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Fiscal Policy at a Cross Road!
Priced on June 01, 2012 KSE-100 Index 13,876.97 FYTD Chg. 11.1% KSE Market Cap PkR3,552bn (US$37,787mn) FYTD KSE-100 High/Low 14,617.97 / 10,842.26 FYTD Avg. Daily Traded Value PkR4,054.91mn (US$45.323mn) KSE-30 Index / KMI-30 Index 12,056.44 / 24,202.81 FYTD Chg. 4.1% / 15.6% As % of Total Cap. 18% / 13% AKD Universe 75% of KSE-100 Market Cap.
June 2012
A landmark 5th Federal Budget by the incumbent Government is thematically designed for election year politics focusing on providing broader relief while leaving structural issues unanswered. This could potentially pose risk 6-12 months down where mitigation includes Pakistan's return to the fold of the IMF and sharp pull back in international hard and soft commodity prices. While budgeted measures include further streamlining within the current collection ambit, additional steps need to be taken in terms of revenue enhancing measures. For projections to be realistic, power sector reforms remain critical and require refocusing on rationalizing power sector tariffs and leakages from public sector enterprises at a brisk clip representing the core of fiscal imbalances. From the market's vantage, inclusion of Capital Gain Tax reforms in the Finance Bill 2012 and broader sector wide neutral to benign impacts should provide for post budget upside. We retain our Dec'12 end Index target of 16,000 but sustainable gains would require balancing of inflationary pressures (continued . recourse to SBP financing) and risk mitigation on Pakistan's external account. Economy Outlook: While the fiscal deficit in FY12 remained high at 7.4% of GDP (inclusive of 1.9% of GDP debt consolidation) and real GDP growth logged in at 3.7%YoY vs. the target of 4.2%YoY, positives included below target inflation of 11%, tax revenue collection (up 22%YoY) and buoyance in remittances. In our view Pakistan has and still needs structural and fiscal reforms that address external and chronic fiscal imbalances. With election year politics striking, a balance between growth objectives and fiscal consolidation appears challenging. We expect fiscal deficit to exceed 6% of GDP in FY13 vs. FY13B estimate of 4.7% of GDP with risks of continuing monetization of subsidies and uncertain outlook for external financing. On the revenue side the GoP's main focus for tax revenue enhancement is through improved tax administration and compliance while current expenditures remain entrenched. Market Implications: Inclusion of CGT reforms introduced via Presidential Ordinance and included in the Finance Bill 2012 will likely provide for renewed upside ahead of vetting by the Parliament. Sector impacts are largely neutral to benign in our view. Market implications include imposition of 0.01% CVT on purchase value of shares introduced through the Finance (Amendment) Ordinance 2012 and entrusting NCCPL to collect advance tax from members in respect of margin financing. Imposition of CGT on immovable property and increase in tax rate for banks investments in money market and income funds can potentially provide for increasing stock market investments. Sector Impacts: Budget contains positives for cements in the shape of lower FED and incentivizes the use of alternative lower cost energy while for autos reduction in custom duties is a positive. Upstream exploration receives the benefit of one-time tax charge @40% against inconsistency between PCA's and Statute. For Banks, a minor negative in terms of higher taxation on dividends from income and money market funds but considering expectations of harsher treatment, we believe the sector could post a relief rally. Insurance receives benefit of revision in CGT rates while life insurance premiums for tax credit have been enhanced. Chemicals face negative implications on enhancement of Gas Infrastructure Development Cess ahead of temporary weakening in pricing . power.
0 10,500 Jun-11 Aug-11 Dec-11 Mar-12 May-12 Volume (LHS) KSE-100 Index
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June 2012
Contents
The KSE outperforms in lower Global Risk Tolerance! ........................................................................04 Self-centered Pakistan .........................................................................................................................06 Corporate Earnings are topping estimates...........................................................................................06 Budgetary Implications .........................................................................................................................07 Budget Implications on Sectors ......................................................................................................08-09
Economy Election Year Budget............................................................................................................................10 RISKS...................................................................................................................................................10 Budget Snapshot ..................................................................................................................................11 EXPENDITURE....................................................................................................................................12 REVENUE: FBR trying to achieve double digit Tax to GDP.................................................................13 Non Tax Revenue Measures ................................................................................................................14 Deficit & Financing: Elusive fiscal deficit target of 4.7% of GDP.........................................................14 Total external financing ........................................................................................................................16 Medium Term budgetary Targets..........................................................................................................16
Sector Implications Cements ...............................................................................................................................................17 Banks ...................................................................................................................................................17 Oil & Gas ..............................................................................................................................................18 Autos ....................................................................................................................................................18 Insurance..............................................................................................................................................19 Fixed Line Telecom ..............................................................................................................................19 Fertilizer................................................................................................................................................20 Textiles .................................................................................................................................................20 Chemicals.............................................................................................................................................20 Annexure - Salient features of the FY13 Budget ............................................................................21-22
02
15,000 14,500 14,000 13,500 13,000 12,500 12,000 11,500 11,000 10,500
Additional revenue measures PML-N parts announced after IMF ways with PPP in Punjab talks Raymond Davis issue affects PakUS ties Securities Lending and Borrowing Product launched
President Zardari signs the Stock Exchange Demutualization Act, 2012 Presidential Ordinance on CGT released
US says Pakistan MQM parts not doing ways from enough to coalition MENA combat crisis militancy escalates US forces kill Osama Bin Laden in Abbottabad MTS launched Punjab Governor assassinated
Global recession concerns + US pressure on Pakistan Selloff inline with global equities
Gop agrees to SECP demands for relaxation in CGT Regime NATO attacks and memo scandle US freezes US$700mn aid to Pakistan
The US Congress proposes stopping preferential trade with Pakistan and reducing aid to just 10% of available funds
SECP Chairman announces the delay in implementation of new CGT regime due to legal formalities.
FY12 Budget announced Moodys gives assurance on Pakistans sovereign debt DR reduced by 50bps
CPI Deteriora tumbles ting law & due to order in rebasing Khi
US freezes CSF Consensus made on which rule should be amended to dilute the impact of CGT on share transaction
Pakistan makes US$417mn repayment to IMF. Newsflow indicates the Privatization Commission will shortly table the secondary offering details for PPL.
10,000 Jan-11
Mar-11
May-11
Aug-11
Oct-11
Dec-11
Mar-12
May-12
03
Relative Performance
4.25 3.75 3.25 180% 160% 140% 120% 100% 80% 60% 40% 20% 0% -20% -40% Dec-09 Mar-10 Jul-10 May-12 Jan-09 Aug-09 Nov-10 Feb-11 Jan-12 Apr-09 Jun-11 Oct-11 MXEF Index MXWO Index KSE100 Index
40.0 30.0 20.0 10.0 VIX Index (LHS) US 10 Yr. Treasury (minus) Fed Rate Sep-09 May-09 May-10 Sep-10 May-12
2.75 2.25 1.75 1.25 0.75 0.25 May-11 Sep-11 Jan-09 Jan-10 Jan-12 Jan-11
2,000 1,500 1,000 500 Dec-09 Mar-08 Jul-10 May-09 Aug-07 Sep-11 Feb-11 Oct-08 Apr-12
During periods of low risk tolerance, VIX (a measure of implied volatility - fear gauge) increases while the spread between benchmark 10yr U.S. Treasury and Federal Funds rate contracts. Two rounds of asset purchases by the U.S. Federal Reserve led to declining levels in VIX and increasing U.S. Treasury yields which underscored a broader rally in risk assets. During 1QCY12, decline in risk aversion was underpinned by the U.S. Economy moving past trough with manufacturing at the heart of the recovery while housing showed signs of stabilizing within the backdrop of the U.S. Federal Reserve extending the maturity profile of its securities portfolio (see chart on the right for US$400bn in maturity extensions) in efforts to lower longer term interest rates. European Governments negotiated a second bailout for Greece while Asian economies moved to unconventional monetary stimulus with balance sheet expansion by the BoJ (Bank of Japan) while the PBOC (Peoples Bank of China) moved to ease lender reserve requirements. However, recent shift in the European political landscape with risks to scale-back in austerity measures and fallout contagion have lowered global risk tolerance - 10yr U.S. Treasury yields have declined to record lows with the Feds maturity extension program coined "Operation Twist" scheduled to expire in Jun'12. Pakistan Market's returns since 2009, in periods of risk-off investment on average
04
show 7% outperformance vs. the MSCI EM and MSCI World Indices. In our view, this vindicates Pakistan's low correlation in broader global sell-offs. Markets will likely look to the FOMC meeting scheduled for later this month for cues on the Federal Reserve's response where balance sheet expansion will likely be weighed for political support ahead of U.S. Presidential Elections as well as anchoring inflationary expectations while maturity extension programs will likely be limited with capacity at the shorter end of the yield curve.
KSE Correlation
100% 80% 60% 40% 20% 0% -20% -40% 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 MXEF Index Linear (MXEF Index)
(0.60)
2011 2012
-60%
MSCIEM-SPGS MSCIWO-SPGS
MSCIEM-TRJ MSCIWO-TRJ
Pakistan's historically volatile yet relatively low correlation underscores corporate earnings drivers in confluence with domestic demand as well as oft volatile political landscape and external account stress
Taking monthly returns since 1991 over an annual time series, Pakistan's correlation to MSCI EM and MSCI World has gradually increased off a low base but at 0.4 (linear trend) it remains weak enough, in our view, to retain outperformance potential even within the backdrop of a global sell-off in risk assets. Pakistan has posted volatile correlation over our time series, in contrast to a sustained correlation between MSCI World and MSCI EM at 0.78 on monthly returns since 1991. Pakistan's historically volatile yet relatively low correlation underscores corporate earnings drivers in confluence with domestic demand as well as oft volatile political landscape and external account stress. Despite these negatives, Pakistan has posted the 7th best US$ adjusted return over the last decade!
While we have highlighted Pakistan's low correlation, we remain cognizant of Pakistan's exposure to global commodity prices where 55% of KSE-100 market capitalization is commodity based. Taking monthly returns over an annual time series between MSCI World
05
and MSCI EM, correlations to commodity indices (S&P GSCI and TRJ-CRB) show returns in increasing lockstep with correlation on average logging in at 0.8 since 2009, undermining traditional asset class discrimination in our view. Downside risks to commodity prices will likely have implications for the commodity-based market cap at the KSE. A sharp pull back in commodities poses downside risks for Oils, Fertilizers and Textiles - cotton is already at multi-year lows (barring composites). Within this backdrop, while we retain selective conviction within the commodity-backed market cap, we flag Commercial Banks as potential outperformers over FY13 (see our section on commercial banks). Self-centered Pakistan: Recent Capital Gain Tax Reforms announced via Presidential Order and now included in the Finance Bill 2012 will likely serve to extend the Pakistan market disconnect. Tracing back to the Finance Minister's announcement of the same in Jan12, daily market volumes have risen to an average of 245mn shares while traded value has improved to US$66mn - levels last seen in CY09. FII participation has held up with an inflow of US$90.7mn within the same time frame (since Jan 2112) while individual and market maker asset classes have returned (inflow of US$53.6mn) improving liquidity, and consequently the KSE has seen a re-rating of valuations and a compression in the discount to regional peer group.
Corporate Earnings are topping estimates: With the recent Capital Gain Tax Reform shoring up market liquidity, price discovery has tracked a stellar trend in corporate earnings, which are consistently topping consensus estimates. Over the last 4 sequential quarters, earnings have topped ours as well as consensus estimates by 1%-6%. Following a 7% bottomline expansion in 2QFY12, earnings growth for 3QFY12 clocked in flat (dragged lower by Fertilizer Sector earnings) but beat ours as well as consensus expectations by 5%. Oil and Gas and autos topped forecast by 33% and 10%, respectively, while banks remained in-line with a marginal 3% deviation. Going forward for 4QFY12, we expect coverage cluster earnings to decline by 4% led by oil and gas (lower oil prices) and commercial banks (impact of revision in floor rate of savings deposits) whereas cements and fertilizers will likely outperform on improving fundamentals and a lower base effect. That said, over the next 12 months, we retain conviction with commercial banks and flag the sector an outperformer where the sector trades at below floor level valuations despite marked improvement in asset quality metrics, expected uptick in lending yields and continuing focus on risk free investments.
06
Over the last 4 sequential quarters, earnings have topped ours as well as consensus estimates by 1%-6%
30% 20% 10% 0% -10% -20% -30% 1QCY10 YoY Growth 2QCY10 3QCY10 4QCY10 1QCY11 Deviation from AKD Est. QoQ Growth 1QCY12 2QCY11 3QCY11 4QCY11
-20% -40%
Sustainable gains will require balancing of inflationary pressures and risk mitigation on Pakistan's external account (increase in NFA)
Budgetary Implications: Recent budgetary measures in line with election year politics should provide the market reason to rejoice where sector related developments have panned out Neutral to benign in our view, contrary to negative expectations. Expansionary/populist nature of the Federal Budget 2012-13 and resultant growth in reserve money led by NDA expansion should provide for market upside to our end-Dec'12 Index target of 16,000 but sustainable gains will require balancing of inflationary pressures and risk mitigation on Pakistan's external account (increase in NFA) which includes an inevitable return to an IMF program. Budgetary measures include a repeat of prior year targeted foreign flows and remain ambitious where our Economist Anum Dhedhi estimates a 28%YoY rise in NDA in the event of non-materialization of foreign inflows which could provide upside risks to inflation.
07
Budget Implications
CGT reforms introduced through Presidential Ordinance has been made part of Finance Bill 2012. CVT imposed at 0.01% of purchases value is a slight negative in overall positives. NCCPL to collect 10%WHT on margin financing
Market
Positive
Positive
The overall theme for cements in Budget FY13 remains positive with i) a PkR100 per ton cut in FED, ii) reduction of duty on rubber scrap / shredded tyres to 10% (previous: 20%) and iii) increased PSDP allocation at PkR873bn. A move to normal tax regime (NTR) from current final tax regime (FTR) for exports is also provided for, should companies decide to avail it. Custom Duty on imported CKD kits is reduced to 30% from 35%. Advance tax on 1300cc to 1600cc cars is increased to PkR25,000 from previously PkR16,875, no change for below 1300cc cars. The prevailing fear of reducing duties on CBUs is no longer present which is positve for the local auto sector Exploration and Production companies have been given a one-time option to pay tax @40% against profits and gas net of royalty for tax year 2012 onwards subject to withdrawal of pending appeals etc and outstanding tax liability up to tax year 2012. Royalty targets remain flat relative to revised estimates at PkR58bn while dividends from oil and gas are expected to increase by 10% with notable change from PPL
Positives aplenty for the Construction & Materials sector, however, FED reduction has been a tad bit on the lower side than initial market expectations. The move to NTR from FTR is unlikely given that exporters will likely lose out through incurring higher taxes should they avail it
Cements
Neutral to Positive
Budget impact on the Auto sector is Neutral to Positive as there is no reduction on the duties of CBUs. The advance tax change will not impact the local auto industry where custom duty reduction will likely pressurize to decrease the prices of locally assembled cars
Autos
Positive
We view budget implications as positive for oil and gas companies. One-off change in tax regime to clear pending disputes in relation to inconsistency between Mining Act 1948 and respective PCAs @40% tax bodes well for pending litigation and outstanding tax liabilities. Increase in expected dividends from PPL is a positive while flat royalty collection targets indicate production additions to offset declining assets
FMCGs
Positive
100% tax credit for fully equity financed dairy farming projects. Sharp reduction in GST on tea from 16% to 5%
GoP trying to incentivize the high potential dairy segment and this may lead towards new corporate players in the field. Lower GST on tea to help combat smuggling
Neutral to Negative
Budget remains mixed for textiles. Option to opt out from FTR may provide relief to some textile manufacturers. Modest increase of PkR50mn in EDF is unlikely to support textile exports to a material extent. Increase in GIDC will hamper the profitability of those textile manufacturers who have natural gas fired captive power facility
Textiles
While FY13 budget is neutral to negative for textiles, intl cotton prices and fundamentals of the companies will drive price performance
08
Budget Implications
Electricity
Neutral
Budget is largely a non-event for the Electricity (Power) sector. No concrete measure has been announced for resolving circular debt but power sector subsidies are envisaged to be slashed by about 60%, indicating a continuing resolve to rationalize tariffs
Banks
Neutral to Negative
Dividend income arising from money market/income funds to be taxed at 25% in FY13 and at 35% in FY14, up from 10% at present. Much feared increase in corporate tax rate/tax on T-bills did not materialize For tax credit purposes, limit of investment in securities and insurance as proportion of taxable income increased from 15% to 20% and from PkR500k to PkR1mn, whichever is lower. Required retention period of shares is also being reduced to 2yrs from 3yrs. At the same time, FED on livestock insurance has been eliminated which should prove to be uplifting at the margin GoP has announced a 20% hike in salaries for government employees which will lead to escalation in costs for PTC. GST on telecom services has been maintained at 19.5%. 3G auction target has been slightly upward revised to PkR79bn, while the GoP has maintained its FY12 dividend target of PkR6.5bn for PTC
Insurance
We see FY13 Budgetary proposals as Neutral to slightly Positive for the Insurance sector. Potential increase in funds flow to the equity market should bode well for listed Insurance companies given their hefty reliance on investment income We view budgetary measures for FY13 as Neutral to Negative for the Telecom sector with the significant hike in government employee salaries being the biggest negative for PTC. However, given the GoP fiscal constraints, PTC is likely to announce its first interim dividend for FY12 this month, which based on GoP estimates of PkR6.5bn translate into a expected DPS announcement of PkR2.05 With pricing power curtailed due to excess urea supply, urea manufacturers are unlikely to fully pass on the impact of GIDC. Furthermore, given the total urea subsidy of PkR26bn and current landed cost of US$525/ton, GoP can import a further 1.2mn tons in FY13 and keep the market well supplied.
Telecom
Neutral
Negative
GIDC on fertilizers has been further increased with feed stock and fuel stock prices raised by PkR103/mmbtu and PkR87/mmbtu, respectively. Urea subsidy target has been revised down to PkR26bn from last year's level of PkR45bn
Chemicals
Fertilizer
Negative
Status quo as far as import duty on PTA is concerned. Higher gas prices (GIDC on fuel stock) to pare margins
The budget FY13 was largely a non-event for the chemical sector as there was no change in PTA import duty. Higher fuel charges to hit EPCL and LOTPTA's margins
09
Fiscal rules operate at the crossroads of politics and economics. Slippages in implementing IMF prescribed fiscal reforms, particularly implementation of RGST, elimination of electricity subsidies and resolution of circular debt, in our view inter alia are the key reasons for a sustained high deficit. While the government in FY12 managed to achieve below targeted inflation of 11% and on track tax revenue collection, up 22%YoY in FY12, fiscal deficit remained at 7.8% of GDP (inclusive of 1.9% of GDP debt consolidation). A confluence of unfavorable factors included a global environment with non-materialization of expected foreign flows (3G license/Etisalat payment/CSF and lower logistical support receipts from the US). Going forward, total budgetary outlay has been set at PkR3.2trn for FY13 (up 15.8%YoY) with current expenditure at a rigid 82% of total outlay. Gross revenue target is set at PkR2.5trn, up 24%YoY, resulting in a budgetary gap of PkR1.2trn (4.7% of GDP - inclusive of provincial surplus of PkR80bn). Heading upto election year, budget expenditure risks overshooting with fiscal deficit likely to exceed 6% of GDP. Budgetary measures include broader relief while heightened tax collection targets will likely fall on the shoulders of improved administrative and collection measures.
Key Points 1.) Fiscal deficit 2.) PSDP outlay 3.) Tax collection Target 4.7% of GDP or PkR1.2tr inclusive of provincial surplus Target of PkR873bn with federal component at PkR360bn Tax collection target up 24%YoY to PkR2.5tr. Comment Fiscal deficit target is conservative given the continuing subsidy burden We expect utilization inline till general elections Target dependent upon continued streamlining of administration and collections Source: AKD Research
Fiscal Deficit
FY92
FY94
FY96
FY98
FY00
FY02
FY04
FY06
FY08
FY10
Total Expenditure
Total Revenue
RISKS: As with prior years, expenditure overshooting is a key risk with increasing subsidies and realization of development expenditure with election year politics. Acknowledged risks to the Budget remain on the back of 1) weak external financing, which can lead to a spiraling twin deficit, 2) matching upside and downside risk to oil prices and impact on oil import bill, 3) spillover effect from global slowdown (particularly the Eurozone) and 4) increasing share of budgetary borrowing from domestic sources leading to crowding out of private sector credit growth and inflationary central bank borrowing.
10
FY12
Expenditures
Expenditures (PkRbn) Defence Subsidies Debt Service (Foreign) Debt Repayment (Foreign) Debt Service (Domestic) Total Debt Servicing Public Order & Safety Economic Affairs Education Affairs Health Affairs Others Total Current Expenditure Development Exp (PSDP & Others) TOTAL EXPENDITURE As percentage of Total Expenditure Defence Subsidies Total Debt Servicing Public Order & Safety Economic Affairs Education Affairs Health Affairs Others Total Current Expenditure Development Exp (PSDP & Others) 18% 11% 39% 2% 4% 2% 0% 21% 63% 19% 21% 19% 41% 3% 4% 2% 0% 20% 72% 18% 24% 25% 47% 3% 2% 2% 0% 21% 82% 23% FY10R 378 229 71 148 596 815 37 81 32 7 439 2,017 405 2,422 FY11R 445 396 74 127 654 855 59 80 40 7 414 2,296 382 2,678 FY12R 510 512 72 137 772 981 62 72 45 7 443 2,632 478 3,110
Budget Snapshot
Revenues
Indirect Taxes Direct Taxes Total Tax Revenue Income from Property & Enterprise Civil Admin & Other Receipts Misc. Revenue Sources Total Non-Tax Revenue 70 54 48 8 537 2,612 591 3,203 70 65 50 8 550.00 2,744 600 3,344 Gross Revenue Receipts (Less: Provincial Share) Net Revenue Receipts Net Capital Receipts External Receipts Estimated provincial surplus Privatization Proceeds Bank Borrowing TOTAL RESOURCES As percentage of Total Revenues Indirect Taxes 26% 10% 55% 3% 3% 2% 0% 26% 81.5% 28% 26% 11% 59% 3% 3% 2% 0% 26% 86% 29% Direct Taxes Total Tax Revenue Income from Property & Enterprise Civil Admin & Other Receipts Misc. Revenue Sources Total Non-Tax Revenue Gross Revenue Receipts (Less: Provincial Share) Net Revenue Receipts Net Capital Receipts External Receipts
Source: AKD Research & MoF
Revenues (PkRbn)
FY10R 943 540 1,483 116 338 115 569 2,052 655 1,397 260 578 262 89 2,586 36% 21% 57% 4% 13% 4% 22% 79% 25% 54% 10% 22% 10% 0% 3% 100%
FY11R 1,052 627 1,679 104 303 150 557 2,236 998 1,238 459 290 120 452 2,559 41% 24% 66% 4% 12% 6% 22% 87% 39% 48% 18% 11% 5% 0% 18% 100%
FY12R 1,279.6 745.0 2,025 93.719 249 169 512.2 2,537 1,208.62 1,328 525 226 91 939 3,110 46% 27% 73% 3% 9% 6% 19% 92% 44% 48% 19% 8% 3% 0% 37% 100%
FY13B 1,572 932 2,504 179 354 197 730.3 3,234 1,459 1,775 478 387 80 484 3,203 57% 34% 90% 6% 13% 7% 26% 117% 53% 64% 17% 14% 3% 0% 19% 100%
FY13 AKD 1,356 904 2,260 209.00 313 143 665 2,925 1,287 1,638 490 350 100 696 3,344 49% 33% 82% 8% 11% 5% 24% 106% 47% 59% 18% 13% 4% 3% 27% 100%
11
EXPENDITURE
Expenditures on face value show marginal YoY growth; however in view of election year politics, there are concrete risks to overshooting. Total Federal outlay has been earmarked at PkR3.2tn versus a revised PkR3.11tn last year, up a marginal 3%YoY. Last year, budgeted expenditures were overshot by 16% or PkR343bn underpinned by Power Sector and Fertilizer subsidies. Current expenditures are projected at PkR2.61tn down a tepid 1%YoY. However, this includes a sharp reduction in subsidies at 59%YoY to PkR209bn which we believe is extremely optimistic. Debt servicing inclusive of repayments, are projected to increase by 16%YoY and account for 36% of total expenditures. Defense expenditures logged in line with previous year trends up 7%YoY and at 26% of total expenditures. Considering election year, we believe the tradition of balancing expenditure subsidies with PSDP is unlikely. For FY13, the Federal Budget targets Federal development expenditure at PkR591bn (PSDP PkR360bn) up 24%YoY from a revised PkR478bn last year where we expect targets to be inline till the run up in general elections. Inclusive of provincial allocations, PSDP is targeted at PkR873bn (3.7% of GDP) up 19%YoY versus a revised PkR743bn last year.
We view targets as conservative particularly in relation to containing subsidies particularly as PSDP cuts may prove difficult specifically till the run up in general elections. This will include allocations to complete ongoing projects and schemes (96% allocation) with the power sector allocation earmarked at PkR185bn. Expenditure side slippages have become recurring with sharp deviations in subsidies led by power where revised estimates for FY12 place the subsidy bill at PkR512bn against PkR166bn budgeted with tariff differential subsidies exceeding the target by PkR383bn (inclusive of KESC). We expect this is where chronic challenges will likely remain where based on our estimates taking only fuel oil generation; we expect power sector tariff under-recovery in excess of 34% (including the recent 16% hike) against consumer tariffs for 700-1000 units (as a proxy). . Even with downside risks to oil prices we believe the GoP will be required to rationalize power sector tariffs at a brisk pace. Our sensitivity shows for international crude oil prices at US$90/bbl fuel oil generation costs over an annual basis would exceed consumer tariffs by PkR165bn. This compares to a total tariff differential allocation of PkR170bn inclusive
12
FY13
FY11
Fuel Oil Generation Cost Consumer Rates 700 - 1000 Units Under Recovery (RHS)
of KESC allocations and life line consumer subsidies. The overall subsidy package of PkR209bn includes increasing allocations for FFBL at PkR3.4bn and USC for the sale of sugar at PkR6bn.
Rev as % of GDP
Tax to GDP
Pakistan's tax to GDP (FBR) at 9.3% is one of the lowest in the region. The GoP is targeting domestic internal revenue generation in FY13 of nearly Pk2.5trn, up 24% YoY to bring tax to GDP to double digits at 11.1%. While no new tax is imposed, achieving a 25%YoY increase in Direct tax and 23%YoY increase in Indirect tax is ambitious with our projected nominal GDP growth target of 15.2%. While this is achievable, it will require continued focus on improving administrative and collection measures. Of particular note is the imposition of 1% withholding tax on disributors/dealers, which would help in enhancing documentation in the economy and curb hoarding practices going forward. In our view, going by the recent track record of the government, growth in tax collection will gather pace on the back of 1) efforts to increase tax payer documentation and strengthening electronic payment, 2) improved tax administration and risk based audit, 3) simplifying the taxation system by focusing on Income tax and Sales Tax, 4) close watch on Afghan transit trade and recovering arrears and 5) natural course of PkR/US$ depreciation. .
Tax Collections
(PkRbn) 200.0 160.0
Breakup of FED
POL Products Others
Others
120.0 80.0
40.0 Jul-11 Feb-12 Aug-11 Nov-11 Mar-12 Sep-11 Dec-11 Jan-12 Oct-11
Source: SBP
13
We expect FY13 target of Income tax collection (96% of Direct tax) at PkR914bn to be an uphill task
Out of the total tax collection, 57% is through indirect taxation (PkR1,572bn) where sales tax growth is targeted in line with FY12 and is estimated to increase 26%YoY to PkR1.07trn in FY13. Total indirect collection against FED and Customs/Regulatory Duty is projected at PkR372bn, up a marginal 5%YoY. This is despite the abolishment of FED on 12 items, reduction in FED on Cement by PkR100/ton and custom duties on stationery items being abolished and reduced on pharmaceutical raw material. Petroleum levy is targeted at PKR120bn, up 74%YoY against the revised FY12 estimate, which in our view is realistic provided oil prices do not rebound sharply. That said, we expect FY13 target of Income tax collection (96% of Direct tax) at PkR914bn to be an uphill task.
This growth will largely be underpinned by auction of 3G licenses expected to generate PkR79bn which failed to materialize over the past two years
Dividend Estimates
2011-12 2012-13 (PkRmn) Revised Budget Est. FINANCIAL INSTITUTIONS 405.9 408.7 National Investment Trust 27 27 National Bank of Pakistan 33 33 Allied Bank of Pakistan 48 48 United Bank Limited 25 28 Habib Bank Limited 65 65 PaK Oman Investment Co, 108 108 Pak Brunei Investment Co, 50 50 Pak China Investment Co, 25 25 Pak Iran Joint Investment Co. 25 25 NON-FINANCIAL INST. PPL MARI PSO PARCO SNGPL SSGCL GHPL OGDCL PTCL Others Total 61,543.96 67,842.76 6,358 9,339 60 65 385 450 2,400 3,000 174 500 1,115 1,200 13,000 13,500 25,000 26,000 6,500 6,500 3,276 3,644 58,674 64,607 Source: Budget Brief
SBP profits
15% 14% 13% 12% 11% 10% 9% 8% FY05 FY06 FY07 FY08 FY09 FY10 FY12 FY13 FY11 250 200 150 100 50 0
Gas Dev. Surcharge Interest Oil/Gas Royalty
Others
Defense Receipts
SBP Profit
expenditure as a counter balance; however, considering election year, outlays are likely to remain in line with projections particularly in the run up to general elections. We expect total expenditure outlays to overshoot by approximately PkR200bn. The GoP estimate for FY13 fiscal deficit of PkR1.1trn (4.7% of GDP), in our view, is optimistic and will likely exceed 6% of GDP. The budget plans to finance this shortfall by PkR135bn from Net External Financing and PkR971bn from Domestic Sources (Bank and Non Bank borrowing). In our view, FY13 budget has unrealistically estimated external financing to the tune of PkR386.9bn, up 71%YoY from the revised FY12 estimate of PkR226.1bn. While only 54% of budgeted foreign flows materialized during the current fiscal year, we conservatively expect PkR265bn to materialize in FY13. Out of the total Capital Receipts long term debt (Floating and Permanent) and NSS have been highlighted as the two main funding sources with an aggregate target of PkR477bn in FY13. Coupled with expected recourse to central bank borrowing we believe this could provide for upside pressure on money market yields.
While Pakistan has positive real interest rates, increasing government borrowing for budgetary support and uncertain materialization of foreign inflows (leading to a weak PkR/US$) remain the key risks to interest rate outlook
While Pakistan has positive real interest rates, increasing government borrowing for budgetary support and uncertain materialization of foreign inflows (leading to a weak PkR/US$) remain the key risks to interest rate outlook. Should external financing fall below target and expenditure overshoot by by our estimates in FY13, we estimate deficit monetization will increase average CPI inflation to 12.5%YoY from budgeted 9.5%YoY and above our base case estimate of 11%. That said, pressure on fiscal deficit may be contained with vigilance on inflation and focus on curbing the leakage from PSEs and refocus on power sector tariff rationalization.
FY08
FY10
Domestic Financing
90% 80% 70% 60% 50% 40% 30% 20% 10% 0% FY08 FY09 Non Banks FY10 FY11 Banks FY12 JULMAR 6.0 5.0 4.0 3.0 2.0 1.0
0.0
NDA/NFA
15
The government has estimated external loans of PkR274.8bn, up 34%YoY against the revised FY12 estimate. These include project loans of PkR140.3bn, down 15.3%YoY and program loans (budgetary support) of PkR41.4bn, up 9.2x. At the same time, GoP expects a challenging PkR46.5bn from Euro Bonds which we view as unlikely considering increasing strains in global financial markets. The budget estimates External Grants of PkR112bn for FY13, up 11.6%YoY from a revised FY12 target of PkR45bn. Out of this, PkR74.4bn is estimated from Privatization Proceeds including the SPO of PPL, OGDCL exchangeable bond offering and small ticket items including Heavy Electrical Complex and NPCC.
For FY13, Pakistan continues to face challenges on the external front with IMF repayments of US$2.78bn at the forefront. That said, the sell-off in global commodities will dissuade risks and provide some respite. As for oil, the main import driver, we expect the import bill to contract by ~US$1.2bn for every US$10/bbl fall in crude price. Furthermore, external account risk mitigates also include a return to the fold of an IMF program. . We have provided our sensitivity analysis of Oil (Arab light) price and Oil import bill.
Manufacturing
Investment is targeted to improve from the current level of 12.5% of GDP to 13.1% in FY13, while addressing energy shortages the GoP has committed to utilize the increase in Gas Infrastructure Development Cess for the construction of Iran-Pakistan (IP) and TurkmenistanAfghanistan-Pakistan-India (TAPI) pipelines to overcome the energy shortages.
16
Cements
Relative Performance
1M Absolute (%) Rel. Index (%) 1.4 2.2 3M 44.6 37.4 6M 91.6 71.5 12M 75.0 61.9
Performance Chart
100% 80% 60% 40% 20% 0% -20% May-11 Aug-11 Nov-11 Feb-12 May-12
KSE-100 Index
Cements
The Finance Bill provides for exporters to move towards the normal tax regime (NTR) from current final tax regime (FTR), should they decide to avail it. Clause 41AA provides an option to opt for the NTR instead of the FTR, however, stipulates that minimum tax liability under NTR should not be less than 50% of the realized proceeds at the time of exports. Given, however, that even the biggest cement exporter (LUCK) is currently paying a tax (turnover) that translates to just 4.2% (9MFY12 current tax), it would be ill-advised to enter into NTR and therefore, we deem it unlikely that any manufacturer will opt for it.
Banks
Relative Performance
1M Absolute (%) Rel. Index (%) -3.2 -2.3 3M 7.7 0.5 6M 25.1 5.0 12M 8.4 -4.8
Performance Chart
25% 20% 15% 10% 5% 0% -5% -10% -15% -20% -25% May-11 Aug-11 Nov-11 Feb-12 May-12
KSE-100 Index
Banks
17
Performance Chart
25% 20% 15% 10% 5% 0% -5% -10% -15% -20% May-11 Aug-11 Nov-11 Feb-12 May-12
KSE-100 Index
Autos
Relative Performance
1M Absolute (%) Rel. Index (%) -1.6 -0.8 3M 12.4 5.1 6M 31.5 11.4 12M 6.4 -6.7
Performance Chart
25% 20% 15% 10% 5% 0% -5% -10% -15% -20% -25% May-11 Aug-11 Nov-11 KSE-100 Index Feb-12 May-12 Automobile and Parts
Electricity
Relative Performance
1M Absolute (%) Rel. Index (%)
25% 20% 15% 10% 5% 0% -5% -10% -15% May-11 Aug-11 Nov-11 Feb-12 Power May-12
3M 3.8 -3.4
A non-event for the Electricity (Power) sector where the government announced no tangible steps for curbing or even controlling circular debt. Total subsidy for tariff differential has been projected at PkR185.3bn compared to revised figure of PkR464.2bn for FY12, indicating further round of tariff hikes. That said, we remain skeptic of subsidy targets being met, given revision in FY12 targets from initial allocation of PkR147.3bn. Electricity tariffs and loadshedding will likely be one of the focal points of all political parties in the election year expect subsidy targets to be revised upwards again!
3.6 4.4
Performance Chart
KSE-100 Index
18
Insurance
Relative Performance
1M Absolute (%) Rel. Index (%) 5.3 6.1 3M 1.7 -5.5 6M 27.0 6.9 12M 11.6 -1.5
Performance Chart
25% 20% 15% 10% 5% 0% -5% -10% -15% -20% May-11 Aug-11 Nov-11 Feb-12 May-12
KSE-100 Index
Insurance
We see FY13 Budgetary proposals as Neutral to slightly Positive for the Insurance sector. Potential increase in funds flow to the equity market (as Banks shift away from money market funds) may be positive for overall stock price recovery, which should bode well for listed Insurance companies given their hefty reliance on investment income. At current levels, we retain our preference for AICL.
GoP has announced a 20% hike in government employee salaries which is negative for the service oriented telecom sector. The GoP has maintained its FY12 dividend target for PTC at PkR6.5bn (DPS PkR2.05) and the FY13 target has also been kept at PkR6.5bn. We believe that PTC is likely to announce a dividend this month, which is likely to keep the stock in limelight in the near term. Recall, GoP has 62% shareholding in PTC. GST on telecom services has been kept unchanged at 19.5%. The already ambitious 3G auction target has been increased by PkR4bn to PkR79bn. The budget appears Neutral on the telecom sector, however, an interim dividend announcement by PTC is likely to excite in the near term. Furthermore, any tangible development on ICH will likely lead to a sector re-rating.
Performance Chart
30% 20% 10% 0% -10% -20% -30% -40% -50% May-11 Aug-11 Nov-11 Feb-12 May-12
KSE-100 Index
Food Producers
Relative Performance
1M Absolute (%) Rel. Index (%)
60% 50% 40% 30% 20% 10% 0% -10% -20% May-11 Aug-11 Nov-11 Feb-12 May-12
3M 20.7 13.5
6M 49.1 29.0
3.3 4.1
Performance Chart
KSE-100 Index
Food Producers
19
Fertilizer
Relative Performance
1M Absolute (%) Rel. Index (%) -3.5 -2.7 3M -7.5 -14.7 6M -0.6 -20.7 12M 0.9 -12.3
Performance Chart
25% 20% 15% 10% 5% 0% -5% -10% -15% May-11 Aug-11 Nov-11 Feb-12 May-12
KSE-100 Index
Fertilizers
Textiles
Relative Performance
1M Absolute (%) Rel. Index (%) 2.3 3.1 3M 13.9 6.6 6M 26.8 6.8 12M -1.8 -15.0
Performance Chart
25% 20% 15% 10% 5% 0% -5% -10% -15% -20% -25% -30% May-11
Aug-11
Nov-11
Feb-12 Textile
May-12
KSE-100 Index
Among textile sector, we retain our liking for NML where recent dip in price should be taken as an attractive entry point.
Chemicals
Relative Performance
1M Absolute (%) Rel. Index (%) 7.2 8.0 3M 5.4 -1.9 6M 20.0 -0.1 12M -2.5 -15.7
20
Annexure
Salient features of the FY13 Budget are as follows: Taxation slabs for individuals and AOPs to be reduced to 5 from earlier 17. Further, taxable income for salaried individuals and AOPs to be increased to PkR400k p.a from previous PkR350k p.a. Moreover, AOPs will also be taxed at progressive rates rather than previous flat rate of 25%. CGT related changes approved by Finance Ordinance, 2012 will now gain statutory status through Finance Bill 2012. Expenditure made on BMR will be get tax credit of 20% and shall be adjustable upto 5 years. Stock exchanges will not collect WHT on carry over trades. NCCPL will collect WHT @10% on margin financing in share business. Investment in IPOs and insurance premium will obtain a tax credit; higher of 20% (15% in FY12) of taxable income or PkR1mn (PkR0.5mn in FY12). Moreover, retention period has also been reduced from 3 years to 1 year. Property sold before 2 years of possession will be subject to CGT ranging from 5% to 10%. Dividend and profit from intra group debt is to be exempted from WHT for the companies entitled to group taxation. Tax arbitrage opportunity for banks has been purged by imposing 25% tax in FY13 and 35% in FY14 on dividend received from money market funds and income funds. Retailers having revenue up to PkR5mn will be subject reduced tax rate of 0.5% from earlier 1%. E&P companies have been provided with option to pay tax@40% of profits and net of royalty gains from FY12 onwards provided these companies withdraw pending appeals and payment of tax liability up to FY11 by Jun 30'12. Exporters, importers and suppliers are provided an option to exit Final Tax Regime (FTR) and enter Normal Tax Regime (NTR). Manufacturers will act as withholding agents to collect 1% tax from traders and distributors which will be adjustable against tax liability of those traders/distributors. Expansions in PPE made before Jul 1'11 through 100% fresh equity will get tax credit for 5 years from commencement of commercial production. Initial depreciation on building will be reduced to 25% from earlier 50%. Tax exemption granted on venture companies and private equity is to be extended for 10 years period. FED on cements will be reduced by PkR100/ton.
21
Import duty on rugged tryres to be reduced to 10% from 20%. Additional GIDC is to be imposed on fertilizer sector by PkR103/mmbtu on fuelstock and on PkR87/mmbtu. GST has been rationalized at 16% for goods. Sales tax on steel sector enhanced from PkR6/Kwh to PkR8/Kwh. Minimum price for new brands is floored to 95% of most popular price category brands. Limit of taxable cash withdrawals (subject to 0.2%WHT) has been on enhanced to 50k pd from previous 25k pd. 100% tax credit will be provided against tax payable to industrial undertakings including dairy farming. 15 items, including lub oils, have been exempted from FED. FED on 88 pharmaceutical raw materials has been reduced.
22
PAKISTAN
Muhammad Farid Alam Chief Executive Officer Tel: (9221) 111 253 111 farid.alam@akdsecurities.net
Naveed Vakil Director, Research & Business Development Sector: Strategy, Oil & Gas, Power Tel: (9221) 111 253 111 (Ext:692) naveed.vakil@akdsecurities.net Anum Dhedhi Economist/Investment Analyst Sector: Pakistan Economy/Banks Tel: (9221) 111 253 111 (Ext:693) anum.dhedhi@akdsecurities.net Qasim Anwar Technical Analyst & Equity Dealer Tel: (9221) 111 253 111 (Ext:680) qasim.anwar@akdsecurities.net Nasir Khan Database Officer Tel: (9221) 111 253 111 (Ext:639) nasir.khan@akdsecurities.net
Raza Jafri, CFA Head of Research Sector: Commercial Banks, Insurance, Economy Tel: (9221) 111 253 111 (Ext:693) raza.jafri@akdsecurities.net Usman Zahid Senior Investment Analyst Sector: Cement, Power Tel: (9221) 111 253 111 (Ext:693) usman.zahid@akdsecurities.net Hassan Quadri Research Database Manager Tel: (9221) 111 253 111 (Ext:639) hassan.quadri@akdsecurities.net Tariq Mehmood Library Incharge Tel: (9221) 111 253 111 (Ext:643) tariq.mehmood@akdsecurities.net
Ayub Ansari Senior Investment Analyst Sector: Fertilizer, Chemicals, Telecom Tel: (9221) 111 253 111 (Ext:693) ayub.ansari@akdsecurities.net M. Naeem Javid Investment Analyst Sector:Fertilizer, Textile Tel: (9221) 111 253 111 (Ext:643) tariq.mehmood@akdsecurities.net Azher Ali Quli Database Officer Tel: (9221) 111 253 111 (Ext:639) azher.quli@akdsecurities.net
The 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 estimates contained in the document constitute the department's judgment as of the date of this document and are subject to change without notice an are provided in good faith but without legal responsibility. This report is not, and should not be construed as, an offer to sell or a solicitation of an offer to buy any securities. AKD Securities (the company) or persons connected with it may from time to time have an investment banking or other relationship, including but not limited to, the participation or investment in commercial banking transaction (including loans) with some or all of the issuers mentioned therein, either for their own account or the account of their customers. Persons connected with the company may provide corporate finance and other services to the issuer of the securities mentioned herein, including the issuance of options on securities mentioned herein or any related investment and may make a purchase and/or sale of the securities or any related investment from time to time in the open market or otherwise, in each case either as principal or agent. Neither the company or any of its affiliates, nor any other person, accepts any liability whatsoever for any director or consequential loss arising from any use of this report or the information contained therein. Subject to any applicable laws and regulations, AKD, its associate or group companies or individuals connected with AKD may have used the information contained herein before publication and may have positions in, may from time to time purchase or sell or have a material interest in any of the securities mentioned or related securities or may currently or in future have or have had a relationship with, or may provide or to have provided investment banking, capital markets and or other services to, the entities referred to herein, their advisors and/or any other connected parties. This document is being distributed in the United State solely to "major institutional investors" as defined in Rule 15a-6 under the U.S. Securities Exchange Act of 1934, and may not be furnished to any other person in the United States. Each U.S. person that receives this document by its acceptance hereof represents and agrees that it: is a "major intuitional investor", as so defined; understands document wishing to follow-up any of the information or to effect a transaction in such securities should do so by contacting a registered representative of AKD Securities Limited. The securities discussed in this report may not be eligible for sale in some states in the U.S. or in some countries. Any recipient, other than a U.S. recipient that whishes further information should contact the company. This report may not be reproduced, distributed or published, in whole or in part, by any recipient hereof for any purpose.
June 2012