Returning conviction
With the IMF staff-level agreement in place, the much-needed breathing space for Pakistan’s economy reinforces our liking for the banking sector. The absence of banks from debt restructuring in Zambia and Sri Lanka also comforts if this conversation crops up again in Pakistan next year.
1QCY23 results indicate underlying profitability is strong, on rising margins and resilient asset quality. Our 2023-27f earnings estimates remain broadly unchanged, even as we conservatively factor in a higher cost of risk and a recurring 49% tax rate (we treat 10% super tax as permanent).
Pakistan banks are cheap, trading at a CY23f P/B of 0.6x and P/E of 2.5x, which stacks up very well against strong 20%+ ROE expected over the next few years. There is good variety on offer too – MEBL delivers sector-beating ROE, UBL and MCB are excellent on dividend yield, and HBL, BAFL and BAHL have significant room to rerate.
Pakistan banks are worth a revisit
Pakistan’s late push to better align itself with the IMF did not secure the 9th review of the EFF programme but arguably lands it something better – a 9 month SBA facility. This defers the debate on external debt restructuring, if not outright putting it to rest, and allows the next government (we expect elections on time in October) to resume the reforms process under a successor long-term IMF programme. We have seen this stabilization-to-growth path falter consistently in Pakistan, and this time may be no different, but the deeply attractive valuations (our banks universe trades at a c 35% discount to 5yr PB) mean there is still room for a rally, in our view. We are further comforted by banks not featuring in the debt restructuring plans for Zambia and Sri Lanka, something that could apply to Pakistan banks, given the similar argument of high sovereign exposure and poor cost-benefit tradeoff, should this conversation resume again next year.
Earnings estimates unchanged through the cycle
1QCY23 earnings were strong (pre-tax profits up 31% QoQ and 70% YoY), with margins continuing to expand and asset quality remaining resilient. Underlying earnings momentum should remain buoyant in our view, even as we build in (i) a recurring 49% tax rate (we conservatively treat the recently imposed 10% super tax as permanent given the government’s weak finances) and (ii) a relatively elevated cost of risk, especially for 2024f. Asset quality is holding up very well so far, with some banks continuing to post net reversals. We were wary of potential issues in the import-dependent sectors but, with import restrictions out of the way, this does not seem to be a problem anymore. Even so, given the stresses on the economy and record-high interest rates, we keep our cost of risk estimates for 2023/24f at 70bps and 90bps, respectively, vs. 30bps in 2022. Our 2023-27f earnings estimates remain broadly unchanged, with higher margins acting as the offsetting factor.
Earnings momentum to help shore up capital
A combination of mark-to-market losses on domestic fixed income, ECL / impairment on Pakistan Eurobonds, and high cash payout ratios have driven down CARs towards the regulatory minimum for some banks. In response, the SBP has deferred IFRS 9 implementation by another year and relaxed D-SIB requirements. Banks may have chosen to become conservative on their cash payouts, but with the IMF providing temporary comfort on the economy, and with strong earnings momentum likely to help rebuild capital buffers, we keep our projected payout ratios broadly unchanged. This holds for BAHL too, despite relatively thin CAR at 12.6%. For UBL, the strategy seems to be one of maximum payout for now, and we build in the same.
Valuations are highly compelling
Banks have underperformed the KSE100 in 2023td, but we believe the ingredients are in place for them to lead the market’s rebound as the economy stabilizes. Pakistan Banks offer ROEs of 20%+ over the next few years, while trading at a c 35% discount to 5yr P/B and c 60% discount to 5yr P/E. Our top pick is MEBL but there is enough about the others to merit a Buy call across our coverage cluster (UBL and MCB look excellent on D/Y, while HBL, BAFL and BAHL are cheap on P/B).
Courtesy- Intermarket Securities Limited