By: Next Capital Limited
Pakistan Equity Market Strategy 2016;
Whilst KSE valuations look undemanding at first glance…
- With PERs significantly below most emerging/frontier market peers, a potential upgrade to MSCI EM is seen by most to be a key catalyst for a rerating. However, consider the following:
- The KSE-100’s 5 year total return CAGR of 23.9% (in USD) is the highest amongst peers, and in sharp contrast to the peer group avg. of -0.4%.
- A 5 year earnings CAGR of 21.1% (in USD) versus peer group avg. of -2.4%.
- Net profit margins that are 60% above the average of the last 5 years, where peer group margins are 10.7% below their 5 year average.
- Best in class ROEs of 19.2%, versus peer group avg. of 10.2%.
- The PKR has been the best performing currency in the last two years in its peer group, up 0.6% against the USD, whereas peers have on average declined by 16.7% in the same period.
…they flatter to deceive
- Our analysis, in contrast to consensus, finds the KSE not as cheaply valued as it seems based on simple PER, for three reasons.
- Profit margins/ROEs are at or nearing record levels in many industries such as Autos, Cement, Steel, Consumer, and Pharma. Thus, although the trailing PER is low, the KSE-100’s (ex-oil and ex-banks) Cyclically Adjusted Price to Earnings (CAPE) is high at 16.2x. (Cyclically Adjusted Price to Earnings (CAPE) is calculated using current price divided by average inflation adjusted earnings of the last five years. In times when profit margins are excessively high or low, CAPE is a better measure of the market valuations as compared to normal PER).
- In sharp contrast to the last five years, there is a significant corporate earnings slowdown ahead (for Next Universe, we expect a 3 year earnings CAGR of a mere 5%, with risks tilted further to the downside).
- On the basis of REER, the Pak Rupee seems overvalued by 15%-20%.
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