Weekend Trading Ideas | Pakistan Equities Sunday, 11 July, 2021

Research Entity Number: REP-039

Research Idea # 1: Mills (GATM PA Equity) Key Catalyst: Promoting exports has become essential for sustaining Pakistan’s economic environment, particularly in view of the recent shift towards long-term sustainable growth. The incumbent government continues to prioritize exports through various incentives, including cheaper financing, subsidized energy and taxation reliefs. Gul Ahmed (GATM) stands to greatly benefit from the shift, heavily investing in building the foundation for exponential growth.

Highest value on offer within the textile space: Gul Ahmed offers one of the highest values within Pakistan’s textile space, trading at undemanding GATM offers the highest value valuations in all key metrics. GATM’s last close suggests the company is trading GATM NML* ILP IMAGE at a PS of 0.3x and a PE of 4.8x, significantly below the industry average. The PS (x) 0.30 0.48 1.22 1.47 company is set to register the highest sales within the industry at PKR 85bn EV/S (x) 0.84 0.89 1.78 1.54 during FY21. Given GATM’s brand value and its ambition for growth (evidenced PE (x) 4.79 6.22 9.90 13.36 by its recent capital investments plans), we believe its valuations are well set to Source: KASB Research, PSX converge towards the industry mean. * not adjusted for NML’s portfolio value

Ideas IPO to unlock the segment’s lucrative valuations: GATM has been planning to carve out its domestic retail business ‘Ideas’, targeting 1HFY22 to finalize the transaction. We believe separation of ‘Ideas’ from core operations will enable the segment to realize the retail sector’s lucrative valuations. To highlight, ‘Ideas’ is projected to record net sales of PKR 25bn in FY21 and realize lucrative gross margins of 28%. As a proxy, IMAGE, which solely focuses on the retail segment, is trading at a PS of 1.5x (FY22 PS of 1.0x) against GATM’s PS of 0.3x.

Export growth to materialize as incentives play out: Pakistan’s textile industry, particularly GATM, is projected to greatly benefit from the incumbent government’s focus on promoting exports. To highlight, the government is targeting textile exports to touch USD 20.0bn during FY22 against USD 15bn projected during FY21, implying an increase of 33% YoY.

The sector’s allowance for subsidized energy is expected to continue into FY22 as the government earmarked PKR 20bn for the incentive. Moreover, the textile sector has so far been the greatest beneficiary of SBP’s TERF financing, availing nearly 70% of the approved amount. This fact, in tandem with the already available subsidized financing (LTFF & ETF) will allow the sector to finance its growth at low, insulated rates. As GATM has been in the forefront of the sector’s recent expansion cycle, we project the company’s exports to grow sharply, onwards. To highlight, the company has an annual Capex target of PKR 5.0bn and plans to enhance its spinning and weaving capacity by 30%.

An effective vaccination program at key markets ensuring sustained demand: Over 50% of the population of both the US and UK has been fully vaccinated,

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two of GATM’s key export market. Consequently, GATM appears to have a full order book well into FY22 as these economies continue to open further.

Concerns may arise over the recent 4th wave being witnessed in the UK with infection rates spiking several-fold; however, the vaccines have shown to offer great resistance against variants of the COVID-19 virus in both the countries. Only 0.09% of the active cases in the US are labelled as ‘critical’ while the figure is even lower in the UK at 0.07%. We believe the low mortality rate post the vaccination program will instil confidence into economies to open further despite rising infection rates.

Lockdowns in competing countries may further enhance Pakistan’s order books: Bangladesh and Vietnam, two of the major textile exporters, are presently under lockdown to combat the heavy spread of the virus. To note, infection rates in Bangladesh have risen by 5x to over 10,000 daily cases while Vietnam is witnessing its first wave with daily cases nearing 2,000. To highlight, Pakistan has greatly benefitted from order diversion from competing countries, including Bangladesh & India, during FY21 on account of the pandemic. Sustained lockdown in the aforementioned countries may further enhance Pakistan’s textile order book, particularly if Vietnam opts to intensify its lockdown program.

Key risks

1) The global cotton shortage continues: The cotton shortage has caused the commodity’s prices to skyrocket globally. Domestic cotton prices are up 63% to ~14,000/40kg since Sep20. While GATM has so far insulated itself by procuring cotton inventory up to Nov’21, higher cotton prices post CY21 may 1yr Price Performance constrict the company’s gross margins.

2) Revocation of GSP+ status: The EU parliament has asked for a review on Pakistan’s eligibility for the GSP+ status over alleged human rights violation. Potential suspension of the status may remove the duty benefits afforded to Pakistan, likely affecting exports to its key market in EU.

About the Company: Gul Ahmed Textiles (GATM) has been household name within the sphere of domestic textile, operating under the name since 1953. GATM has now grown to one of Pakistan’s largest textile companies, setting up over 130,000 spindles and over 300 weaving units. In 2003, the company Source: Bloomberg established its IDEAS brand, which has since increased to over 100 outlets across Pakistan.

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Research Idea # 2: (HBL PA Equity); 24% upside Key catalyst: We like HBL because of its growth aspirations and being the 1yr Price Performance largest commercial bank in the industry.

Why to Buy: The bank is at favourable position accredited to strong asset quality as the coverage and infection ratio clocked in at 100% and 6.29%, respectively, in 1QCY21. Additionally, with the closure of NY branch, the cost to income ratio is expected to normalize to industry’s average.

Strong asset quality: HBL has a coverage ratio of 100% and the bank prudently recorded provisioning worth PKR 12.2bn in CY20. This keeps the bank at a favourable position with risks on asset quality being overplayed. As the economy has recovered sharply in post COVID environment, general provisioning reversals cannot be ruled out this year and would be an upside Source: Bloomberg trigger for the bank.

Closure of NY branch would normalize cost to income ratio: As per the Year end: Dec CY19A CY20A CY21F CY22F CY23F management, the bank’s cost to income ratio would reduce to 50% in line with EPS (PKR) 10.5 21.0 22.5 24.3 26.5 PER (x) 12.2 6.1 5.7 5.3 4.8 banking industry over the next 2yrs as against 61% in CY20 as a result of higher DPS (PKR) 5.0 4.3 6.8 9.7 13.2 operating expenses as the bank hired many foreign consultants in the D/Y (%) 4% 3% 5% 8% 10% restructuring process. Our model assumes a ratio of 58% for the next 2yrs and P/B (x) 0.8 0.7 0.7 0.6 0.6 Source: KASB Research any improvement in C/I ratio would expand the bottom-line of the bank.

Dividend paying capacity to open up: We foresee the bank’s dividends to gradually increase over the next years as the capital position has strengthened as Tier 1 CAR increased to 13.9% vs 13.5% and total CAR increased to 17.9% vs 17.2%. To highlight, the bank reduced its dividend payout to 20% in CY20 as opposed to 3yr historical average of 82% to build adequate capital buffer after the implementation of D-SIB by SBP. Consequently, we have kept HBL’s DPO at 30% and 40% for CY21 and CY22, respectively that would give HBL time to enhance CAR.

Investment perspective: Our TP of PkR158/share is based on justified P/BV multiple of 0.8x arrived at by using ROE of 14%+, cost of equity of 16% and growth rate of 11%.

Key risks: i) Deterioration in asset quality, ii) slower normalization of C/I ratio and iii) higher provisioning depending on the intensity of 4th wave.

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Research Idea # 3: Indus Motor Company Limited (INDU PA Equity); 56% upside

Key Catalyst: Ali Asghar Jamali, CEO Indus Motors has said the company 2year Relative Performance targets 18% production growth for FY22. We put our weight behind this and 50% KSE 100 INDU incorporate it in our estimates. 40% 30% Why to Buy? The street is abuzz with the incoming auto policy and relaxation 20% measures extended to the automotive sector. Our initial impression pins the 10% possibility of expansion kick off for existing OEMs while the market expands 0% -10% to previous highs. One prime takeaway is the HEV concession where INDU is -20% expected to take the first mover advantage. To highlight, HEV expansion can -30% bring in valuations of PKR 659/sh for INDU based on our back of the envelope -40% -50%

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Dec-19 Dec-20 Aug-20 Aug-19 The auto story has resumed once again: The auto sector demand is reflecting Source: Bloomberg, KASB Research strong growth and it isn’t pent up. That being said, we expect the sector to benefit from concessions offered. We also see reduced prices to encourage INDU Financial Snapshot demand. The industry is expected to reach 275k in FY22. We see INDU as a FY19 FY20 FY21E FY22E direct benefitiary of this development as it has a market share of 25%. We also EPS -40.6 64.6 142.2 210.1 see the market share to expand as companies undertake expansion under the DPS 115.0 30.0 100.0 137.0 upcoming policy. Toyota has revealed intentions to venture into HEV P/E 10.7 21.1 9.6 5.9 P/B 2.7 2.6 2.1 1.8 production. That said, we think it can bring in valuations of PKR 659/sh based DY% 8% 2% 7% 11% on our back of the envelope calculations. Source: KASB Research Order book remains healthy: We expect INDU’s core profitability to remain exciting as healthy order book and demand uptick translates to earnings. Positives from a stable PKR and lower interest rate should reflect well on its bottom-line. We expect the company to post an EPS of PKR 142/sh in FY21E and an EPS of PKR 210/sh in FY22 as we incorporate management guidance of 18% production growth target, better margins and healthier income on cash. The 48% uptick in profitability is yet to be priced in. We see potential for capital gains.

Investment case: We have an Outperform rating on the stock and our target price stands at PKR 1,924/sh, providing an upside of 56% from the last close of PKR 1,232/sh. The stock is trading at an inexpensive P/E of 5.9x vis-à-vis index multiple of 7.7x. Key risks: Major risks to our investment case include i) rapid rise in interest rate can hamper vehicle affordibility, ii) unfavourable operating environment, iii) inconsistent policies and iv) raw material shortages.

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