Pakistan Market Strategy 2017: Prepare for a Sideways Market

Pakistan Market Strategy 2017
Prepare for a Sideways Market
BRP - 116
www.jamapunji.pk
January 10, 2017
By Next Research
Email: research@nextcapital.com.pk
+92-21-111-639-825 Ext:109

3
OVERVIEW: PREPARE FOR A SIDEWAYS MARKET
1. Most of the re-rating has already transpired
• Although most of the market is not acknowledging it, significant re-rating has already occurred. The KSE-100’s trailing PER
has increased from 10x in Dec-15 to 13.4x, currently. Our estimate of forward PER is 12.7x. In terms of PER, the KSE has
reached the peak levels of the 2006-2008 bull cycle.
• Dividend yield of the market is now 3.9%. Excluding banks, power, and fertilizer, the yield is now 2.8%.
• Aggressive selling by large existing EM and FM funds is masking MSCI inflows, and will continue to do so.
• Limited scope for further re-rating; Pakistan’s peaked margins and over-valued currency justify a discount to regional peers.
2. Corporate earnings slowdown; the spectre of competition now visible on the horizon
• We foresee limited earnings growth ahead; Next Universe has a 6.7% growth next year, and ex- E&P earnings are flat.
• Increasing international and domestic competition is now a reality in sectors like Autos, Cements, and Steel. As per Tobin’s
Q, most major manufacturing sectors are trading at a greater premium today than they were in the previous bull cycle of
2005-2007.
3. “Liquidity” fixation leading to under-pricing of rising macro risks
• With investors fixated upon the rising liquidity, rising macro risks are being under-priced, in our opinion.
• The trade deficit (which has been large for a couple of years now) is finally resulting in current account deterioration, with
remittances sliding and oil prices picking back up.
• Currency over-valuation has worsened, with the PKR now 26% over-valued on a REER basis, making it amongst the top 5
most over-valued currencies in the world. A 15% devaluation is a rising probability in the next 12-18 months.
4. A sideways market is the most likely scenario
• We expect the KSE to enter into a low return environment now, with limited growth in earnings, dividends, and re-rating. On
a strategy level, we advise our clients to adopt a more defensive approach to portfolio allocation, increase reliance on
dividend yield, and avoid over-valued stocks and sectors.
• On a sector level, we are Over Weight on Banks and Market Weight on E&Ps OMCs, Cement and Steel. However, we are
Under Weight on Autos, Fertilizers, Consumers, and Pharmaceuticals.

4
RE-RATING HAS ALREADY TRANSPIRED, MARKET NOT RECOGNIZING IT
 KSE valuations; If not steep, then not cheap!!
 Considerable re-rating has already happened, with the PSX-100 trailing PER rising from 10.0x in Dec-15 to 13.4x
currently. Removing Banks, Power, and Fertilizer, the trailing PER rises to 17.4x. The forward PER of the market as
per our estimates is 12.7x, the same level of valuations it had achieved in the last boom cycle of 2006-2008.
 Dividend yield of the market is 3.9% currently; excluding Banks, Power, and Fertilizer, this yield falls to 2.8%. This is
well below the 10 year bond yield of 8.6%, and also below the rental yield in many cases.
 Pakistan’s currency over-valuation and peak corporate margins warrant a discount to regional EM countries.
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Dec-05
Dec-06
Dec-07
Dec-08
Dec-09
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Dec-12
Dec-13
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Dec-15
Dec-16
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Dec-16
Source: PSX, SBP, Next Research
Figure 1 – KSE-100 PER approaching peak levels from last bull cycle… Figure 2 – …with D/Y of 3.95% now well below the 10 year PKRV of 8.6%

5
THE CURIOUS CASE OF THE KSE-100 PER
 In 2017 strategy notes, we find that consensus has under-stated both the trailing and forward PER. This is creating an
impression that re-rating has not happened as yet, whereas our numbers indicate that significant re-rating has already taken
place.
 Some of the reasons for the divergence are 1) we are assuming super-tax imposition in FY17/18 as well (a high likelihood,
in our opinion), and 2) we have taken consensus estimates for companies not in our coverage, which accounts for
companies in sectors with high multiples.
Figure 3 – Next PER significantly higher than consensus
Source: PSX, Company Accounts, Next Research
11.9
10.7
13.4
12.7
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2.0
4.0
6.0
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12.0
14.0
16.0
Trailing PER Fwd PER
Consensus Next

6
LIQUIDITY- SELLING BY EXISTING EM/FM FUNDS MASKING MSCI INFLOWS
 Although some of the MSCI related FIPI inflow is coming through, it is being masked by FIPI outflow from existing EM
and FM funds that are reducing Pakistan’s exposure. This has resulted in a significant net foreign outflow of US$ 639mn
in the last two years.
 In the last year, whilst overall net FIPI selling has been US$ 120mn, it also includes buying from foreign corporates worth
US$ 133mn.
 We expect selling from existing foreign funds to continue in 2017 as well; thus the net impact of MSCI inflows (initially
estimated to be around US$ 300-500mn including both active and passive) is likely to be significantly lower.
465
329
137
40
(62) (97)
(171)
(639)
(800)
(600)
(400)
(200)
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200
400
600
Mutual funds NBFC's Individuals Others Broker prop Companies Banks FIPI
Net buy/(sell) (US$ mn))
Source: NCCPL, Next Research
Figure 4 – FIPI outflow in the last two years has been US$ 639mn

7
WHILST EARNINGS GROWTH HAS HISTORICALLY OUTPERFORMED…
 In the last five years, the earnings growth achieved by Pakistan’s equity market has significantly outperformed regional
peers.
 Pakistan’s robust earnings growth is in sharp contrast to all regional peers.
Source: Bloomberg, Next Research
Figure 5 –Pakistan’s 5 year earnings growth CAGR (in US$) has significantly outperformed regional peers
-7.0%
-0.7% -0.5% -0.4%
0.9% 1.5%
3.2%
4.2%
15.7%
-10.0%
-5.0%
0.0%
5.0%
10.0%
15.0%
20.0%
Malaysia India Sri Lanka Turkey Indonesia Thailand Philliphines Vietnam Pakistan

8
…THE OUTLOOK IS SUBDUED…
 For the Next Universe, we expect an earnings growth of 6.7% in 2017; ex-E&P earnings expected to remain flat. We have
assume continuation of super-tax in our estimates (a high likelihood, in our opinion).
 A corporate earnings slowdown is visible across sectors, after a period of very strong earnings growth in the last few years.
Historically, the KSE has enjoyed strong double-digit growth in both earnings and dividends.
Figure 6 – Earnings growth (ex-E&Ps) do not paint a bright picture
Source: Next Research
PKR mn 2016 2017F 2018E 1yr CAGR 2yr CAGR
Banks 123,408 117,390 124,841 -4.9% 0.6%
E&P 86,384 109,905 137,297 27.2% 26.1%
Cement 39,769 48,123 51,302 21.0% 13.6%
Fertilizer 33,770 34,451 34,922 2.0% 1.7%
Power 27,204 27,003 29,456 -0.7% 4.1%
Autos 19,619 18,346 16,695 -6.5% -7.8%
OMC 19,146 16,830 17,889 -12.1% -3.3%
Steel 5,306 6,912 11,327 30.3% 46.1%
Textile 4,316 3,981 4,331 -7.8% 0.2%
Total 358,922 382,940 428,059 6.7% 9.2%
Total- ex E&P 272,538 273,035 290,762 0.2% 3.3%

9
…AND COMPETITIVE PRESSURES ARE NOW ON THE HORIZON
Source: Company Accounts, Next Research
Figure 7– Based on Tobins’s Q ratio, most sectors are trading at a greater premium to replacement cost than they were in 2006-2007 bull cycle
 As per Tobin’s Q, industries such as Cement and Autos are trading at a much higher premium to replacement cost today
than they were in the previous bull run of 2006-2008.
 The initial signs of increasing international and domestic competition is now much more visible in sectors like Autos,
Cements, and Steel. Thus, mean reversion in margins is a real possibility within a 2 year time-frame.
2.46
2.73
2.03
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0.5
1.0
1.5
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2.5
3.0
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Cement Autos Steel

10
WITH LIQUIDITY FIXATION; MARKET UNDER-PRICING RISING MACRO RISKS
 We are already seeing the initial signs of a build-up of pressure on the balance of payment in FY18:
 Current account (CA) deterioration is setting in; we expect the CA deficit is expected to increase to 1.5%-2.0% of
GDP in FY17 and 2.0-2.5% of GDP in FY18.
 This is a result of 1) trade gap worsening with stagnant exports and recovering oil prices (we assume oil at US$
60/bbl), and 2) remittances also coming under pressure, with 63% of Pakistan’s remittances coming in through
Saudi, UAE, and GCC (we have assumed stability in remittances from current levels).
 A US$ 10/bbl increase in oil prices increases our oil import bill by US$ 1.5bn.
 With significant external debt repayments due in FY17 and FY18, and inflow from the IMF program having been
completed, some run-down in FX reserves is expected.
Figure 8– Sharp deterioration expected in the current account from FY17 (US$mn)
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6,000
8,000
10,000
FY14A FY15A FY16A FY17E FY18F

11
OVER-VALUED CURRENCY- OUR BIGGEST MACRO CONCERN
 PKR’s REER at 126 shows a 25% over-valuation in the last three years, and is an untenable situation in the long-run.
This is a major cause of a sharp decline in exports (down 21% from FY14 levels), when the PKR REER was fairly valued.
With CPEC infrastructure and power projects, it is imperative that the export base is widened, else these projects will start
to become a drain on the fiscal and current account post FY18, as FX outflow (debt repayment and dividends) will begin.
 We expect the govt. to try keeping the currency under check leading into election year, but a sharp devaluation (of around
15-20%) in the next 18-24 months is a rising possibility.
 The equity market is underpricing these macro risks at the moment given the fixation with liquidity, in our view. Sectors
that will be disproportionately hurt by souring macros are Autos and Pharma.
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Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16
Figure 9– PKR’s REER currently stands at 126, an overvaluation of 25% over the last three years

12
PKR REER AMONGST THE HIGHEST IN THE WORLD
 The Pakistan Rupee’s REER is the third highest in the world, highlighting a high degree of over-valuation in the
currency.
Countries Value Countries Value
Venezuelan Bolivar 1,162 Danish Krone 96
Iceland Krona 143 Romanian Leu 96
Pakistani Rupee 126 Chilean Peso 94
Nigerian Naira 125 Indonesian Rupiah 94
Hong Kong Dollar 124 Australian Dollar 93
Saudi Riyal 123 Croatian Kuna 93
Chinese Renminbi 122 Euro 91
United States Dollar 117 Swedish Krona 90
UAE Dirham 113 Czech Koruna 90
Philippine Peso 111 Hungarian Forint 89
South Korean Won 110 Norwegian Krone 89
Swiss Franc 109 Polish Zloty 88
New Zealand Dollar 109 Malaysian Ringgit 85
Singapore Dollar 108 Brazilian Real 83
Taiwanese Dollar 106 Russian Ruble 82
Israeli Shekel 106 Canadian Dollar 81
Thai Baht 101 Japanese Yen 81
Indian Rupee 101 Turkish Lira 79
Peruvian Sol 100 South African Rand 76
British Pound 97 Mexican Peso 75
Algerian Dinar 97 Colombian Peso 74
Bulgarian Lev 96 Argentine Peso 74
Figure 10– On the basis of REER, the PKR is amongst the most over-valued currencies in the world

13
DWINDLING EXPORTS A CONSEQUENCE OF EXCHANGE RATE POLICY
 Pakistan’s export to GDP is the 8th lowest in the world, and has been on a downward trend over the last three years,
mainly as a consequence of an over-valued exchange rate.
 Exports have fallen by 21% from FY14 levels; current export numbers are similar to what was being achieved ten years
ago.
 This is creating a significant macro-economic imbalance in the economy, and in the context of CPEC investments, it is
imperative that we widen our export base on a priority basis.
Source: World Bank, Next Research
Figure 11– Pakistan’s export as % of GDP (goods + services) amongst the lowest in the world
10.6 13.2
17.3 19.9 20.5 21.1 22.1
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Pakistan Egypt Bangladesh India Sri Lanka Indonesia China Turkey Philippines South Africa Morocco Thailand Malaysia Vietnam

14
A SIDEWAYS MARKET- THE MOST LIKELY OUTCOME
Source: Company Accounts, SBP, Next Research
 For the PSX, one of two scenarios can play out over the next two years:
a) The PSX moves into a low return environment (from a very high one), a phenomenon known as a sideways market,
given that there is limited growth in earnings and dividends, and re-rating. At this point, this seems the more likely
scenario. or;
b) A significant correction if macro variables start to deteriorate, in particular the balance of payments.
 On a strategy level, we advise our clients to adopt a more defensive approach to portfolio allocation, increase reliance on
dividend yield, and avoid in-favor over-valued stocks and sectors.
Figure 12– Sideways case seems more likely; advise a more defensive approach
Sideways Case Bear Case
Market return Jan-12 Jan-17 Jan-19 Jan-19
Earnings CAGR (PKR) 12.4% 9.0% 5.0%
Dividends CAGR (PKR) 15.9% 8.0% 5.0%
PER 7.30 13.4 13.4 10.0
Re-rating 82.9% 0.0% -25.1%
KSE-100 11,125 49,383 63,169 44,474
CAGR (PKR) 34.7% 13.1% -5.1%
CAGR (US$) 30.9% 3.1% -13.4%
PKR dep CAGR 2.9% 7.0% 10.0%

15
FAIRLY VALUED IS THE NEW UNDER-VALUED
Source: PSX, Next Research
 On a strategy level, we advise our clients to adopt a more defensive approach
to portfolio allocation, increase reliance on dividend yield, and avoid over-
valued stocks and sectors. It is important to understand that we are about to
enter a low return environment, a significant change from the last few years.
 Given the liquidity driven valuations at the moment, DCF based valuations
are likely to under-shoot market prices.
 The key is to avoid the over-valued stocks and sectors. Fairly valued
would be the new under-valued.
 Avoid sector where earnings are susceptible to adverse macro outcomes
(currency deval, increase in oil prices, increase in interest rates).
 On a sector level, we are Over Weight on Banks and Market Weight on E&Ps,
OMCs, Cement and Steel. However, we are Underweight on Autos, Fertilizers,
Consumers, and Pharmaceuticals.
 Our top picks are MCB, MEBL, BAHL, OGDC, PIOC, NPL, and ASTL.
Sector Rating % weight in KSE-100
Banks Overweight 24.2%
Oil and Gas Marketweight 15.4%
Cement Marketweight 11.5%
Autos Underweight 2.8%
Steel Marketweight 0.9%
Fertilizer Underweight 6.3%
Power Marketweight 7.2%
Figure 13– Sector ratings

17
BANKS: RALLY STILL HAS LEGS (OW)
 Despite the strong price performance in the last six months (Banking sector universe
up 32% in 6m), we continue to maintain an Over-Weight stance on the sector.
 The reason why we expect the banking sector to continue to do well is 1) it is likely
to be the biggest beneficiary of MSCI flows , 2) whilst TP upside may be limited, in
the context of the overall market valuations, the sector still offers better relative
value, and 3) it largely remains counter-cyclical and is therefore a good defensive play
against adverse macro outcomes.
 MCB is our top pick in the sector, followed by BAHL and MEBL.
Figure 14 – MCB and MEBL to clock in the
strongest earning profile in the next two years
Dec-17 TP Current % upside Recommendation
MCB 294 238 24% O/P
BAHL 72 59 22% O/P
MEBL 76 68 13% O/P
HMB 45 39 15% NEUTRAL
UBL 268 247 9% NEUTRAL
HBL 295 278 6% NEUTRAL
ABL 122 120 2% NEUTRAL
BAFL 41 39 5% NEUTRAL
Figure 15 – PER and PB of Next Banking universe
Base case CY16F CY17F CY18F 2yr CAGR
HBL 24.58 22.30 24.89 0.6%
UBL 25.31 22.46 23.84 -2.9%
MCB 18.63 23.40 23.84 13.1%
ABL 13.34 12.44 12.50 -3.2%
BAFL 4.85 4.03 4.10 -8.0%
BAHL 6.40 7.09 7.77 10.2%
HMB 4.84 5.73 6.43 15.2%
MEBL 5.17 6.32 8.55 28.6%
PER CY16F CY17F CY18F PB CY16F CY17F CY18F
HBL 11.41 12.55 11.25 HBL 2.11 2.01 1.87
UBL 10.11 11.00 10.36 UBL 2.02 1.90 1.76
MCB 12.78 10.17 9.98 MCB 1.92 1.78 1.65
ABL 8.99 9.64 9.60 ABL 1.49 1.39 1.30
BAFL 8.01 9.64 9.46 BAFL 1.15 1.08 1.01
BAHL 7.73 8.17 7.45 BAHL 1.63 1.50 1.36
HMB 7.84 6.31 5.64 HMB 0.99 0.94 0.87
MEBL 12.76 10.45 7.72 MEBL 2.28 2.04 1.80
Source: PSX, Next Research

18
MCB: BENEFITS FROM NIB ACQUISITION NOT BEING PRICED-IN
* All per share values calculated at Post-NIB acquisition number of shares for MCB post CY16
 MCB, the relative under-performer of the banking sector, is poised to Outperform in 2017
 NIB deal adds value on three fronts, 1) significant tax savings, 2) scope for large scale NPL reversals, 3) build-up of a
sizeable Islamic banking footprint, and 4) MCB trades at a much higher multiple than at which it has acquired NIB.
 The equity market’s major concern regarding MCB was the earnings dip in 2017/2018, which will now be averted given NIB
acquisition.
Figure 16 – MCB has underperformed massively owing to
concerns over expected earnings decline
10.9%
31.0%
36.7%
42.8%
44.0%
46.5%
54.3%
63.7%
0.0% 10.0% 20.0% 30.0% 40.0% 50.0% 60.0% 70.0%
MCB
HMB
BAHL
ABL
UBL
HBL
BAFL
MEBL
Particulars CY13A CY14A CY15A CY16E CY17E CY18E
EPS 19.3 21.9 23.0 18.7 23.4 23.8
BVPS 99.0 116.9 123.8 123.6 133.5 144.0
P/B 2.4 2.0 1.9 1.9 1.8 1.7
P/E 12.3 10.9 10.4 12.74 10.2 10.0
D/Y 6% 6% 7% 7% 7% 7%
ROE 20.3% 20.2% 19.1% 14.6% 18.2% 17.2%
ROA 2.7% 2.8% 2.62% 1.92% 2.28% 2.08%
NIMS 5.3% 5.5% 5.8% 4.4% 4.1% 3.8%
Cost of funds 4.2% 4.8% 4.0% 3.2% 3.3% 3.6%
Interest yield 9.5% 10.2% 9.7% 7.6% 7.3% 7.4%
NPL to gross loans 8.7% 6.8% 6.1% 5.6% 4.7% 3.8%
NPL coverage 85.7% 85.6% 90.8% 90.8% 90.8% 90.8%
Advance to Deposit 42.4% 46.8% 47.0% 47.1% 47.3% 47.4%
Investment to deposit 71.1% 71.9% 77.7% 77.0% 78.5% 78.5%
Operating cost to deposit 2.96% 2.99% 3.17% 3.05% 2.96% 2.86%
Deposit growth 16% 9% 2.9% 11.5% 11.5% 13.0%
RATIOS - STAND ALONE BASIS
Figure 17 – MCB financial snapshot

19
E&PS: DEFENSIVE PLAY IN A SIDEWAYS MARKET (MW)
Our oil price assumption for FY17 is US$ 50/bbl and a long term oil price assumption is set if US$ 60/bbl.
 OPEC output cut decision is expected to balance the global oil market in
2017; we expect oil prices to sustain at US$ 60/bbl.
 Although the rally post OPEC cut announcements has been significant,
OGDC and PPL still offer room in terms of their valuations.
OGDC/PPL/POL trade at 7.5x/7.6x/9.1x based on FY18 earnings. A sharp
PKR depreciation is an upside risk to our estimates.
 The production growth in both OGDC and PPL has not been fully factored
in by the market.
90.1
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2013 2014 2015 2016E 2017E
Demand Supply Surplus (RHS)
Figure 18– Global oil market to balance in 2017 (mn BPD)
Figure 19 – Earnings sensitivities at various oil prices
Source: OPEC/Next Research
EPS
US$/bbl
OGDC PPL POL
FY17 FY18 FY17 FY18 FY17 FY18
70 19.3 22.5 16.1 25.3 44.0 60.3
60 18.5 20.4 15.3 22.3 40.9 51.7
50 17.7 18.2 14.4 19.3 37.7 43.1
40 16.7 15.8 13.6 15.6 34.5 34.3
30 15.8 13.2 12.8 12.0 31.4 24.8
PE
US$/bbl
OGDC PPL POL
FY17 FY18 TP FY17 FY18 TP FY17 FY18 TP
70 8.8 7.6 228.0 12.0 7.6 247.0 12.4 9.0 625.0
60 9.2 8.3 206.0 12.6 8.7 217.0 13.3 10.5 521.0
50 9.6 9.4 184.0 13.4 10.0 187.0 14.4 12.6 417.0
40 10.2 10.8 159.0 14.2 12.3 154.0 15.8 15.9 309.0
30 10.8 12.9 142.0 15.1 16.1 133.0 17.3 22.0 251.0

20
CEMENTS: SANGUINE OUTLOOK LARGELY PRICED-IN (MW)
- High capacity utilizations are likely to intensify over the next two years,
which will allow manufacturers to retain pricing power.
- We eye 2yrs local demand CAGR of 15% which would increase domestic
utilization to 88% by FY18, from 72% in FY16.
- Increasing utilization levels, besides delays in expansions, maintain our
comfort on pricing arrangement going forward. We have revised our
expansion timeline and extend the completion time by 6mths (fig 20 for
details). Any sustainable increase in coal prices is likely to be passed-on.
Company Rating TP (PKR/sh) Upside
PIOC PA BUY 169 18%
MLCF PA Neutral 141 8%
DGKC PA Neutral 243 6%
CHCC PA Neutral 169 -4%
LUCK PA Neutral 817 -6%
KOHC PA Neutral 297 -2%
ACPL PA Neutral 290 -14%
Figure 20– Expected timeline of announced expansions Figure 21 – Domestic utilization to increase to 88% by FY18
0%
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80%
90%
100%
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017E
2018E
Local Total
Capacity Completion Total capacity
North South North South North South
LUCK 2.3 1.3 Jul-19 Jan-19 6.1 4.9
DGKC 2.3 3.0 Dec-17 Dec-18 6.5 3.0
ACPL - 1.3 - Jan-18 - 5.7
MLCF 2.3 - Dec-18 - 5.7 -
PIOC 2.3 - Jan-19 - 4.3 -
POWER - 1.7 - Jan-19 - 2.6
GWCL 2.4 - Sep-18 - 4.5 -
CHCC 1.3 - Jan-17 - 2.4 -
Industry 12.9 7.2 49.9 15.8
Source: APCMA, Next Research

21
COAL PASS-ON LIKELY, AND SOME MORE?
 Given high utilizations, we expect any sustainable increase in cement prices to be passed-through. If coal prices sustain
at US$ 75/ton, we estimate that a PKR 30/bag increase is required to maintain profitability.
 If retail prices are increased even more than the required PKR 30/bag (bull case in fig 22), that can lead to another rally
in the sector.
 Our top picks in the sector are PIOC, MLCF, and DGKC.
Figure 22- Extent of pricing power is key
Base case Complete pass on Bear case Bull case
Coal at US$ 66/ton
PKR 30/bag price increase with coal at
US$75/ton
US$ 75/ton and no price change
PKR 70/bag price increase with coal at
US$75/ton
FY17 FY18 TP FY17 FY18 TP FY17 FY18 TP FY17 FY18 TP
LUCK 59.2 61.7 817.0 59.2 61.7 816.0 57.2 59.6 782.0 61.8 64.7 863.0
DGKC 23.2 25.0 243.0 23.6 25.3 247.0 22.4 24.0 223.0 25.2 27.2 279.0
ACPL 30.9 34.6 290.0 30.9 34.5 286.0 29.2 32.3 259.0 33.1 37.5 322.0
MLCF 13.4 13.7 141.0 13.5 13.5 135.0 12.7 12.6 122.5 14.5 14.6 153.0
KOHC 30.9 30.9 297.0 31.2 31.2 297.0 29.5 29.3 276.0 33.4 33.6 324.0
CHCC 13.8 17.9 169.0 13.7 17.8 165.0 12.8 16.3 147.0 15.0 19.9 187.0
PIOC 10.8 12.7 169.0 11.0 12.9 169.0 10.2 11.8 143.0 12.2 14.4 204.0

FERTILIZER: INVENTORY GLUT LIKELY TO PERSIST (UW)
 Following the recent government decision to remove subsidies on all
fertilizer products, we expect urea off-take to remain under pressure in
CY17 unless subsidies are restored. Inventory levels will remain elevated
until manufacturers are able to export their products, as Pakistan has moved
from a urea deficit to a marginal urea surplus.
• Post subsidy removal, we expect firms to increase the prices by a certain
proportion to pass on the impact of subsidy. We have outlined sensitivity of
CY17 EPS to manufacturers increasing prices to pass on 50% and 100%
impact of the subsidy removal.
• Until an equilibrium is achieved and inventory levels normalize, pricing
power of manufacturers is likely to remain limited.
Fig 25 – Higher production to keep inventory elevated unless the government facilitates subsidies for exports
0.00
0.20
0.40
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0.80
1.00
1.20
1.40
1.60
1.80
4.0
4.5
5.0
5.5
6.0
6.5
7.0
2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
Production (mn tons) Consumption Inventory (RHS) ME Urea (US$/MT)
175 200 225 250 275
PKR/USD
105 1332 1487 1641 1796 1951
110 1400 1563 1726 1889 2051
115 1464 1634 1804 1974 2145
Fig 24 – Sensitivity of landed cost of ME Urea (PKR/50kg
bag) to ME prices (US$/MT) and exchange rate
Fig 23 – Impact of fertilizer subsidy removal on
profitability of the manufacturers
*corresponds to 50% pass on of subsidy removal without any
impact on volumes
**100% pass on of subsidy impact with 5% decline in volumes
of urea, CAN, DAP and NP
CY17 EPS FFC EFERT FFBL Fatima
Base 9.73 9.02 4.05 3.25
50%* 8.26 7.17 2.22 2.80
Change -15% -21% -45% -14%
100%** 9.31 8.47 3.26 2.92
Change -4% -6% -20% -10%
Source: NTDC, Next Research
Source: Next Research, Bloomberg

EFERT STANDS OUT FROM A YIELD PERSPECTIVE
23
 With lack of earnings growth and limited international investor’s interest, all
focus in the sector will be on dividend yield. In this regard, EFERT stands out;
whilst our fertilizer universe offers an average DY of 9% in CY17/CY18,
EFERT offers a yield of 13%.
 Urea exports would be an upside risk to our estimates as it would improve
profitability and clear up the massive inventory, thus freeing up working capital
and boosting valuations.
 On the phosphates front, we reiterate our Neutral stance on FFBL. Although
higher urea production after coal power project comes online in 2HCY17 will
boost earnings, lower margins on DAP front compared to historical levels will
continue to create an overhang on profitability.
0%
2%
4%
6%
8%
10%
12%
14%
16%
2015 2016 2017 2018
Dividend yield (%)
EFERT Fertilizer
Fig 27– Next fertilizer universe offers a dividend yield of 9%
with EFERT offering the highest yield of 13% for CY17
Fig 28 – EFERT remains our only recommendation with a total return of 21% in CY17. We maintain our
U/P stance on FFC and Fatima and Neutral on FFBL
EPS DPS TP
CY16 CY17 CY18 CY16 CY17 CY18 CY16
FFC 9.89 9.73 9.42 9.50 9.25 9.00 103
EFERT 8.13 9.02 9.56 8.00 8.50 9.50 80
Fatima 4.06 3.50 3.63 3.00 3.25 3.50 29
FFBL 1.96 4.05 3.93 1.75 3.75 3.75 55
0
500
1,000
1,500
2,000
2,500
3,000
Jun-13
Aug-13
Oct-13
Dec-13
Feb-14
Apr-14
Jun-14
Aug-14
Oct-14
Dec-14
Feb-15
Apr-15
Jun-15
Aug-15
Oct-15
Dec-15
Feb-16
Apr-16
Jun-16
Aug-16
Oct-16
Dec-16
PhosAcid Cost Gas Cost PM PRs/bag
Fig 26 – Despite revision in phosacid prices, the decline in local DAP
has pushed margins downward

24
AUTOS: COMPETITIVE LANDSCAPE CHANGING QUICKLY (UW)
Source: Company Accounts, PAMA, Next Research
• Incumbents are likely to face pressure on both volumetric growth and
margins from new competitors entering the market and rising imports. By
our estimates, incumbents are expected to clock in a modest 3yr volume
CAGR of 2% (assuming overall demand growth of 11%), with new
entrants and imports capturing a higher market share.
• Increasing competition will also test pricing power, and we do not expect
that margins can improve from current levels.
• Any sharp depreciation in the PKR (a high probability in the next 18
months, in our opinion), will also put margins under pressure.
Figure 30 – Local OEM’s average margins have dropped to
13% from a peak of 15% in 1QFY16
Figure 29– Auto sales growth for existing local players to
remain limited at 3yrs CAGR of 2% vs Industry growth of 11%
Figure 31 – Imports of Completely Built Units (CBU) of autos
has more than doubled in 5MFY17 (US$ mn)
0
20
40
60
80
100
120
FY13 FY14 FY15 FY16 5MFY16 5MFY17
0%
2%
4%
6%
8%
10%
12%
14%
16%
18%
4QFY14
1QFY15
2QFY15
3QFY15
4QFY15
1QFY16
2QFY16
3QFY16
4QFY16
1QFY17
0%
2%
4%
6%
8%
10%
12%
14%
16%
18%
20%
FY13-16 FY17-19F
Existing players Total autos Industry

25
TIME TO PRICE IN THE RISKS
• Automobile sector’s bull run ( avg. return of 87% vs. 45% of KSE-100 in CY16) has lifted sector’s valuations into the corridor of
uncertainty.
• Earnings vulnerability to competition and adverse macro shocks is significant.
• Our Tobin’s Q analysis suggests that the market is assigning a much higher replacement cost to the sector and thus it is expected to
reverse to its mean in the next 2-3 years.
TOBIN’s Q 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
INDU 1.21 1.55 2.02 1.46 0.91 1.3 1.12 1.08 1.27 1.86 2.47 1.8
HCAR 1.03 1.25 1.25 1.31 0.89 1 0.96 1.17 1.31 3.1 3.08 3.06
PSMC 1.18 1.53 1.62 0.55 0.6 0.55 0.55 0.6 0.79 1.4 1.43 1.73
EPS PE
2016F 2017F 2018F 2016F 2017F 2018F TP Upside Rating
INDU 146 134.00 137.00 11.4x 12.4x 12.1x 1,560.00 -6% Underweight
PSMC 35 39.00 42.00 17.7x 15.8x 14.7x 540.00 -13% Underweight
HCAR 25 40.00 46.50 27.9x 17.4x 15.0x 653.00 -6% Underweight
Figure 32- Autos at a higher replacement cost than 2007-08 which is expected to reverse in the next two years
Figure 33- Valuation snapshot

26
STEEL: POSITIVES LARGELY PRICED IN (MW)
Source: Company Accounts, World Steel Association, Next Research
Figure 35 – Normalizing long rolled steel margins dragging
average steel margins down 100bp to 17% in 1QFY17
Double digit steel demand growth
Growing
demand of
electrical
goods
Infrastructur
e boom with
increased
PSDP and
CPEC
projects
Automobile
growth
amid
increasing
local
demand
Figure 34 – Pakistan’s steel consumption per capita has grown
at a 5yr CAGR of 24% CAGR through FY10-FY15 (kgs/capita)
12 12
14 16
18
21 20
15 16
13
18
21 23
28
38
-
5
10
15
20
25
30
35
40
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
0%
5%
10%
15%
20%
25%
30%
FY12 FY13 FY14 FY15 FY16 FY17F FY18F
Mughal ASTL ISL Average
• We foresee a sanguine demand outlook, where steel sector demand is expected to
grow at a 5yrs CAGR of 12% over FY17-21F.
• However, long-rolled steel players margins (ASTL, Mughal and DSL) will remain
under pressure given constrained pricing power. Unlike cements, local long-rolled
players do not operate under an oligopolistic structure. Thus, forthcoming capacity
expansions in a tender bidding system to secure corporate sector orders limits the
pricing power.
• On the other hand, margins of flat steel players (ISL and ASL) are expected to
improve amid (1) easing dumping pressure from China and (2) improving HRC-CRC
margins with rising Chinese steel prices.

27
PRICE RUN-UP HAS BEEN SIGNIFICANT
• Despite strong demand prospects, the 120% price rally in CY16 has already
factored in most of the positives, leaving limited upside on the table.
• In terms of downside risks, very high dependence on temporary Regulatory
Duty (which is not of a permanent nature) possesses a major threat to the
medium to long-term margins outlook. This will limit further re-rating in the
sector.
• However, ASTL still remains a Buy as its forthcoming capacity expansion
(with expected commissioning in Sep-17) and sufficient melting capacity
makes it ideally poised to capture robust rebar demand.
Figure 36– Steel sector has out-performed in the last 6 mths
Company Rating
TP Dec-17
(PKR/sh)
Upside
ASTL BUY 92 16%
MUGHAL Neutral 105 12%
ISL Neutral 109 10%
INIL Neutral 219 5%
EPS PE Div. Yield
FY16 FY17F FY18F FY16 FY17F FY18F FY16 FY17F FY18F
ASTL 4.31 3.87 7.59 18.4x 20.5x 10.4x 3% 2% 4%
MUGHAL 7.10 8.60 10.00 13.2x 10.9x 9.3x 3% 4% 4%
ISL 2.71 4.87 8.42 36.4x 20.2x 11.7x 1% 2% 3%
INIL 11.99 15.38 24.12 17.4x 13.6x 8.6x 2% 2% 4%
0%
20%
40%
60%
80%
100%
120%
140%
160%
180%
ISL INIL ASTL MUGHAL KSE-100
Figure 37– Valuation snapshot

POWER: EXPANSIONS ARE THE KEY (MW)
28
• IRRs excluding expansions is not attractive in the case of all IPPs. Including expansions, the IRRs become much more attractive.
• Although any future devaluation of the PKR vis-à-vis the USD would have a one time positive impact on earnings, we believe higher policy
rates would eventually reduce the attractiveness of the IPPs.
• Historically, the yield on IPPs has been at ~2.3% premium to the yield on 10yr bond. We believe the already increasing bond yields due to
higher inflation expectations would continue to put pressure on IPPs as investor may demand a similar premium.
Fig 38 – PKR IRR of major IPPs with/without coal vis-à-vis 10 year bond yield
0%
2%
4%
6%
8%
10%
12%
14%
16%
18%
20%
HUBC KAPCO NPL NCPL
Without coal With coal 10 year yield

NEXT CAPITAL RESEARCH AND SALES TEAM
29
Research Team Sectors Contact Email
Farrukh Karim Khan, CFA Strategy +92-21-35295650 farrukh.karim@nextcapital.com.pk
Ameet Doulat Banks, Insurance & Economy +92-21-35169518-9 ameet.doulat@nextcapital.com.pk
Sonia Agarwal Cements, E&Ps and OMC +92-21-35619519 sonia.agarwal@nextcapital.com.pk
Aijaz Siddique Fertilizers & Power +92-21-35619515 Aijaz.Siddique@nextcapital.com.pk
Asad Ali Steel & Autos +92-21-35169518 Asad.ali@nextcapital.com.pk
Owais Shahid Manager Database +92-21-35169515 owais.shahid@nextcapital.com.pk
Sales Team Contact Email
Karachi
Saad Iqbal +92-21-35292642 saad.iqbal@nextcapital.com.pk
Muhammad Zubair Ellahi +92-21-32468865-66 zubair.ellahi@nextcapital.com.pk
Ahmed Hanif +92-21-35292644 Ahmed.hanif@nextcapital.com.pk
Muhammad Shakeel +92-21-35293637 muhammad.shakeel@nextcapital.com.pk
Saad Rafi +92-21-35169512 saad.rafi@nextcapital.com.pk
Abdul Basit +92-21-35169517 abdul.basit@nextcapital.com.pk
Lahore
Zulqarnain Khan +92-321-4252200 zulqarnain.khan@nextcapital.com.pk
Muhammad Yaqoob +92-301-4604045 muhammad.yaqoob@nextcapital.com.pk
Asim Aslam +92-322-4306868 asim.aslam@nextcapital.com.pk
Junaid Naseem +92-322-8401344 Junaid.naseem@nextcapital.com.pk
Usman Khokar +92-322-4455566 Usman.khokar@nextcapital.com.pk
Email: research@nextcapital.com.pk

DISCLAIMER (1/2)
30
Analyst Certification: All of the views expressed in this report accurately reflect the personal views of the responsible analyst(s) about any and all of the subject securities or
issuers. No part of the compensation of the responsible analyst(s) named herein is, or will be, directly or indirectly, related to the specific recommendations or views expressed
by the responsible analyst(s) in this report.
Disclaimer
This 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 and 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. Next Capital Limited (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
transactions (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 or have provided 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, or offer to 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.
This report may contain forward looking statements which are often but not always identified by the use of words such as “anticipate”, “believe”, “estimate”, “intend”, “plan”,
“expect”, “forecast”, “predict” and “project” and statements that an event or result “may”, “will”, “can”, “should”, “could” or “might” occur or be achieved and other
similar expressions. Such forward looking statements are based on assumptions made and information currently available to us and are subject to certain risks and uncertainties
that could cause the actual results to differ materially from those expressed in any forward looking statements. Readers are cautioned not to place undue relevance on these
forward looking statements. NCEL expressly disclaims any obligation to update or revise any such forward looking statements to reflect new information, events or
circumstances after the date of this publication or to reflect the occurrence of unanticipated events.
Exchange rate fluctuations may affect the return to investors. Neither the company or any of its affiliates, nor any other person, accepts any liability whatsoever for any direct
or consequential loss arising from any use of this report or the information contained therein.
Next Capital Limited, its respective affiliate companies, associates, directors and/or employees may have investments in securities or derivatives of securities of companies
mentioned in this report, and may make investment decisions that are inconsistent with the views expressed in this report.

DISCLAIMER (2/2)
31
Rating System
Next Capital Limited employs a three tier rating system depending upon sector’s proposed weight in the portfolio as compared to sectors weight in KSE-100 index, as follows:
Ratings are updated regularly based on the latest developments in the economy/sector/company, changes in stock prices, and changes in analyst’s assumptions.
Next Capital Limited employs a three tier rating system, depending upon expected total return (R) of the stock, as follows:
Where;
•R = Expected Dividend Yield + Expected Capital Gain
•‘R’ is before tax
•Investment horizon is between six months to twelve months
Ratings are updated regularly based on the latest developments in the economy/sector/company, changes in stock prices, and changes in analyst’s assumptions.
Valuation Methodology
The Research Analyst(s) has used DDM methodology to arrive at Target Price for Power Companies, Justified P/B methodology to arrive at Target Price for Banks and DCF
methodology to arrive at Target Price for all other sectors.
Key Risks
Currency devaluation. Commodity price fluctuation. Interest rate fluctuations. Increase in gas prices. Delay in projects (new/expansions/efficiency)
Unfavorable outcome on GIDC imposition on fertilizer plants having fixed price contracts
Slower than expected private sector credit growth.
Deteriorating receivable position (Circular debt). Unfavorable law & order situation. Heavy dependence on few fields.
Decline in cement prices, greater than expected increase in coal prices, delay in expected projects (expansion, efficiency projects)
Increase in scrap prices, increase in oil prices, reduction in import duty leading to cheaper imports, greater than expected increase in electricity tariff.
WAPDA’s inability to pay dues, oil price reversal to take away efficiency gains for inefficient IPP’s (LPL and PKGP).
GoP’s inability to implement IMF polices of arrears reduction plan in the power sector. Decline in auto sales
New auto policy. Increase in imported cars
Rating Sector’s proposed weight in the portfolio
Over Weight > Weight in KSE 100 index
Market Weight = Weight in KSE 100 Index
Under Weight < Weight in KSE 100 Index
Rating Expected Total Return
Buy R ≥ 15%
Neutral 0% ≥ R < 15%
Sell R < 0%

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