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Elixir Securities Limited – Strategy

Karachi, January 12, 2016 (PPI-OT): Pakistan Equity Market Outlook 2016: Buy Optimism, Buy Pakistan

2015 was a year marked by a dichotomy between turnaround in the country’s key macros and equities performance, primarily due to foreign selling which kept a lid on the domestic equities performance. Having said that, Pakistan equity market remained resilient relative to peers, outshining the MSCI FM by a hefty 20%.

Going forward, Elixir Securities Limited remains upbeat on Pakistan’s progressing fundamentals underpinned by 1) strengthening political landscape, 2) continuation of structural/institutional reforms, 3) massive scale-up in energy and infrastructure development projects under the ambit of CPEC, 4) better fiscal management through various tax measures and subsidy reduction, 5) stable external account position, 6) potential reclassification to the MSCI EM club 7) deflating local security risks, and 8) improved relations with the neighbouring countries, especially India.

Improving Macros to Fuel Market in 2016

Some of the key economic indicators in 2015 saw a turnaround, including i) CPI inflation touching multi-decade low at 1.3%YoY in Sep’15 followed by massive cuts in the Policy Rate by the SBP to reach at 6.0%, ii) consistent buildup in the SBP FX reserves to USD15.7bn (5+ months import cover) resulting in a relatively stable exchange rate, and iii) much improved fiscal position as seen from declining fiscal deficit to 5.0% in FY15 (GoP expects 4.3% for FY16), from a recent high of 8.5% in FY12.

Moreover, concrete development on SECMC, lending credence to swift materialization of the CPEC projects will eventually boost investment-to-GDP ratio to beyond 19% seen in FY05-FY08. In a nutshell, strong commitment towards structural reforms and resultant expansion in economic activity should set the stage for significant re-rating of market multiples, where the market currently trades at a forward PE multiple of 8.7x – at a deep discount of 23% from average 11.3x seen in earlier expansionary cycle (CY06-CY07).

MSCI Reclassification to Set Stage For Market Re-Rating:

MSCI has put Pakistan on a review list for the potential reclassification to its Emerging Market Index, which trades at a premium of 37% and 48% from MSCI FM and KSE-100, respectively. This is expected to showcase Pakistan to a much bigger pool of investors (both in terms of number and size) than those within the existing FM space, albeit with lower weight. Based on liquidity criteria, 6/7 companies are likely to make foray into the EM space where banks (HBL, MCB and UBL) will potentially hold a lion’s share followed by OGDC, FFC, ENGRO and LUCK, in Elixir Securities Limited’s view.

Steep Valuation Discount That Can’t Be Ignored:

KSE-100 trades at a stark discount of 23% to 8.7x on CY16 earnings from an average 11.3x witnessed in CY06-CY07, while the discount is more profound when compared with regional economies which are trading on a high premium despite lacklustre performance during 2015. To highlight, Pakistan trades at a discount of 32.5% from the MSCI EM. Thus, tangible improvement on macro front followed by timely execution of the projects under the CPEC should eventually draw foreign investors’ attention and thus narrow down the said discount, going forward.

Investment Strategy:

Elixir Securities Limited expects index to make a strong comeback in 2016 with Dec-16 index target of 38,500+ pts, indicating a potential capital return of 18.9%. Going forward, Elixir Securities Limited highlights infrastructure and energy projects as the key themes of 2016 and consequently have ‘overweight’ stance on Cements and Steels. Within Cement space, Elixir Securities Limited is bullish on LUCK and DGKC due to relatively low-cost structures and multiple triggers in the offing.

Within Banks, Elixir Securities Limited expects UBL and HBL to yield high alpha due to their de-risked balance sheets and diversified revenue streams. In Oil Marketing space, Elixir Securities Limited favour PSO against its peers on account of alleviating liquidity constraints and higher volumetric growth expected. Elixir Securities Limited also likes ENGRO because of cheap valuations and unparalleled growth prospects.

Elixir Securities Limited selectively likes Fertilizers with top pick being EFERT given its relative immunity to gas price hike and likelihood of additional gas flows. Although Elixir Securities Limited expects oil prices to remain volatile with upward stickiness in 2016, Elixir Securities Limited prefers stocks having relatively low sensitivity to oil prices amidst steep valuation discount like OGDC and PPL in the E and P space.

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