Sector analysis

As per the latest data released by the FBS, CPI inflation dropped to 10.6%YoY in Aug’09 as compared 11.1%YoY in Jul’09. This is higher than our forecast of 10.1%YoY for the month. We note that core inflation has dropped to 12.6%YoY in Aug’09 from 14%YoY in Jul’09, taking real interest rates into the positive territory. In our recent report titled “will inflation keep on trending downward?” dated 4th Sep’09 we argued that the downward inflationary phase will continue especially with regards to core inflation. This is because HRI inflation, which has a weight of 23.43% in headline CPI, will maintain its downward trajectory as a result of the sharp drop in WPI building materials over the last six months. We continue to maintain this view and expect the declining phase in “core inflationary cycle” to continue till Dec’09.

The recent increase in the slope of the yield curve supports our view that investors’ expectation regarding domestic growth outlook is improving. Why? Empirical research has shown changes in the slope of the yield curve to be a strong leading indicator for economic growth performance. This is because improvement in the economic growth trajectory raises future inflationary expectations and hence increases the premium on long term bonds. Research shows that the steeping of the yield curve is followed by an improvement in economic growth with a lag of twelve months. The higher growth expectation seems logical bearing in mind that the economy has stabilised and the fiscal stance is likely to remain expansionary on the back of higher external loan flows. For FY10, we expect real GDP growth to be around 3% as compared to 2% growth achieved in FY09.

In the PIB auction held after a gap of nearly three months and post the recent DR cut of 100bp, the cut-off yields on all tenors experienced a sharp decline. Yields on average dropped by 40bps. Despite this reduction, the primary market rates are still on average 40bps higher than the rate they are trading at in the secondary market. This in our view indicates that there is still further room for primary yields to decline in the short term. Medium to long term trajectory will depend on whether the downward inflationary trend can be maintained. In this regard, the inflationary statistics for Aug’09 (release date 9th Sep’09) will be crucial in clarifying the quantum of monetary easing in Sep’09 especially when the IMF has been raising concerns regarding potential renewal of domestic inflationary pressures due to increase in utility & fuel prices. In this report, we assess the likely changes in the term structure of interest rates based on different discount rate scenarios.

The prevailing demand slump, both domestic and international, coupled with structural and security problems has contributed towards a sub-optimal level of economic growth for Pakistan in the last two years. With the industrial sector contracting by more than 8% in FY09 and corporate sector profitability taking a hit, an adverse interest rate environment has led to progressive deterioration in banking sector asset quality. Since the start of CY08, the NPL ratio (infection ratio) has risen from 6.8% to 12.1% in 2QCY09. Nevertheless, considering that all major macroeconomic stability indicators especially inflation have more or less reached “normal” levels, the question arises as to whether the banking sector asset quality deterioration has now bottomed on the back of potential economic growth recovery in FY10. Indeed the recent easing of the monetary stance and reduction in inter-bank lending rates, should gradually spur credit demand, level of investment and in-turn economic growth.

Our view that improvement in macro and monetary environment is linked to external inflows is holding traction – Kerry Lugar bill and Tokyo pledges are the critical links in this regard.

We estimate BOP surplus of US$5.7bn, SBP FX reserves of US$15.5bn and 8.0% increase in RM in FY10E that should be sufficient for nominal GDP growth of 13%. This includes above two exceptional fundings.

We stick to our thesis of a further 200bp cut in policy rate in 2009. In the near-term, we expect market yields to soften ~50-100bp once external liquidity starts to flow in.

Recovery in exports and foreign private inflows are the key upside risks to our BoP estimate. Key downside risks include 1) energy shortages; 2) lower agriculture production; 3) commodity prices and 4) delay in foreign disbursements.

 KASB Securities and Economics Research

National accounts statistics for FY09 (Jul-Jun) reveal contraction of real domestic demand by 1% YoY; first time since FY01.

Saving-Investment Gap is down to 5.3%, but this is due to a greater decline in capital formation (down 6.5% YoY) than increase in savings – a concern.

Investment drag now demands policy stimulus in our view i.e. monetary easing and fiscal traction – hence higher GDP growth in FY10E remains imminent.

However, causality requires greater emphasis on external inflows and fiscal prudence which is likely to jolt adequate monetary policy response.

Impediments to impact of stimulus duo in our opinion are: 1) prolonged energy deficit & governance, and 2) higher commodity prices in FY10E.

On the flipside, upside is contingent on: 1) recovery in exports due to demand pickup from G3, and 2) strong inward workers remittances.

Our view of a further 200bp cut in policy rate to 11% by Dec-09 remains intact.

Inflation is the key macro data to watch in the near term where we expect August-09 YoY inflation to settle at ~10.7%.

 KASB Securities and Economics Research

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·         sharp increase in monetary aggregates in developing economies and the subsequent weakening of the US$

·         reserve restructuring and easing of restriction on local gold trade by China

·         seasonality and increased demand during the festival season in South Asia

We revise upwards PSMC’s CY09E earnings estimate to PRs5.6/sh following (1) renegotiation of CKD prices with SMC at favorable terms and (2) 1H09 results. 68% lower YoY sales, Rupee depreciation and higher fixed costs colluded to shrink 1H09 earnings by 73% YoY to PRs1.96/sh. Our view that the earnings cycle will lag sales recovery by 6-12 month is substantiated by the fact that PSMC is targeting a price sensitive audience leaving volumes as the only option to cover fixed costs. We have revised our PO for PSMC to PRs65/sh (up 30%), however, we maintain our Underperform rating on the stock. While we remain upbeat about favorable terms offered by SMC on CKD imports; we believe depressed market appetite, wafer-thin margins and Rupee depreciation will drag earnings performance in the near-term.

In theFederal Open Market Committee (FOMC) meeting [on 24^th September], the US Fed decided to maintain the policy rate at a record low of 0%-0.25% highlighting limited inflationary risk and the need to solidify recent economic gains. With interest rates locked in at record lows for the foreseeable future, the US$ has experienced renewed weakening while both global commodities and equities have retained investor interest. On the domestic front, as the State Bank of Pakistan contemplates its policy options for its next bi-monthly monetary policy, domestic equities have continued to re-rate where the KSE-100 index is up 102% from its CYTD low of 4,815. This process has basically tracked the flow of foreign portfolio investment, where foreign holding in Pakistan’s equity market has risen to PkR148bn (US$1.78bn) which is 5.3% of the market capitalization.                      …..                 ..                 ..                 .

Balance of payment (BoP) position and net foreign assets (NFA) of the banking system have shown YoY improvement in Jul-Aug 09.

Two line items stand out on detailed scrutiny ie 1) trade account and 2) financial account. The trade balance has improved due to decline in imports whereas financial account mirrors net IMF financing to the Budget.

FX reserves (central & commercial banks) also continue their upward spiral to touch US$14.5bn by mid-Sep 09 – historically beneficial for asset prices.

Our view remains that improvement in monetary and macro environment going forward is linked to FoDP pledges and Kerry-Lugar bill.

Moreover, we believe scrutiny is warranted as to what portion of reserve accumulation is fuelled by debt related flows and flows which do not add to rupee liquidity in the system.

Management of fertiliser companies have confirmed an increase in urea prices by PkR30 per bag. The latest increase in prices takes urea price to PkR730 per bag (ex-factory), boding well for fertiliser companies. Within our coverage universe, the increase will have a positive EPS impact of PkR0.47 for Engro, PkR0.47 for FFC and PkR0.095 for FFBL. Also, NFDC has released the latest fertiliser numbers for the month of Jul’09. Total urea offtake in 7MCY09 stood at 3.6mn tons compared to 3.2mn tons during the corresponding period last year – a growth of 12.8%YoY. DAP sales continued to please, clocking in at 702k tons in 7MCY09 – a growth of 262%YoY. On a MoM basis, urea and DAP depicted increases of 13.9% and 58.5%, respectively. Currently, DAP prices stand at PkR1,910 per bag after having been raised from their previous level of PkR1,860 per bag in the middle of Aug’09. We maintain our ‘Overweight’ stance on the Fertiliser sector.

Latest auto sales numbers show overall auto (cars + LCVs) sales to have posted a growth of 22%YoY (11%MoM) to 20,913 vehicles during 2MFY10 against 17,122 vehicles sold in 2MFY09. Cars recorded a YoY growth of 35% (10%MoM growth) to 17,950 vehicles sold in the review period compared with 2MFY09. That said, LCV’s posted a decline of 22%YoY to 2,963 units sold in the period under review against the same period last year. A look at the breakup reveals that car sales growth was primarily a result of a 173%YoY growth in Toyota Corolla sales during 2MFY10. However, normalising the low base effect set last year when the 9th generation Corolla was in the process of being phased out gives a static YoY car sales growth. An 11%MoM growth in overall auto sales highlights the effect of reduced prices as vehicle sales are largely dependent on consumer affordability. In this regard, sales for the 800-1000cc segment have increased by 20%MoM in Aug ’09. The reduced vehicle prices coupled with expectations of a sizable reduction in the discount rate by year end will form the basis of a gradual recovery; however, any upward change in modeled input costs will lead to revision of earning estimates. With the 800cc-1000cc engine displacement constituting the bulk of product variants, PSMC is our top pick in the local auto sector. PSMC trades at a forward P/B of 0.5x against the market P/B at 1.4x. Current price implies a Buy stance to our target price of PkR160/share.

Its déjà-vu all over as what seemed to have been a difficult year for FFBL has suddenly taken on an upward turn, a similar story to last year. While various factors contributed to FFBL’s dismal performance in 1HCY09, increase in product prices (urea and DAP) coupled with increased primary margins and a stellar offtake (DAP) are likely to push earnings in 2HCY09 significantly upward. For full year CY09, we now expect FFBL to post earnings of PkR2.8bn (EPS-PkR3.04) compared to earnings of PkR2.9bn (EPS-PkR3.10) during the corresponding period last year – a marginal decline of 2.2%YoY. Along with the result, we expect the company to pay out a total dividend of PkR2.8 per share in CY09. Post the earnings revision, we upgrade our stance to ‘Accumulate’ on FFBL with a target value of PkR23.1 per share.           .                 .

The Education Department, Government of Punjab, signed a Memorandum of Understanding (MoU) with Microsoft Pakistan under the company’s “Partners in Learning” global programme. This collaboration aims to provide schools, governments and partners with resources, training, expertise and technology blueprints that will help create institutions to better prepare students for life and work in the 21st century. Both parties will work cooperatively to participate in a four-year program from 2009 till 2013.

The program recognises the value of providing technology to schools and seeks to jointly provide access to and improve the use of information and communication technology (ICT) for the support of teaching and learning.

It was decided under the MoU that Microsoft’s and the Education Department’s associates will provide a joint report to the Government of Punjab and Microsoft every 90 days. The report will provide an assessment of the purpose, progress and impact of the Partners in Learning programme in Punjab, Pakistan.

According to the MoU, Microsoft will provide four weeks of internship to four students suggested by the Government of Punjab every year through Microsoft’s certified partners in Pakistan.

Through its unlimited potential commitment, Microsoft is working with governments, intergovernmental organisations, nongovernmental organisations and industry partners in order to meet its first major milestone by 2015, i.e. to reach the next one billion people who have not yet realised the benefits of technology.