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Karachi Stock Exchange Showcases a Booming Pakistani Equity Market

In the midst of a long overdue economic expansion, Pakistan's Equity Market offers robust returns for international investors

By Mr. Shehryar Ahmad
Vice President at BMA Capital
Oct 20, 2005

By Mr. Shehryar Ahmad Vice President at BMA Capital Oct 20, 2005 Pakistani stocks present one of the world's most attractive investment opportunities. Buoyed by sensible economic policies following years of misrule, Pakistan's real GDP grew by 8.4% in 2005, making it the best performer in the world after China.

Pakistan's stock market has also followed this strength in the underlying economy with the Karachi Stock Exchange posting some of the highest returns within the global emerging market universe over the past four years.

This is despite the fact that it is one of the world's most under-researched markets and as a result attracts minimal foreign investment. The Pakistan market is currently trading on a FY05 PE multiple of 10.1x, according to BMA estimates. This is an average of a 37% discount to the Asia Pacific region and a 71% discount to the Middle Eastern markets. Average daily market turnover YTD is over US$570m, which is more than the combined turnover of Thailand, Malaysia, Indonesia and the Philippines.

Pakistani equities are trading at attractive discounts, offering tremendous medium to long-term opportunities for Middle Eastern investors", according to Muddassar M. Malik, Chief Executive of BMA Asset Management. "One of the ways in which Gulf investors can share in the tremendous growth occurring in Pakistan is investing in Mutual Funds which in turn invest in the Pakistani Equity markets". BMA Capital is one of Pakistan's Premier Investment Banking Groups, of which BMA Asset Management is a wholly owned subsidiary. Last year Abraaj Capital, the Dubai based leading Private Equity firm of the Middle East, entered into a 50/50 Joint Venture with BMA Capital to grow the Groups businesses in Asset Management, Real Estate, and Private Equity. BMA made history recently by advising Etisalat on the acquisition of PTCL, Pakistan's State-owned Telecom Monopoly.

"Against the backdrop of rising oil prices and the resultant capital surpluses in the Middle East, Pakistan's proximity and cultural affinity with the Gulf oil producing nations has led to the nation attracting significant investments emanating from the Arab world."

The market's decline and consolidation of recent weeks, is mostly the result of technical and regulatory factors such as the phase out of "Badla" financing. As a result the KSE100 index is currently down 26% since its peak of 10,303 in March 2005. Higher interest rates have also drained some of the liquidity from the market. In the medium term, domestic mutual funds, pension funds commercial banks and leading business groups are expected to bring in strong inflows as the Securities and Exchange Commission of Pakistan and the Karachi Stock Exchange work to find a solution to the "Badla" financing issue. The total size of fresh money inflows from domestic investors could be in excess of USD 1 billion over the coming 12 months.

The KSE 100 Index has undergone a sharp re-rating since 2002. While the market is off its peak of March 2005, the KSE100 is still up 22% YTD in 2005 and remains one of the best performing equity markets in the world.

Corporate earnings are expected to grow by over 20% in for FY'06, implying an FY'06 PE multiple of 8.4x and a dividend yield of 6%.

This compares favorably to most Asian stock markets' valuations. The 10-year Pakistan Investment Bond yield at 9.4% implies a notional PE multiple of 11.1x for fixed income instruments. With earnings expected to grow 20% this year, a target PE multiple of 13x to 14x for equities would appear reasonable, implying an index level above 10,000 or 40% above current levels. Supported by high liquidity levels, earnings growth will be the major theme in any market upswing. The key sectors to be targeted by investors in the country include Energy, Banking, Telecoms, Fertilizers, Textiles and FMCG's.

Pakistan is fast becoming a case study in successful economic re-engineering in recent years. The global economic downturn has underscored Pakistan's continued success at attracting growing domestic and international investment. Though international economic growth has slowed post 9/11, Pakistan has proved itself one of the most sought after investment destinations in the world. Reforms aimed at improving governance have borne fruit. Pakistan has posted the highest growth rate in the world after China at 8.4% (GDP growth), and the international investment community is now starting to take notice.

Gen. Pervez Musharraf took over the reins of power in 1999 with a promise to reform Pakistani governance. To this end he appointed Citibank Senior Executive Shaukat Aziz initially as Finance Minister to clean up the economic mess left after years of misrule. Aziz' savvy understanding of the fiscal and economic medicine that Pakistan desperately needed paved the way for greater reforms in the government and regulatory authorities such as the Central Board of Revenue, State Bank of Pakistan, etc. For the first time in recent Pakistani history, Musharraf and Aziz's team of economic managers were able to have a stable Rupee. This caught the notice of the domestic and expatriate Pakistani investor. Coupled with this came a wave of growing worker remittances and reverse flight capital in the wake of the 9/11 attacks in the US. Unofficial money transfer channels known as "havala" were shut down and official coffers began growing as a result of the official bank transfers.

The Musharraf Government's role as frontline state in the global war on terror proved a watershed in the nation's image building. Pakistan is again perceived as a country that shares the values of the international community to fight intolerance and extremism. The resultant economic benefits have strengthened the hand of Islamabad in continuing and deepening the reformist agenda. Shaukat Aziz has been elected Prime Minister and has vowed to continue his policies of the last 6 years. Political stability, and continuity of policy, which had been painfully lacking in Pakistan was the elixir of life for the rebirth of the Pakistani economy.

Prime Minister Aziz engineered a massive private sector credit expansion (encouraging banks to issue credit cards, auto loans, home loans, etc.), which has created an economic boom with surging demand on all fronts. The stable policy environment and buoyant economic growth has resulted in a renewed focus on modernization of existing production facilities and capacity enhancements in the automotive, textile, cement, and telecommunication sectors. With over 41% growth in capital goods and raw material imports in 2005, the trade balance has admittedly tilted. However, due to strong inflows into the capital account, resulting from expatriate Pakistanis sending money home and a surge in foreign direct investment proceeds, the current account deficit remains benign at 1.2% of GDP. During 2005, Pakistan has been the recipient of over USD 1.52 billion in FDI flows, which is a telling and impressive improvement upon the average of USD 874 million over the previous two years. This is excluding the recent USD 2.6 billion FDI inflow from the privatization proceeds of Etisalat’s acquisition of 26% shares in PTCL, Pakistan's state owned telecom monopoly.

Against the backdrop of rising oil prices and the resultant capital surpluses in the Middle East, Pakistan's proximity and cultural affinity with the Gulf oil producing nations has led to the nation attracting significant investments emanating from the Arab world. Notable among these are Etisalat and Warid of the United Arab Emirates, who have both invested heavily in Pakistan's telecommunications sector. Middle Eastern investments in the energy sector include the recent acquisition of the state-owned National Refinery at a significant premium to the market price. Sheikh Al Nahyan's Abu Dhabi Group, in partnership with the Bestway Group of the UK, acquired United Bank Limited, and EMAAR Properties and DAMAC have recently invested in Pakistan's real estate sector. These are illustrative of the growing confidence of the international investment community in Pakistan. These continuing capital flows are likely to provide significant support for asset prices moving forward.

The time is ripe for the international community to build up their exposure in Pakistan's equity markets. Domestic investors have been reaping windfall profits and the continued and accelerating economic expansion promises dividends to the educated and timely investor. Gulf investors who are in tune with the regional economic scenario will surely take advantage of the opportunities emerging in Pakistan.

Source: Dinar Standard (20 Oct. 2005)