re-rating and the gradual resolution of interoperate debt would build the case for price run-up.



32

Key data



Upside 15%

Bloomberg Code PSO PA




Free float (%) 46



PE (x) 4.3 6.4

Div Yield (%) 2.3 2.7

ROE (%) 28 17

ROA (%) 6 4

PBv (x) 1.3 1.1

40%

60%

80%

100%

120%

140%

Jan‐14

Feb‐14

Mar‐14

Apr‐14

May‐14

Jun‐14

Jul‐14

Aug

‐14

Sep‐14

Oct‐14

Nov‐14

Dec‐14

Jan‐15

PSOKSE

United Bank Limited • UBL – with assets valued at PRs1,000bn or US$10bn – is Pakistan’s third largest bank with a market

share of 10% in total banking advances, deposits and assets.

• While overall banking spreads are expected to remain under pressure, UBL’s NIMs profile is likely to depict a stable-to-rising trend due to its heavy accumulation of PIBs, rising share of zero-cost deposits and growing credit off-take. That said, UBL's NIMs are projected to inched up to 5.2% in CY15 from 4.8% in CY13 and would reach 5.3% in CY17.

• The bank’s strategy to reduce funding cost has been the cornerstone of its liability management. Liability mix has been greatly skewed towards cheaper deposit franchise which consoles the impact of yield risk. Increase in CASA franchise worked well for UBL as its Cost of Deposits dropped to 3.9% in 1HCY14 from that of 4.2% in 2008.

• On a consolidated basis, international deposits and advances make up 28% and 33% of the bank’s total deposits and advances, respectively. UBL’s international operations are highly concentrated in the Middle East market – with UAE, Qatar, Bahrain and Yemen making up 53%, 9%, 8% and 6% respectively of international net advances (cumulative 76%). This means 27% (or US$1.2bn) of total lending by UBL is in the ME region.

• UBL, being more aggressive bank in building up its position in PIBs in 1HCY14, is likely to witness NIMs expansion (45bps) despite cut in discount rate. We expect the bank to raise its holding to 55% level in PIBs by Dec-14 versus that of 24% on end-Dec 2013.

• UBL asset quality significantly improved in 2013, where NPLs fell by PRs4.7bn (or 8% YoY), coverage improved to 84% from 76% a year earlier. As a result of this, NPL provisioning has declined massively in 2013, and is likely to show continuous improvement in next couple of years (NPL ratio to drop by 2pps in CY15).

• At current trading levels, UBL provides a decent 31% upside potential to our fair value of PRs230/share. We recommend a ‘BUY’.



33

Key data



Upside 28%

Bloomberg Code




Free float (%) 40

UBL PA


ADR (%) 46 47

Dividend Yield (%) 6.0 6.5

PE (x) 10.9 9.1

P/Bv (x) 2.2 2.0

ROE (%) 21 22

ROA (%) 2.0 2.2

40%

60%80%

100%120%

140%

Jan‐14

Feb‐14

Mar‐14

Apr‐14

May‐14

Jun‐14

Jul‐14

Aug

‐14

Sep‐14

Oct‐14

Nov‐14

Dec‐14

Jan‐15

UBLKSE

Bank Alfalah Limited • Bank Alfalah Limited (BAFL) – with assets valued at PRs700bn or US$7bn – is Pakistan’s sixth largest

bank with a market share of 6% each in advances and deposits of the total banking system.

• With earnings CAGR of 25% (2014-16E), probable improvement in CAR ratio in the aftermath of IFC equity injection and strong return profile (ROE 20% and ROA 1% in 2015E) make BAFL a strong banking candidate among its domestic peers.

• BAFL’s Islamic deposits, second largest in total Islamic deposits, is likely to play an instrumental role in revenue generation and bottom-line augmentation in the years to come. As such, no other top banks of local industry carry this diversification in particular.

• Despite lukewarm spreads environment, BAFL is expected to depict stable-to-rising NIMs profile. We say this on the back of rising ratio of PIBs in investment mix, increasing share of zero-cost deposits and decent growth in credit off-take.

• Other distinguishing factors of BAFL are its aggressive strategy towards branch expansion & cheaper deposit franchise that guards its balance sheet from the impact of yield risk.

• Recently, IFC has shown its interest to inject equity in the bank to the tune of 15% of capital. The successful equity injection from IFC would resultantly push CAR back to above 12% mark. Simultaneously, this equity injection would also facilitate BAFL to continue its strategy of branch expansion while enabling it to maintain its payout policy.

• BAFL, being more aggressive bank in building up its position in PIBs during 1HCY14, is likely to witness NIMs expansion despite policy rate cuts. We expect the bank’s government paper position in PIBs to touch 65% by Dec-14 versus that of 16% on end-Dec 2013.

• At current trading levels, BAFL provides a decent 12% upside potential to our fair value of PRs38/share. We recommend a ‘BUY’.



34

Key data



Upside 13%

Bloomberg Code




Free float (%) 43

BAFL PA


ADR (%) 50 50


PE (x) 7.5 5.8

P/Bv (x) 1.2 1.1

ROE (%) 17 20

ROA (%) 0.9 1.0

40%

60%

80%

100%

120%

140%

Jan‐14

Feb‐14

Mar‐14

Apr‐14

May‐14

Jun‐14

Jul‐1

4

Aug‐14

Sep‐14

Oct‐14

Nov

‐14

Dec

‐14

Jan‐15

BAFLKSE

Habib Bank Limited • HBL – with assets valued at PRs1,600bn or US$16bn – is Pakistan’s largest bank with a market share

of 13% and 17% in total banking advances and deposits.

• HBL offers an attractive investment opportunity given its robust earnings growth with CAGR (2014-16E) of 18% and healthy return profile (ROE of 20% and ROA of 2%) while trading at CY15E PBv of 1.9x and PE of 10.1x.

• Following smart banking strategy, HBL has also hedged itself from prevailing shrinking spreads by increasing its exposure in high yield PIBs (offering 2.5-3.0pps higher yields than 6M T-bills). Resultantly, the bank’s NIMs are likely to remain flat at 4.5% in CY14 & are estimated to register 30bps improvement in next three years.

• Moreover, growing focus towards zero-cost deposits (3-year CAGR of 11%) and growing credit off-take (3-year CAGR of 10%) are anticipated to contribute duly in profits augmentation.

• The emerging recovery in European economy is now likely to address the concerns of HBL’s overseas operations in Europe (7% of total assets) which lately witnessed some lackluster performance in the wake of European crisis.

• CASA deposits increased 2.6x from PRs397bn in 2008 to PRs1,055bn as of Sep-14. Consequently, its share has improved from 70% to 78% in the said period. The strategy also resulted favorably in reducing Cost of Deposits (COD) of the bank that dropped to 4.9% in Sep-14 from that of 5.0% in 2009.

• The bank’s continued focus to enhance Non-Funded Income (Avg 12% growth during CY09-13) has raised its contribution from 18% to 22% in recent times. We expect this ratio to reach 25% in CY17.

• Capital adequacy ratio of HBL improved to 15.4% in Dec-13 (tier-1 capital of 13.1%), despite a 15%YoY increase in Risk Weighted Assets. This means the bank can adopt aggressive lending and branch expansion strategies.

• At current trading levels, HBL provides a decent 16% upside potential to our fair value of PRs252/share. We recommend a ‘BUY’.



35

Key data



Upside 16%

Bloomberg Code




Free float (%) 10

HBL PA


ADR (%) 39 39


PE (x) 10.9 10.1

P/Bv (x) 2.1 1.9

ROE (%) 21 20

ROA (%) 1.7 1.7

40%

60%

80%

100%

120%

140%

Jan‐14

Feb‐14

Mar‐14

Apr‐14

May‐14

Jun‐14

Jul‐1

4

Aug‐14

Sep‐14

Oct‐14

Nov

‐14

Dec

‐14

Jan‐15

HBLKSE

Analyst Certification

All of the views expressed in this document accurately reflect the personal views of the responsible analyst(s) about any and all of the subject secu-rities or issuers. No part of the compensation of the responsible analyst(s) named herein is, or will be, directly or indirectly, related to the specific recommendations or views expressed by the responsible analyst(s) in this report.

Disclaimer

This information and opinion contained in this report have been complied by our research department from sources believed by it to be reliable and in good faith, but no representation or warranty, express or implied, is made as to their accuracy, completeness or correctness. All opinions and esti-mates contained in the document constitute the department’s judgment as of the date of this document and are subject to change without notice and are provided in good faith but without legal responsibility.

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Pakistan Contact Information

Mian Ehsan-ul-Huq (CEO) [email protected]

Pakistan Research Team

Faraz Farooq [email protected]

Muhammad Rehan Khan [email protected]

Kashif Imran [email protected]

Faizan Sarmad [email protected]

Hayat Khan [email protected]

Pakistan Sales Team

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Hamid Siddiqui (Sales Head) [email protected]

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Farhana Saba [email protected]

North American Sales Contact

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PAKISTAN EQUITY STRATEGY 2015

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