Inter Market Perspective

Intermarket Securities is the Local Research Partner of Exotix Capital

www.jamapunji.pk

ANALYST CERTIFICATION AND REQUIRED DISCLOSURES BEGIN ON PAGE 14, 15 & 16

July 11, 2018

We assign greater probability for PTI to lead government formation at the center, as opposed to another term for the PML-N. Coalition weaving will be tricky but alliances with smaller parties and independent candidates should enable PTI to cross the line. Provincial governments are likely to retain their makeup - PTI in Khyber Pakhtunkhwa, PML-N in Punjab and PPP in Sindh.

Such has been the overbearing pressure from politics and Balance of Payments over the last 12mths that elections should trigger a relief rally, in our view. This is irrespective of who forms government - all parties have immediate term focus on economic stabilization which is likely to culminate in an IMF program under any political permutation. The Index could yet test its Dec’17 low of 38,000pts before it finds a bottom, but this would be a buying opportunity for us.

2018 is a classic transition year, elections coinciding with deep macroeconomic adjustments before a new cycle begins. We rule out valuation rerating for now, even though Pakistan’s forward P/E of 7.3x is already much lower than the long-term average of 8.5x. However, earnings growth outlook for Banks, Oil & Gas, Fertilizers and Textiles is strong. These should outperform at the expense of cyclical sectors over the next year or so.

Change is afoot We see PTI emerging as the largest party at the national level, with 90 of the 272 directly contested seats i.e. a 33% share. PTI should be followed by PML-N with 70 seats and PPP with 30+ seats. A PPP and PML-N alliance is possible but unlikely given deterioration in their relationship over the last year. This should allow space for PTI to form government with smaller parties and independent candidates. Independents attained more than 10% of seats in 2013 and are expected to win an even higher percentage in 2018. Unlike the previous PML-N tenure, however, PTI may be heading a weak coalition with less room for enacting legislation. Working alongside a possible PML-N government in Punjab will carry its own set of challenges. That said, PTI would also bring with it hope of long-awaited structural reform, something that might not be on offer from the old guard.

Elections can be an inflection point Since ex-PM Sharif’s disqualification on Jul 28’17, the KSE-100 has lost 14% (26% in US$ terms). During the last 12mths, the market has navigated immense political noise including uncertainty on whether elections will even be held. In this setting, the 2018 Election on July 25th is a key checkpoint with the potential to shift Pakistan’s narrative from risks to opportunities. Likelihood of an IMF program provides policy footholds where, importantly, the PKR has already adjusted to a great extent while a sharp increase in interest rates in 2HCY18 should no longer come as a surprise. Although the Index can yet test its Dec’17 low of c. 38,000pts, this would be a buying opportunity for us. Initial election excitement can morph into a sustainable rally, provided election results are quickly accepted and talks are initiated with the IMF.

Follow the earnings growth The 2008 and 2013 elections were both followed by IMF programs, and 2018 will be no different. Although the market’s forward P/E multiple has shrunk from more than 12x on MSCI inclusion in mid-CY17 to 7.3x at present, it could potentially bottom out even lower as Pakistan again undergoes a stabilization exercise. Once valuations level off to a new normal – and they have greatly already done so, in our view – the onus will shift to earnings growth. Pakistan stands out on this count with projected 3yrs profit CAGR of almost 15%. The Index is dominated by Banks and Oil & Gas, which benefit from rising interest rates and PKR weakness. We expect Fertilizers and Textiles to do well also. However, cyclical sectors such as Cements and Autos may remain out of favor.

Risks: Continuation of a polarized political landscape and failure to enter an IMF program in a timely manner.

2018 Elections: Change is afoot!

Pakistan Strategy

Market Snapshot

KSE 100 Index 39,452.81

Market Cap (PRsbn) 8,198

Market Cap (US$bn) 67

Market Free Float 28%

Forward PE (x) 7.3

Avg. Daily Vol (mnshrs)* 175

Avg. Daily Td Val (PRs mn)* 8,141

Avg. Daily Td Val (US$ mn)* 74 *FY18

Potential Election Outcomes

PTI-Led Coalition

PML-N Led Coalition

(Likely)

(Unlikely)

PTI 90

PML-N 70

PSP 2

PPP 32

MQM-P 13

MQM-P 13

Independents 26

Independents 9

Others 11

Others 16

Total Seats 142

Total Seats 140 Source: IMS Research

Preferred Sectors & Top picks Banks

Oil & Gas

ABL

OGDC BAFL

PPL

HBL

PSO Fertilizer

APL

ENGRO

SHEL FFC

EFERT

Textiles Power

NML

NPL

NCL HUBC

KTML

KAPCO Source: IMS Research

Research Entity Number – REP-085

Raza Jafri, CFA raza.jafri@imsecurities.com.pk Muhammad Saad Ali, CFA saad.ali@imsecurities.com.pk

+92-21-111-467-000

2 | P a g e

Perspective

2018 Election Manifestos

.

Common Themes Opposing Policies

Push to exports: Textiles in the short-term and IT in the long-term Different degree of importance assigned to infrastructure development

Tilt power sector reforms to T&D, resolve circular debt and improve DISCOs Different degree of importance assigned to healthcare and education

Greater importance attached to healthcare and education reforms Different plans for improvement of SOEs

Farmer friendly policies with focus on better water management

Fiscal constraints after elections may push Agriculture down pecking order, in our view, depending on parties

Reining in the fiscal deficit with focus on tax reform

Pursue strategic ties with China and complete CPEC

PTI

PML-N

PPP

Centrist

Centre Right

Center Left

Economy: No macroeconomic targets given. 10mn

jobs to be created in 5yrs in key sectors such as:

SME, Housing, Information Technology, Education

and Green Economy & Tourism.

Economy: Take GDP growth from 5% to 7%+.

Growth and infrastructure development to remain

central tenets.

Economy: Take immediate remedial measures

including talks with global economic players for a

stabilization program. In follow-up, National

Economic Reform Agenda to be devised in

consultation with all parties.

Energy: Complete electrification of rural areas,

solve circular debt through reducing T&D losses,

and move towards greener energy mix

Energy: Add 15,000MW by 2025. Eliminate circular

debt, privatize DISCOs, expand pipelines, introduce

smart metering and encourage PE investment in

T&D network.

Energy: Eliminate circular debt, give DISCOs more

independence and modernize the T&D network by

encouraging foreign investment.

Infrastructure: Develop 5mn low cost housing

units. Establish Infrastructure Lending Bank to fund

large projects such as Diamer Bhasha Dam.

Infrastructure: Provide finest public transport in 25

major cities. Construct the Diamer Bhasha Dam

and Mohmand Hydropower Project. Develop

mortgage industry by reforming foreclosure laws.

Infrastructure: Develop an equitable framework for

infrastructure development within 3mths of coming

into office. Complete Diamer Bhasha Dam.

Exports & Imports: Export-oriented and allied

sectors to be 100% zero rated and refunds will be

expedited. Tariffs to encourage value-add exports.

Exports & Imports: Continue export support

packages.

Exports & Imports: Immediately release pending

rebates to exporters and set up export-oriented

SEZs. Withdraw rebates for non-exporting sectors

and review FTAs.

Taxation: Have a taskforce to bring back looted

national wealth parked overseas. Increase the tax

net and push direct taxation. Will shift SOEs from

ministries to a wealth fund modeled on Malaysia's

'Khazanah'.

Taxation: Take Tax-to-FDP to 16% and limit fiscal

deficit to < 4% of GDP. Lower corporate tax rate to

25% by 2023 and stop under-declaration of

immoveable assets. Will take losses in SOEs to

zero.

Taxation: Take Tax-to-GDP to 15%. Split FBR into

Direct Tax Authority, Sales Tax Authority and

Customs Authority. Will turnaround SOEs with

private partnerships and will reinstate unions.

3 | P a g e

Perspective

Sector Implications

PTI led coalition PML-N led coalition

Construction

Neutral to Negative. More focus towards social spending rather than infrastructure. Plans to build 5mn houses but funding plans are vague

Positive. Party's central focus is on Infrastructure including Roads, Power plants, LNG, Housing and water infrastructure.

Banks

Neutral to Positive. Plans to increase Deposit-to-GDP ratio to 50% from 30% at present. Encourage shift towards cashless economy along with introduction of innovative financial instruments.

Neutral to Positive. Loan growth would likely be stronger due to emphasis on Infrastructure and GDP growth. Mortgage financing is also a focus area.

Energy

Positive in the longer-run. Plans to reduce transmission and distribution losses and turnaround SOEs by transferring ownership to a wealth fund. Negative from privatization perspective.

Positive. Plans to optimize energy mix, reduce UFG losses, double existing gas and LNG production, and build pipelines. Circular debt injection can also be a short term plug.

Autos

Negative, because of sharp hikes in interest rates and PKR depreciation hurting both demand and margins. Curbing imports will be only respite.

Negative, because of sharp hikes in interest rates and PKR depreciation hurting both demand and margins. Curbing imports will be only respite.

Fertilizers Neutral to Negative, pro agriculture policies will help offtake but popular stance may check recovery in pricing power. IMF will likely enforce removal of subsidies.

Neutral. Supportive policies would be positive for farmer economics. Subsidies can be expected as a popular stance.

Textiles Positive. Emphasis on exports including release of tax refunds and free-market exchange rate.

Positive. Emphasis on exports with support packages to continue

Pharmaceuticals Neutral to Negative, Healthcare reforms could be negative for sector pricing increases and margins

Positive, earlier adopted a favorable stance towards price revisions

Consumers

Neutral to Positive, inflationary environment will help sales growth and margins. Enforcing milk and meat standards would be positive for the formal sector.

Neutral to Positive, inflationary environment will help sales growth and margins. Punjab Food Authority’s vigilance could be positive for raising food standards.

4 | P a g e

Perspective

Change is afoot

We see PTI emerging as the largest party at the national level, with 90 of the 272 directly contested seats i.e. a 33% share. PTI should be followed by PML-N with 70 seats and PPP with 30+ seats. A PPP and PML-N alliance is possible but unlikely given deterioration in their relationship over the last year. This should allow space for PTI to form government with smaller parties and independent candidates. Independents attained more than 10% of seats in 2013 and are expected to win an even higher percentage in 2018. Unlike the previous PML-N tenure however, PTI may be heading a weak coalition with less room for enacting legislation. Working alongside a possible PML-N government in Punjab will carry its own set of challenges. That said, PTI would also bring with it hope of long-awaited structural reform, something that might not be on offer from the old guard. Momentum is with PTI We see PTI emerging as the largest party at the national level, with 90 out of the 272 directly contested seats i.e. a 33% share. PTI should be followed by PML-N with 70 seats and PPP with 30+ seats. This is in sharp contrast to the 2013 elections where a surge in Punjab enabled PML-N to emerge with a clear majority.

Despite decent performance by PML-N across 2013-2018, including good progress in resolving the energy crisis, our reasoning for an anticipated swing towards PTI is premised on:

Immense pressure on PML-N over the last 12mths including disqualification followed by recent conviction of ex-PM Nawaz Sharif, and multiple defections to PTI especially in South Punjab which accounts for an estimated 40 of the 141 NA seats in Punjab.

Limited anti-incumbency in Khyber Pakhtunkhwa where PTI may build on its lead in the 2013 elections. This would be a first as the province has historically always voted for change

.

Poor service delivery in Sindh combined with breakup of Karachi-centric MQM into factions will likely benefit PTI.

Emergence of small new parties as well as strong ‘electables’ standing as independent candidates. They will likely be open to forming an alliance with PTI over PML-N, which appears to be out of favor.

Recent polls, which indicate that momentum is with PTI in the run-up to elections. The latest Gallup poll showed more than 15% voters as undecided, and they may now potentially turn towards PTI following the indictment of ex-PM Nawaz Sharif on Jul 6’18. However, a possible sympathy vote for PML-N cannot completely ruled out.

Elections 2018 (Projected) - National Assembly

Elections 2013 - National Assembly

Political Parties

Punjab Sindh KPK Baluchistan FATA +

Islamabad Total

Political Parties

Punjab Sindh KPK Baluchistan FATA +

Islamabad Total

PML-N 66 1 1 1 1 70

PML-N 117 1 4 1 3 126

PTI 55 8 21 2 4 90

PTI 8 1 17 - 2 28

PPP 2 30 - - - 32

PPP 2 32 - - - 34

PML-Q 1 - - - - 1

PML-Q 2 - - - - 2

MQM-P - 13 - - - 13

MQM-P - 18 - - - 18

PSP - 2 - - - 2

PSP n.a n.a n.a n.a n.a n.a

ANP - - 2 1 - 3

ANP - - 1 -

1

JUI-F - - 4 3 1 8

JUI-F - - 6 4 1 11

JI - 1 1 - - 2

JI - - 3 - - 3

Others 2 3 5 5 1 16

Others 2 7 3 5 - 17

Independents 15 3 5 4 8 35

Independents 16 1 1 4 7 29

Total 141 61 39 16 15 272

Total 147 60 35 14 13 269 Source: IMS Research Source: ECP

5 | P a g e

Perspective

Independent ‘Electables’ holds the key While a PPP and PML-N alliance is not impossible - they were initially coalition partners in 2008 and it makes sense to ally themselves against PTI – we think it is unlikely given the deterioration in their relationship over the last year. PPP not backing PML-N’s candidate for Senate chairman is a pertinent example. This should allow space for PTI to form government with smaller parties and independent candidates. Independents attained more than 10% of seats in 2013 and are expected to win an even higher percentage in 2018. Prospects of no party being able to form government are slim, in our view.

Possible look of PTI-led coalition (Likely)

Possible look of PML-N led coalition (Unlikely)

PTI-Led Coalition

PML-N Led Coalition

PTI 90 33%

PML-N 70 26%

PSP 2 1%

JUI-F 8 3%

MQM-P 13 5%

MQM-P 13 5%

Others 11 4%

PPP 32 12%

Total 142 52%

Independents 9 3%

Others 8 3%

Total 140 52%

Provinces should retain their makeup to a great extent Punjab, Sindh and Khyber Pakhtunkhwa should continue to be ruled by PML-N, PPP and PTI, respectively. However, while PTI may increase its strength in Khyber Pakhtunkhwa, the PML-N and PPP majorities in their provincial strongholds are likely to be less resounding compared to 2013. Given ex-PM Nawaz Sharif’s indictment earlier this month, we also think a PTI government in Punjab cannot completely be ruled out.

Provincial Assemblies (2013 Elections)

Punjab: PML-N dominated by a wide margin

309

308 20

PML-N PTI PPP Others

Sindh: PPP & MQM show a rural-urban split

9450

7 4 11

PPP MQM PML-N PTI Others

KPK: PTI's first role in government

57

16

16

10

614

PTI JUI-F PML-N QWP PPP Others

Baluchistan: Split mandate

21

1411

8

56

PML-N PMAP NP JUI-F PML-Q Others

We think there is a greater chance for PTI to form government, albeit as part of a coalition

Source: Provincial assemblies' websites

6 | P a g e

Perspective

New government will have its work cut out Unlike the previous PML-N tenure, PTI may be heading a weak coalition with less room for enacting legislation. Working alongside a possible PML-N government in Punjab – the largest province – will carry its own set of challenges. That said, PTI would also bring with it hope of long-awaited structural reform, something that might not be on offer from the old guard.

The new government will inherit a high-potential economy but one that is currently undergoing a transition phase. Immediate post-election steps could entail:

• Initiation of talks with IMF with a view to enter a stabilization program by end-3QCY18

• Overseeing the ongoing adjustment in headline macroeconomic metrics including the PKR exchange rate and interest rates

• Take administrative steps to curb imports and further tilt policy focus towards pushing exports

• Commencement of fiscal consolidation; subsidies and development expenditure to be cut, and taxes to be raised

• Lifting morale of a populace polarized along political lines

Over the longer-term, PTI can potentially commence a systemic overhaul that, if done right, could lead to immense benefits including a significant rerating of the Pakistan market. This could encompass a greater anti-corruption & accountability drive together with focus on social reforms especially improvements in healthcare, education and law & order. However, these must be accompanied by deep economic reforms including efforts to widen the tax net, promote diversification in the export base and substitute imports by domestic production, in our view. Risks emanate from a polarized political landscape and too abrasive a stance by the winning party against political opponents.

Persistent themes irrespective of political outcome

Theme Comment Beneficiaries/Losers

Rising interest rates

DR is up 75bps in 1HCY18 to 7.0% and may rise even quicker by Dec'18, since core inflation has crossed 7% and an IMF program is likely.

Banks especially domestic-oriented names with strong focus on asset quality e.g. MCB, ABL, BAFL, BAHL and MEBL

Push to exports

BoP constraints dictate exports will have to be pushed and all party manifestos reflect this. PTI also explicitly states a free-market PKR exchange rate will be followed.

Given its importance, the Textile sector will be a key beneficiary. We like NML, NCL and GATM. We expect long-term benefits for the IT sector also. Beneficiaries are AVN, SYS and NETSOL.

CPEC

All major parties are in favor of CPEC under the ambit of further strengthening ties with China. Building dams is now also being prioritized in the national agenda.

Construction & allied sectors where preferred stocks are LUCK, MLCF and ASTL. However, PSDP could be at risk.

Energy Reforms

Circular debt remains a priority issue and there is realization that reforms now need to take place on Transmission & Distribution network. Remedies used will differ from party to party however.

Common measures regardless of government include tariff hikes to pass on outstanding balance. PML-N will resume privatization; PTI and PPP will be averse. Both will beckon FDI into the T&D network. OMCs and IPPs could benefit.

Fiscal consolidation

Under IMF program, GoP will cut PSDP and raise taxes to finance rising debt burden. Higher tax will likely be levied on petroleum & imports in particular. Upward revision of corporate and income taxes is possible.

Construction sector could see slowdown in demand due to lack of GoP support. Sectors that might be targeted could be Banks and Cements.

Source: IMS Research

7 | P a g e

Perspective

Elections can be an inflection point

Since ex-PM Sharif’s disqualification on Jul 28’17, the KSE-100 has lost 14% (26% in US$ terms). During the last 12mths, the market has navigated immense political noise including uncertainty on whether elections will even be held. In this setting, the 2018 Election on July 25th is a key checkpoint with the potential to shift Pakistan’s narrative from risks to opportunities. Likelihood of an IMF program provides policy footholds where, importantly, the PKR has already adjusted to near fair value while a sharp increase in interest rates in 2HCY18 should no longer come as a surprise. Although the Index can yet test its Dec’17 low of c. 38,000pts, this would be a buying opportunity for us. Initial election excitement can morph into a sustainable rally provided election results are quickly accepted and talks are initiated with the IMF.

Market Performance: Pre & post elections

1m 3m 6m 12m

Elected Govt. Election Date Prior After Prior After Prior After Prior After

PPP 5-Oct-93 5% 15% 9% 59% 22% 79% 10% 67%

PML-N 2-Feb-97 17% 1% 7% -4% 6% 21% 0% 4%

Military 12-Oct-99 9% -5% 11% 25% 25% 53% 47% 25%

Military/PML-Q 11-Oct-02 4% 9% 14% 39% 10% 40% 73% 101%

PPP 15-Feb-08 4% 5% 10% 1% 13% -31% 25% -60%

PML-N 10-May-13 6% 11% 14% 18% 23% 16% 38% 42%

PML-N/Caretaker* 25- July-18 -4% - -14% - -12% - -14% - Source: IMS Research, *based on last closing prices

Elections can change Pakistan’s narrative While the post-MSCI upgrade overhang is still popularly upheld to be behind the Pakistan market’s poor performance over the last 12mths, we believe that the main reasons for the blowout are political noise and concerns over the economy – in particular Fx reserves drawdown. Coming from this backdrop, the 2018 Elections have the potential to move Pakistan past the events of last year and focus on the future, irrespective of who forms the government. Much as the last two IMF programs in 2008 and 2013 provided a base that gave rise to new economic cycles, a stabilization program is needed again. Compared to a caretaker setup, an elected government will be in a much better position to take ownership of reforms under an IMF program. As Fx reserves start to build and immediate concerns are addressed, investor attention can again turn to Pakistan’s growth story backed by under-penetration in almost every sector. Following the ongoing adjustment period, shift of focus to these factors will renew optimism on the Pakistan market, in our view.

Darkest before dawn… The macroeconomic adjustment is not yet complete. After remaining stable for the best part of the PML-N’s term, the PKR has slipped by more than 15% vs. the US$ since Dec’17. With a few months to go until IMF tranches commence – assuming a new program is taken – Pakistan

Balance of Payment crises coincide with elections

0.0

2.0

4.0

6.0

8.0

10.0

12.0

-

5,000

10,000

15,000

20,000

Ap

r-0

4

May

-05

Jun

-06

Jul-

07

Au

g-0

8

Sep

-09

Oct

-10

No

v-1

1

De

c-1

2

Jan

-14

Feb

-15

Mar

-16

Ap

r-1

7

May

-18

Elections 2008

SBP Reserves (US$mn) -LHS SBP Import Cover (mths)

Elections 2013

Source: SBP & PBS

Elections have the potential to shift focus from risks to opportunities.

8 | P a g e

Perspective

will need the ongoing amnesty scheme to raise at least US$1-2bn in the interim to avert Fx reserves falling significantly below 2mth import cover. If this does not take place, it is possible that the currency slips again and commercial bank borrowing is needed, likely from Chinese institutions. We expect another c. 5% slip before year end – just before entering an IMF program seems like a plausible time. At the same time, the interest rate is poised to rise sharply in 2HCY18. Rates have been raised by 75bps in 1HCY18 and are likely to rise by at least the same quantum over the next 6mths where last month’s CPI reading of 5.2% is already the highest since Oct’14. This is coinciding with fiscal belt tightening where the caretaker government has been quick to pass-through higher international oil prices. …but Pakistan has seen worse Major macro indicators – inflation, interest rates, C/A deficit, and debt-to-GDP – are already on the same path as in FY08-09 (when an acute BoP crisis stirred ballooning inflation and in turn sharp interest rates increases and currency adjustment). The economy almost slid into recession in the subsequent years due to extreme measures to curb demand. Right now, however, what is different is (i) rising oil prices are offset by soft food inflation, (ii) government has already taken measures to arrest fiscal deficit and curb aggregate demand, which will be strengthened under an IMF program, and (iii) bulk of the currency depreciation may have already taken place. Additionally, 2008-09 coincided with the global financial crisis, which dried up capital flows and the ensuing global recession exacerbated the C/A deficit. Any deterioration of indicators will certainly slow the economy, but not as severely as in 2008-09, in our view. We anchor against IMF’s expectation of GDP growth of 4.7% for FY19 which will be slower than the projected 5.5% for FY18.

Key risks which could worsen the macro outlook are (i) water shortage crisis escalating to hurt agricultural output and accelerate CPI, (ii) oil prices overshooting much higher beyond US$80/bbl, (iii) worsening circular debt hurting power supply for industries, and (iv) weak coalition government delaying necessary macro reforms.

2018/19 to be better than 2008/09

The exchange rate has greatly adjusted already

95

100

105

110

115

120

125

130

Jun

-14

Sep

-14

Dec

-14

Mar

-15

Jun

-15

Sep

-15

Dec

-15

Mar

-16

Jun

-16

Sep

-16

Dec

-16

Mar

-17

Jun

-17

Sep

-17

Dec

-17

Mar

-18

Jun

-18

PkR/US$ REER

Source: IMS Research

Core inflation > DR means interest rates will rise quickly

-

5

10

15

20

Jul-

03

Jun

-04

May

-05

Ap

r-0

6

Mar

-07

Feb

-08

Jan

-09

Dec

-09

No

v-1

0

Oct

-11

Oct

-12

Sep

-13

Au

g-1

4

Jul-

15

Jun

-16

May

-17

Ap

r-1

8

CPI-Core DR Source: IMS Research

2008 Elections 2018 Elections

1yr prior 1yr later 1yr prior 1yr later

GDP growth 6.80% 1.20% 5.30% 4.70%

CPI 7.80% 20.80% 4.20% 7.50%

PKR/US$ 60.77 80.10 105.40 129.94

Discount rate 9.50% 15.00% 6.25% 9.25%

C/A Deficit (% of GDP) 4.80% 5.70% 5.20% 4.50%

Fiscal Deficit (% of GDP 4.30% 5.30% 5.80% 5.00%

Debt-to-GDP 60.50% 61.60% 70.80% -

Tax-to-GDP 10.20% 10.30% 12.50% -

Source: SBP, IMF, IMS Research

Macroeconomic indicators will slip more before improving, but we think this is priced in already

9 | P a g e

Perspective

The ‘bad’ is already priced in Although the macroeconomic adjustment is not yet complete, we believe it has already been priced-in to a great extent. In contrast to 2013, this time PKR depreciation and interest rate hikes have commenced in advance of elections. This has provided the market plenty of time to acclimatize to new dynamics. Not surprisingly, the market’s forward P/E multiple has already corrected significantly from 12x on MSCI upgrade to 7.3x at present. As a result, while the KSE-100 Index could yet test its Dec’17 low of c. 38,000 points, this would be a buying opportunity for us. Historically, the Index’s rebound following such transition years has tended to be very strong and we think a secular rally can commence in the latter part of CY18 and extend into CY19. That said, this is subject to an improvement in the current polarized political landscape, early entry into an IMF stabilization program and clarity on medium-term growth.

This time around the macroeconomic adjustment has commenced well in advance of elections.

KSE100 Index rebounds tend to be strong

-25

%

74

%

-5%

-27

% -11

%

31

%

-46

%4

9%

7%

-16

%

11

2%

66

%

39

% 54

%

5%

40

%

-58

%6

0%

28

%

-6%

49

%

49

%

27

%

2%

46

%

-15

% -3%

-80%

-40%

0%

40%

80%

120%

160%

CY9

2

CY9

3

CY9

4

CY9

5

CY9

6

CY9

7

CY9

8

CY9

9

CY0

0

CY0

1

CY0

2

CY0

3

CY0

4

CY0

5

CY0

6

CY0

7

CY0

8

CY0

9

CY1

0

CY1

1

CY1

2

CY1

3

CY1

4

CY1

5

CY1

6

CY1

7

CY1

8td

Source: IMS Research

10 | P a g e

Perspective

Follow the earnings growth

The 2008 and 2013 elections were both followed by IMF programs and 2018 will be no different. Although the market’s forward P/E multiple has shrunk from more than 12x on MSCI inclusion in mid-CY17 to 7.3x at present, it could potentially bottom out even lower as Pakistan again undergoes a stabilization exercise. Once valuations level off to a new normal - and they have greatly already done so in our view - onus will shift to earnings growth. Pakistan stands out on this count with projected 3yrs profit CAGR of almost 15%. The Index is dominated by Banks and Oil & Gas which benefit from rising interest rates and PKR weakness. We expect Fertilizers and Textiles to do well also. However, cyclical sectors such as Cements and Autos may remain out of favor. Market valuations are near cyclical lows By our estimates (IMS Universe; 55% of the KSE-100’s market capitalization), the market trades at a forward P/E multiple of 7.3x, lower than its long-term average of 8.5x. Given rising interest rates and risks to GDP growth, it is possible that valuations continue to tread lower, at least in the near term. Historically, this market has generally traded between 6x-12x and the lower end of this range still implies significant downside. That said, it is difficult to see the reemergence of historical lows which coincided with the global financial crisis in 2009. Instead, we think a P/E range of 7x-8x over the next year or so is more reasonable. This will not be as high as the average under the PML-N term which benefitted from low international oil prices, but also not as low as under PPP, difficult years where recovery was impeded by the global financial crisis and the aftershocks of a transition from military rule to democracy.

Forward P/E is now 7.3x; historical range is 6x-12x Ju

l-0

6

Jul-

07

Jul-

08

Jul-

09

Jul-

10

Jul-

11

Jul-

12

Jul-

13

Jul-

14

Jul-

15

Jun

-16

Jun

-17

Jun

-18

(x)

12.0

10.0

8.0

6.0

Source: IMS Research

P/E averaged 6.8x under the PPP government...

-

2

4

6

8

10

12

14

Mar-08 Mar-09 Mar-10 Mar-11 Mar-12 Mar-13

(x)

PPP Period Avg.

Avg. 6.8x

Source: IMS Research

...and 9.5x under PML-N

-

2

4

6

8

10

12

14

Jun-13 May-14 May-15 May-16 May-17 May-18

(x)

PML-N Period Avg.

Avg. 9.5x

Source: IMS Research

We think a P/E range of 7x-8x over the next year is reasonable.

11 | P a g e

Perspective

Earnings growth to assume precedence Banks, Oil & Gas, Fertilizers, Textile and Food together account for a high 65% combined weight in the KSE-100 Index. Historically, these sectors tend to do well in an environment of rising interest rates and a weakening currency. With valuations expected to remain in a tight band over the medium-term, earnings growth should take precedence hereon, in our view. Although we flag the possibility of analysts' earnings downgrades going forward, these are likely to be concentrated in cyclical sectors. The aforementioned “defensive” sectors should continue to do well. For the IMS Universe, we see 3yr earnings CAGR of 15%. This will be significantly better than flat earnings over the previous 3yrs. Shift from cyclical sectors to more defensive themes Over the last 12mths, sector price performances have depicted a shift in allocations from cyclical sectors to more defensive themes such as Banks and Oil & Gas. With the ongoing macroeconomic adjustment yet to complete, this divergent price performance is expected to persist. Similarly, in an environment of rising interest rates and greater macro uncertainty, sectors with high dividend yields and cheap valuations (low P/E and P/B) will likely outperform the traditional growth sectors - simply because the market's required rate of return will adjust upwards, as return on fixed income securities will become more attractive. From thereon, earnings growth will be key ingredient for future performance. We select the stocks overleaf from our Universe as our preferred picks.

Falling interest rates propelled cyclicals in the last 3yrs...

-41

%

-20

%

10

%

15

%

24

%

33

%

34

%

56

%

60

%

77

%

10

2%

10

6% 2

06

% 29

7%

44

9%

-100%

0%

100%

200%

300%

400%

500%

Tele

com

E&P

s

Ban

ks

Po

we

r

Fert

z.

Foo

ds

Text

ile

Re

fin

ery

OM

Cs.

Ce

me

nt

Ph

arm

a

Ch

em

ical

Oth

ers

Au

tos

Engi

ne

eri

ng

Price performance - Jan 2014 to Dec 2017

Source: IMS Research

...rising interest rates may lead to a repeat of FY11

-29

% -7%

-1%

2% 7%

8%

8% 10

%

11

%

13

%

18

% 31

% 49

%

86

%1

44

%

-90%

-60%

-30%

0%

30%

60%

90%

120%

150%

Tele

com

Oth

ers

Ce

me

nt

Ph

arm

a

Au

tos

OM

Cs.

Po

we

r

Text

ile

Ban

ks

Engi

ne

eri

ng

E&P

s

Ch

em

ical

Fert

z.

Re

fin

ery

Foo

ds

Price Performance - Jul 2010 to Jul 2011

Source: IMS Research

"Defensive" sectors have a high weight in the Index...

1.8

%

1.8

%

2.1

%

2.3

%

3.2

%

5.0

%

5.8

%

5.9

%

7.0

%

13

.1%

15

.4%

24

.2%

0%

10%

20%

30%

Ste

el

Ch

em

ical

s

Text

ile

s

Ph

arm

a

Au

tos

Foo

d

OM

Cs

Po

we

r

Ce

me

nt

Fert

iliz

er

E&P

Ban

ks

Weight in KSE100

Source: IMS Research

...and will drive growth going forward

18% 20%

34%

17%14%

19%

2%

16%19%

-3% -4% -4%

-11%-20%

-10%

0%

10%

20%

30%

40%

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

20

15

20

16

20

17

20

18

F

20

19

F

IMS Universe Earnings Growth (%)

Source: IMS Research

12 | P a g e

Perspective

Top Picks

PER (x) PBV (x) DY (%) ROE (%)

TP (PRs) Stance 2019F 2020F 2019F 2020F 2019F 2020F 2019F 2020F Banks

ABL 115 Buy 7.1 6.1 0.9 0.9 9% 9% 13% 14% BAFL 52 Neutral 7.3 6.4 1.0 0.9 5% 6% 13% 14% HBL 190 Buy 7.1 6.0 1.1 1.0 6% 7% 15% 16%

Fertilizer

ENGRO 371 Buy 8.4 6.1 0.8 0.7 9% 10% 9% 12% FFC 105 Neutral 7.6 8.7 3.5 3.5 11% 11% 47% 40% EFERT 84 Neutral 7.3 6.8 2.2 2.1 12% 13% 30% 31%

Oil & Gas

OGDC 185 Buy 7.0 6.9 1.1 1.0 7% 9% 16% 15% PPL 253 Buy 6.9 6.9 1.5 1.4 7% 7% 22% 20% PSO 431 Buy 5.9 5.9 0.8 0.7 7% 8% 13% 12% APL 779 Buy 7.9 7.0 2.5 2.4 11% 12% 32% 35% SHEL 461 Buy 6.5 5.3 2.6 2.4 12% 0% 40% 46%

Textiles

NML 177 Buy 7.5 7.4 0.5 0.5 5% 5% 7% 6% NCL 68 Buy 5.4 5.8 0.9 0.8 6% 6% 16% 14% KTML 70 Buy 8.2 6.7 1.1 1.1 5% 6% 14% 16%

Power

NPL 36 Buy 2.5 2.3 0.5 0.4 11% 15% 20% 18% HUBC 145 Buy 7.7 5.9 3.0 2.6 9% 12% 39% 45% KAPCO 63 Buy 3.7 3.5 1.2 1.1 21% 23% 33% 32%

13 | P a g e

Perspective

Risks Politics: Failure of a government to form after elections and/or a continuation of a polarized political landscape that may prolong uncertainty Security: Resurgence in terrorism incidents and/or failure to address deficiencies pointed out by the FATF Economy: Failure to enter an IMF program in a timely manner, which will delay the stabilization process. Further rise in international oil prices will exacerbate the BoP position, cause the currency to slip again and lead to a sharper than expected rise in interest rates. Foreign selling: Continued foreign selling, especially in large caps, can dent local investor confidence. Conversely, return of foreign buying can provide support to the Index. Earnings Growth: Projections of earnings growth in the early teens over the next few years can come in for downward revision in case the macroeconomic adjustment is more painful than expected.

14 | P a g e

Perspective

We, Raza Jafri, CFA & Muhammad Saad Ali, CFA, certify that the views expressed in the report reflect our personal views about the subject securities. We also certify that no part of our compensation was, is, or will be, directly or indirectly, related to the specific recommendations made in this report. We further certify that we do not have any beneficial holding of the specific securities that we have recommendations on in this report.

*Based on 12 month horizon unless stated otherwise in the report. Upside is the percentage difference between

the Target Price and Market Price.

Valuation Methodology: We use multiple valuation methodologies in arriving at a Target Price including, but not limited to, Discounted Cash Flow (DCF), Dividend Discount Model (DDM) and relative multiples based valuations.

Risks: Please refer to page 13.

Disclaimer: Intermarket Securities Limited has produced this report for private circulation only. The information, opinions and

estimates herein are not direct at, or intended for distribution to or use by, any person or entity in any jurisdiction where doing so

would be contrary to law or regulation or which would subject Intermarket Securities Limited to any additional registration or licensing

requirement within such jurisdiction. The information and statistical data herein have been obtained from sources we believe to be

reliable where such information has not been independently verified and we make no representation or warranty as to its accuracy,

completeness and correctness. This report makes use of forward looking statements that are based on assumptions made and

information currently available to us and those are subject to certain risks and uncertainties that could cause the actual results to

differ materially. No part of the compensation of the author(s) of this report is related to the specific recommendations or views

contained in this report.

This report is not a solicitation or any offer to buy or sell any of the securities mentioned herein. It is meant for information purposes

only and does not take into account the particular investment objectives, financial situation or needs of individual recipients. Before

acting on any information in this report, you should consider whether it is suitable for your particular circumstances and, if

appropriate, seek professional advice. Neither Intermarket Securities Limited nor any of its affiliates or any other person associated

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Subject to any applicable law and regulations, Intermarket Securities Limited, its affiliates or group companies or individuals connected

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Ratings Guide* Upside

Buy More than 15%

Neutral Between 0% - 15%

Sell Below 0%

15 | P a g e

Perspective

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16 | P a g e

Perspective

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