Fast recovery, but a long way to go Pakistan Equity Market Strategy 2021 14th January 2021

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Research Entity Notification No.: REP-116 See last page for analyst certification and other important disclosures Pakistan Equity Market Strategy 2021 Table of Contents

• Executive Summary………………………………………………………….03  Oil & Gas Exploration Companies ………………………………………………………………….32 • Sector Summary……………………………………………………………….06  Cement.………………………………………………………………………..………….……….……………34  Engineering - Long Steel………………………………………..……………….……….………...... 36 • Investment Strategy…………………….…………………………………..07  Automobile Assembler………………………………………………..…………….……….………….38  A swift turnaround in 2HCY20………………………………………………………….08  Engineering - Flat Steel……………………………………………..……………….……….………….40  Liquidity may continue to improve particularly foreign flows……………09  Fertilizer ……………………………………………………………………….……….……….………...... 42  Positive news flows expected in the short-term……………………………….10  Power Generation & Distribution……………………………..………….……….………...... 43  …to be followed by rough waters…………………………………………………….11  Textile Composite……………………………………………………..……………….……….………….45  Multiples at significant discount on all counts………………………………….12  Initial Target: KSE100 Index 50,000, 14% - Much higher GDP growth • Top Picks ………………………….………………………………………………………….47 needed for significant multiple rerating…………………………………………..14  Habib Bank Limited (HBL)…………………………………………..………….……….….….….….48  Politics - Never a dull moment…………………………………………………………15  United Bank Limited (UBL) …………………………..……………….………….……….…….……49  Geo Politics - A major shift……………………………………………………………..16  Oil & Gas Development Company Limited (OGDC)…………….……….……….……….50  COVID-19 – Still hurting economies around the world……………………..18  Pakistan Petroleum Limited (PPL)…………….……….……….………………………………….51  Risk factors………………………………………………………………………………………19  Lucky Cement Limited (LUCK)……………………………………………..…….……….………….52 • Macroeconomic Outlook………………………………………………….20  Maple Leaf Cement Factory Limited (MLCF)…………..…….……….………………………53  Indus Motor Company Limited (INDU)……………………………………….……….…………54  Improved growth outlook………………………………………………………….…….21  Inflation – Raising its head again……………………………………………………..22 • Next Valuation Summary………………………………………………………………55  Reversal in the Monetary Policy stance is round the corner……..……..23  External account in a comfortable spot……………………………………………25 • Contacts………………………………...... 56  Fiscal challenges remain, here comes the IMF again…………………….....27 • Next Capital Limited | Team………………………………………………………….57  Key Economic Indicators……………………………………………………………….…28 • Analyst Certification & Disclaimer…………………………………………………58 • Sector Outlook.………………………………………………….………..….29  Commercial Banks…………………………………………………………………………..30

Price data as of Dec 31, 2020 2 3 Executive Summary Fast recovery, but a long way to go

Post COVID-19 recovery surpasses expectations • Economic growth of Pakistan was already under stress with the taxation drive under the IMF program and high interest rates before the outbreak of the global pandemic. The subsequent lockdowns towards the end of FY20 resulted in the first in 6 decades, recession for the country where the real GDP shrunk by 0.4% in FY20. Aggressive and preemptive responses by both the fiscal and monetary policies with 625bps cut in interest by the latter and fiscal stimulus package including the long-awaited construction package by the former, resulted in a faster than expected recovery during the first few months of FY21. Index measuring large scale manufacturing recorded an increase of 6.7%YoY during Oct’20 with a cumulative 4MFY21 growth of 5.5%YoY. Real GDP growth expectations that were initially hovering between 1-2% have now been revised upwards with minimum growth estimates of 2% for FY21 that is expected to be followed by a growth exceeding 3.5% in FY22. Industrial and services sectors are expected to lead the recovery while agriculture growth is expected to remain subdued this year. Comfortable external account position in the near term • Healthy contributions from overseas Pakistanis is the main reason for the significant improvement in the external account position of the country with SBP’s reserves enough to cover over 3.5 months of average imports. Decline in international oil prices along with reduction in imports of services have also played a significant role while higher imports of food items restricted the positive impacts. After 5 months of straight current account surplus, it is expected to go in to deficit again during the second half of FY21 with resurge in international oil prices and increase in imports of capital goods and consumer items as economic activities recover. Remittances are also expected to normalize at lower monthly averages. Although the external account seems comfortable for now but going forward strain of current account deficit and increase in debt servicing would require external funding of the external account for which re-entry to IMF program is inevitable. That would not only secure the remaining tranches of the impending EFF program that Pakistan negotiated with the IMF in Jul’19 but it would give confidence to other donor and lending institutions that would greatly support the growth and development of the country. Accommodative policy measures to end in CY21 • Inflationary pressures are likely to resurge during 2HFY21 due to expected slowdown of the pandemic, and on expectations of a healthy economic recovery. We believe real interest rates that are currently in the negative territory will again come in the focus of the MPC. Inflation for FY22 will average close to 8% implying negative real interest rates. 10-year PIB yields already appears to have incorporated an uptick of 100bps in interest rates that are hovering around 10% vs. policy rate of 7% (3% premium to the policy rate, compared to 1.5- 2% on average). Continued spread and threat of COVID-19 and suspension of the IMF program may change our view all together. FATF – Largely compliant • Decision on Pakistan’s status after reviewing of the progress made so far is scheduled in Feb’21. The country has made significant progress and made various legislations and enacted various laws for compliance with the action points. As per the latest update, Pakistan was compliant with 21 actions points while partially compliant with 6, out of the total 27 action points. It is expected that the country would be removed from the grey list but even if it is not removed in Feb’21 plenary, it would be removed in the next plenary after any proposed reviews and audits. This would pave the way for the IMF program and comfort of other multilateral financial institutions and governments.

4 Executive Summary Fast recovery, but a long way to go

Consumption led growth resumes but rate yet to pick up • The revival of growth that has surpassed expectations is likely to result in higher earnings growth for the corporate sector in general and for cyclical sectors including construction and related, autos and allied, consumer goods, utilities and banks in the short to medium term while the structural reform being undertaken under the umbrella of the IMF program would ensure across the board long-term sustainable all inclusive growth for the country. In the near term, growth rate is expected to remain low with counter growth and inflationary structural reforms that would be under taken if IMF program resumes. A growth of 4% and above in the real GDP is not expected earlier than FY23. Heading towards resolution of circular debt • Resolution of circular debt is a dire need for the overall progress of the economy of Pakistan and one of the key action point of the IMF. In the recent past a milestone was achieved where the government signed MoUs with various IPPs whereby reducing their capacity payments obligations, relaxing the exchequer, and devising a plan to release the outstanding amounts to the IPPs. In a most recent development that plan has been agreed in principle for partial payment with final modalities being discussed amongst the stakeholders. Remote chances of abrupt movements in exchange rate • Over the past one and a half years, the SBP has adopted a market oriented exchange rate policy whereby the currency rates are moving in-line with the demand and supply dynamics of the currency market. PKR appreciated from PKR168/USD to PKR160/USD (4.9% during 2HCY20) with the consecutive 5 surpluses of the current account and higher flows of remittances and in the Roshan Digital Accounts. The currency is therefore expected to follow the market demand supply dynamics and no abrupt movements are anticipated. KSE100 Index initial target is 50,000 @ 8x PER, +14% - Secondary target 54,000, +24% • While we acknowledge the fact that Pakistan’s equity market is trading at a discount in multiples on all counts, we would like to highlight that PER tend to hover between 6x-8x in periods of lower GDP growth rates (below 4%). A 2.2% GDP growth even after a recession year is although encouraging but the rate is still lower. In FY22 even the growth is not expected to exceed 4%. Based on this argument, we assign an initial target of 50,000 to the KSE100 Index this year. Our secondary target for the KSE100 Index is 54,000 implying an upside of 24% and a PER of 8.6x, which is close to its historical average PER of 8.5x. This target is based on Dec’21 TP mapping of our coverage universe based on a risk free rate of 11%. Smooth sailing of the IMF program, doing away with the COVID-19 pandemic, and improvement of growth outlook would help in realization of the secondary target. We have an over- weight stance on Banks, Oil & Gas E&P, Cement, and Long Steel. We have a market-weight stance on Autos, Fertilizer & Flat Steel. Our top picks include HBL, UBL, OGDC, PPL, LUCK, MLCF and INDU. Our investment themes favor power companies amidst the resolution of circular debt and textile and related sectors based on growth prospects. Key risks • 1) Second wave of COVID-19 gets worse or the vaccine does not give desired results, 2) geo-political factors get intense, 3) increased political disturbance locally.

5 Sector Summary

Sector Stance Investment Thesis Key Risks

Second wave of the pandemic, worst than expected asset quality deterioration The sector enjoys exposure to the growth story of the economy on solid with IFRS-9 implementation, and regulatory risks including adverse impacts of Banks Over-weight footings of strong asset quality coupled with attractive valuations and implementation of TSA and increase in tax incidence on income from expanding ROEs. government papers.

Higher oil prices and exchange rate are likely to result in revival of earnings Failure and/or slower than expected progress in E&P activities, unfavorable law growth in the near term while huge exploration potential of Pakistan is Oil & Gas E&P Over-weight and order situation and geo-political landscape and volatility in oil prices and warranting long-term growth for the sector, which with expected resolution of exchange rate. the circular debt will open the potential to increase dividend payouts.

Long steel sector will remain in the limelight in line with the construction theme as we believe CY21 will be the year of construction. Fundamentals of Lockdown due to second wave of COVID-19, rising raw material prices and Steel (Long) Over-weight the sector are intact and our liking is based on economic recovery, GoP’s inability to pass on the cost increases, and oversupply promoting construction and conversion from substandard to standard bars.

Government's support to agriculture sector is expected to keep fertilizer Increase in cost of feed and fuel gas, inability to pass on the incremental costs to Fertilizer Market-weight demand on an uptick especially with higher crop support prices. Moreover, the customers, higher inventory levels and abrupt decline in DAP prices. settlement of GIDC has brought the much needed clarity to the sector.

Cement dispatches have witnessed a phenomenal growth post-lockdown, which has forced us to slightly revise up our growth assumption. We remain Complete lockdown amidst the second wave of COVID-19, higher than expected Cement Over-weight upbeat on the demand prospects on the back of Government’s support to the PKR devaluation against USD, and higher international coal and energy prices. sector. Moreover the industry has regained much of its pricing power.

Automobile sector has witnessed a sharp recovery on the back of low interest rates, better farm economics and return of deferred purchases. Moreover, the Stronger USD and JPY against PKR, failure to pass on incremental costs, increase Automobile Market-weight appreciation of PKR against the USD has provided relief to the strained gross in steel prices and significant increase in interest rates. margins. On the basis of above factors we revisit our investment case on the sector and upgrade our stance from under-weight to market-weight.

The sector is oversupplied that is due to a significant decline in market size. Economic recovery is likely to beat expectation but will still remain in range not Complete lockdown, volatility in exchange rate, and influx of imported Steel (Flat) Market-weight sufficient to stimulate significant demand for flat steel. Flat steel demand in our products. opinion will recover in FY21 but will still remain below the level of FY19.

6 7 Investment Strategy – 2021 A swift turnaround in 2HCY20

Pakistan’s Equity Market’s 2020 Performance Overview KSE-100 Index Performance – Absolute vs.. USD (% return) 60% Absolute USD KSE100 Index during CY20 posted a decent return of 7.4% (3.9% in USD terms) and closed the year at 43,755 49% 49% level. CY20 has been one of the most challenging year for Pakistan since the country came into existence. 50% 46%46% 38% 38% However, after taking the initial heat, the market recovered not only from its low but at the same time 40% 33% managed to post a decent return. The year has been a tale of two halves where 1HCY20 saw the emergence 30% 27% of COVID-19 and its effects on the country and the economy whereas 2HCY20 witnessed a significant 20% 10% 7% recovery. Emergence of COVID-19 in February and subsequent lockdown in mid March resulted in market 10% 2% 4% touching its year low on Mar. 25, 2020 at 27,229 level. However, opening up relatively early, aggressive 0% monetary easing, fiscal stimulus and the construction package aided in a V shaped economic recovery, which -10% -2% -2% is evident from high frequency numbers for various sectors. The recovery led to a positive momentum in the -6% -8% -20% -10% market and the KSE100 Index gained 60.7% from its low. -15% -30% -20% -27% Liquidity has increased drastically -40% Accommodative monetary policy stance by the SBP where interest rates were slashed by a massive 625bps to CY11 CY12 CY13 CY14 CY15 CY16 CY17 CY18 CY19 CY20 counter negative impacts of COVID-19 resulted in improved liquidity. Money supply saw a significant increase Source: PSX, Bloomberg, Next Research where double-digit growth has been witnessed in bank deposits (almost 17% for CY20) as documentation of Liquidity has significantly improved the economy improves. With investors placing bets on a V shaped economic recovery, the market witnessed 1,000 Total AUMs (PKRbn) Equity % (RHS) 55% inflows from domestic investors. Average daily turnover of shares and value traded stood at 447mn shares 52% and PKR16.5bn, respectively during 2HCY20 (up 142%YoY and 152%YoY, respectively). Foreign investors 900 50% 48% remained on the selling side this year, while the selling was absorbed by individuals and insurance companies 800 44% 45% that are flushed with liquidity. 43% 700 40%

Equities are becoming the preferred choice 600 35% 33% Mutual funds’ AUM declined 1% during 1HCY20 that is largely attributable to COVID-19, however, with a 500 30% drastic decline in active cases and optimism on future growth, AUMs increased 28% from July to November. 28% 28% 400 25% The allocation to equities touched a low of 20% in May’20 but since then the allocation has increased to 28% 23% 22% in Nov’20. The increase in allocation to equities is a result of significant reduction in interest rates that has 300 20% made equities the preferred asset class. Moreover, the expectations of economic growth leading to corporate 200 15% earnings growth is another reason for this increased allocation. Dec-15 Dec-16 Dec-17 Dec-18 Dec-19 Mar-20 Jun-20 Sep-20 Nov-20 Source: MUFAP, Next Research 8 Investment Strategy – 2021 Liquidity may continue to improve particularly foreign flows

Roshan Digital Accounts Foreigners resume to sell (USDmn) 600 SBP took the initiative of introducing the Roshan Digital Accounts for overseas Pakistanis that enables them to 398 383 open bank accounts with participating Pakistani banks and perform normal banking operations. The Naya 400 Pakistan Certificate is also offered to them carrying a 1-year USD based profit rate of 6.5%. These account 200 126 also provide connectivity with the CDC and the account holders can open equity brokerage accounts online 56 too. Therefore this liquidity if desired can also come in to equities market of Pakistan. So far overseas - Pakistanis have deposited over USD200mn in these accounts out of which majority is invested in Naya Pakistan Certificates. We do not rule out the possibility of increased liquidity flows from these accounts in to (200) (127) the equities market of Pakistan. (400) (315) (361) Foreign selling resumes but buying may return (600) (487) (537) (571) Foreign selling after a break in 2019 resumed in CY20 that is attributable to COVID-19 after which, investors (800)

pulled out money from emerging markets. Moreover, political uncertainty, stalled IMF program and

CY15 CY12 CY13 CY14 CY16 CY17 CY18 CY19 CY20 continuation on FATF’s grey list failed to excite foreigners. They sold USD571mn worth of equities during CY11 2020 whereas selling is worth around USD1.7bn during 2015-20. Companies along with individuals and Source: NCCPL, Next Research Insurance companies absorbed bulk of the foreign selling with investment of USD111mn, USD232mn and Cos. emerge as key participant in addition to Ins Cos. & Ind. (USDmn) USD230mn, respectively during CY20. Going forward, with resumption of growth and IMF program where exchange rate is expected to remain fairly stable, we see foreign investors coming back to Pakistan’s equities Mutual Funds 23 market capitalizing on the growth potential of the country. Insurance 230 External account a major turnaround Banks (33)

Pakistan witnessed a significant turnaround in its current account numbers on the back of higher remittances, Broker (14) tamed imports and a slight pickup in exports. FY20 CAD shrunk to USD3bn with surpluses in Oct`19 and May’20 (USD73mn and USD344mn, respectively). This was followed by another row of consistent current NBFC 3 account surpluses during 5MFY21 (USD1.6bn) courtesy higher remittances. PKR appreciated by a decent 4.9% Other 21 from July to December whereas a buildup was seen in foreign exchange reserves (USD20.5bn compared to Companies 111 USD18.9bn of Jun’20) where reserves with the SBP are enough to cover ~3.5 months of imports. Individuals 232

(50) - 50 100 150 200 250 Source: NCCPL, Next Research 9 Investment Strategy – 2021 Positive news flows expected in the short-term

Negotiations with the IMF resumed, conclusion expected soon Areas to address strategic deficiencies As negotiations with the IMF have resumed we are of the opinion that despite the healthy external account 1. Demonstrate that law enforcement agencies (LEAs) are identifying and investigating the position currently, on forward looking basis where relaxations related to debt repayments amidst COVID-19 widest range of terror financing activities, which target designated persons and entities, and those who act on behalf/direction of the designated persons or entities are expected to end and with rising CAD, external financing requirements are likely to increase significantly. Hence in order to keep the house in order and gain the comfort of IMF and other multilateral donor and 2. Demonstrate that terror financing prosecutions result in effective, proportionate and dissuasive sanctions lending agencies, we believe resumption of the IMF program is inevitable. 3. Demonstrating effective implementation of targeted financial sanctions against all FATF – Largely compliant but geo-politics is critical 1,267 and 1,373 designated terrorists and those acting for or on their behalf; preventing the raising and moving of funds including in relation to non-profit organizations; Pakistan was placed on the FATF ‘Grey List’ in Jun’18 and since then the country was asked to carry out identifying and freezing assets; and prohibiting access to funds and financial services necessary reforms. Pakistan has come a long way and is currently compliant on 21 out of the 27 action points given by the FATF. Pakistan was lucky escaping the enhanced monitoring list in last plenary and was given an 4. Demonstrating enforcement against violation of terror financing sanctions, including in relation to NPOs, of administrative and criminal penalties and provincial and federal extension to carry out the remaining reforms till Feb’21. Pakistan was asked to work on four areas to address authorities cooperating on enforcement cases strategic deficiencies. Although Pakistan has made significant progress in addressing the concerns of FATF including enactment of several legislations, exit from the grey list in Feb’21 Plenary, will be largely dependent Energy Sector Receivables on inspection and Geo-politics. The direction of geo-politics will be set once Biden takes charge. We believe, Sep`20 Trade r/b Trade p/b ST Bor. Net r/b Net r/b /sh. Pakistan will be praised for its efforts in Feb’21 but will have to wait for the next plenary to exit the list. KAPCO 125,386 21,468 39,750 64,168 73 OGDC 342,206 66,206 - 276,000 64 Partial resolution of Circular Debt – A major development, but restricting the incremental is crucial PPL* 326,484 116,101 - 210,383 77 Circular debt has touched PKR2,306bn in Nov’20 and growing on a monthly basis. The government was given MARI** 32,158 39,711 - (7,553) (57) specific target for reducing circular debt by the IMF but the outbreak of COVID-19 instead deteriorated the HUBC* 109,043 79,865 38,553 (9,376) (7) situation. The government is working to reorganize the entire power sector and various ideas are under NCPL 20,770 987 10,293 9,489 26 consideration of the Government. Resolution of the circular debt is a crucial condition for reentering the IMF NPL 19,620 1,062 5,345 13,213 37 program. The recent MoUs with IPPs in order to reduce the capacity payments and means to repay the overdue amounts to the IPPs, is a step in the right direction, but the critical step still is choking of the KOHE 7,730 38 4,788 2,904 17 incremental circular debt that would require a system overhaul and some inflationary measures. However, EPQL 13,483 8,791 3,254 1,437 4 any partial payment of the outstanding amounts would be taken positively by the market and we are hopeful PKGP 22,327 1,084 9,047 12,196 33 in this regard. LPL 20,073 1,034 12,147 6,891 18 PSO*** 195,695 177,490 42,196 (23,991) (51) Source: Company Accounts, Next Research *consolidated, **ex. Fertilizer, ***incl. LPS

10 Investment Strategy – 2021 … to be followed by rough waters

We see interest rates rising from Mar’21 We see interest rates heading north as inflationary pressures are resurging during 2HFY21. With a healthy economic recovery already taking place, we believe that the central bank would again focus on the real interest rates that are currently in the negative territory. Despite the fact, inflation is expected to average lower than that of FY21, it would still be close to 8% implying negative real interest rates. 10-year PIB yields already appears to have incorporated an uptick of 100bps in interest rates that are hovering around 10% vs. policy rate of 7% (3% premium to the policy rate, compared to 1.5-2% on average). Continued spread and threat of COVID-19 and suspension of the IMF program may change our view all together. Current account to go negative again We see a resurgence in trade deficit as economic activities pick-up and due to higher international prices of oil and other commodities, higher imports of food items and cotton, and higher imports of capital goods (courtesy TERF by SBP), and slower growth in exports compared to imports with second wave of COVID-19 in various export destinations of Pakistan. This together with normalization of remittances to averages lower than the current, are likely to result in current account posting deficit during the remaining part of FY21 and in FY22. Flows from remittances and RDAs will restrict the pace however for FY21. IMF program has its implications Acknowledging the necessity of resuming the IMF program, we highlight the impending decisions of independence of NEPRA for electricity pricing, increase in electricity and gas tariffs, increase in FBR revenues etc. are such measures that have inflationary and counter growth consequences in the short-medium term. However, the long-term impacts of these structural reforms are positive for achieving a long-term all inclusive and sustainable growth. Fiscal consolidation in sight With resumption of IMF program, the pending reforms including energy sector reforms, doing away with tax exemptions and subsidies, and measures for increasing documentation of the economy, would definitely have significantly positive impacts in the long term, but would be inflationary and counter growth initially leading to a consolidating fiscal policy focusing on enhancing tax revenues with zero incremental borrowings from the central bank.

11 Investment Strategy – 2021 Multiples at significant discount on all counts

PSX trading at a steep discount to regional markets Significantly higher discount to multiples of Asia Pac. Ex. Japan

Pakistan market massively under-performed the global markets, specifically during the second half of CY20 70% when lockdowns were being lifted and the economies were gradually opening up. PE multiples of Pakistan’s 60% equities historically traded at an average discount of 37% to the multiple of Asia Pac. Ex. Japan as provided by Bloomberg since 2006. This discount has widened significantly during 2019 and 2020. During 2019, the 50% reason for widening of this discount was the overall macroeconomic challenges Pakistan was faced with. With 40% depleting forex reserves and rising interest rates and inflation, Pakistan had to come under an IMF program. After the negotiations with the IMF sailed through and the EFF program was initiated in Jul’19, the discount 30% gradually narrowed. But now, despite Pakistan being relatively less affected with the pandemic, the discount 20% has widened to 66%. We are of the opinion that with the reengagement with the IMF and flattening of the second wave of the pandemic, the discount to multiples of regional markets should narrow gradually. 10%

Unprecedented spread between 1-year T-Bills and earnings yield 0%

2019 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2020 MPC of the SBP had adopted an aggressive response to COVID-19 pandemic by slashing policy rates by 2006 625bps during Mar-Jun’20. However, the earnings yield of the Pakistan’s equities market failed to catch up Source: Bloomberg, Next Research with this movement resulting in unprecedented spreads over the secondary market yield of 1-year T-bills and Unprecedented spread between E/Y and 1Y scnd. mkt. yield the spread is now hovering around 700bps against a historical average of 225bps since 2006. Between Jan- E/Y 1yr PKRV 25% Feb’20, this spread was hovering in the range of 150-300bps before the interest rates were slashed. Going forward while we expect a 200bps increase in interest rates, the spread would still be significantly higher (500bps) and we believe that it would narrow with decline in earnings yields going forward. 20%

15%

10%

5%

0%

2019 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2020 Source: Bloomberg, Mettis Global, Next Research 12 Investment Strategy – 2021 Multiples at significant discount on all counts

Mkt Cap. / GDP Mkt Cap. / M2 45% Mkt. Cap./GDP Average 100% Mkt. Cap./M2 Average 40% 35% 80% 30% 25% 60% 20% 40% 15%

10% 20% 5%

0% 0%

FY07 FY17 FY01 FY02 FY03 FY04 FY05 FY06 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY18 FY19 FY20

Current Current Source: PSX, MoF, Next Research Source: PSX, SBP, Next Research Average during years of low growth 17% Pakistan PE trading at a significant discount to its own historical average Average during years of low growth 42% Average during years of high growth 27% Average during years of high growth 62% 16 19 years average 22% Pakistan PE Average 19 years average 52% 14 12 10 8 6 4 2

0

2018 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2019 2020 Source: Bloomberg, Next Research 13 Investment Strategy – 2021 Initial Target: KSE100 Index 50,000, 14% - Much higher GDP growth needed for significant multiple rerating

FY21 growth not enough for a significant multiple rerating PER hovers b/w 6-8x when GDP growth is <4% Currently Pakistan’s equities are trading at a PER of 7x compared to a historical average PER of around 8.5x. 16 PER PER 6x PER 8x Real GDP Growth (RHS) 7% Although we do not have historical data for market performance during a recession year that is followed by a 14 6% year with subdued growth, we highlight that during the periods of slow or stagnant growth in real GDP during 12 5% the past 15 years, the multiples tend to contain themselves in the range of 6-8x as illustrated in the side chart. Moreover, during the global economic crisis in FY09, domestic multiples touched a trough at 4.1x, 10 4% whereas during the current economic slowdown that primarily is due to a global pandemic, PER of domestic 8 3% equities market has touched a low of 4.6x. In a scenario where the economy has shrunk by 0.4% during FY20 6 2% that is followed by a growth of 2.2% expected for FY21 (previously estimated at 1.2%), the broader earnings growth of our coverage universe is expected to remain in single-digit for CY21 (primarily due to banks and 4 1% E&P companies, the two heavy weights). Current market multiples are at a significant discount on all counts, 2 0% and we see the multiples heading for 8x in the short-term, implying an upside of 14.3% from current level. A 0 -1%

rerating of multiples, onwards would therefore only be witnessed once the confidence on growth that is

2017 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2018 2019 2020 expected to improve further from FY22 increases as the world gets over with the pandemic with vaccines 2006 being implemented. Our present estimates for FY22 GDP growth is 3.8%, whereas a growth less than 4% is Source: Bloomberg, MoF, Next Research not expected to take multiples above 8x on sustainable basis. Initial target of KSE100 Index is 50,000 level at 8x PER, 14% upside Based on the above argument, we assign a target of 50,000 to the KSE100 Index this year. Assigning TPs to our coverage universe yields a higher target for the index, but we strongly believe that achievement of those would depend on significant improvement of growth outlook. Secondary target of 54,000 +24% upside Our secondary target for the KSE100 Index is 54,000 implying an upside of 24% and a PER of 8.6x, which is close to its historical average PER of 8.5x. This target is based on Dec’21 TP mapping of our coverage universe based on a risk free rate of 11%. Smooth sailing of IMF program, doing away with the COVID-19 pandemic, and improvement of growth outlook would help in realization of the secondary target. We have an over- weight stance on Banks, E&P, Cement, and Long Steel. We have a market-weight stance on Autos, Fertilizer & Flat Steel. Our top picks include HBL, UBL, OGDC, PPL, LUCK, MLCF and INDU. Our investment themes favor power companies amidst the resolution of circular debt and textile sector based on growth prospects.

14 Investment Strategy – 2021 Politics - Never a dull moment

Opposition alliance arranging rallies and gatherings despite COVID-19 Political activity has reached its peak in Pakistan as opposition parties have formed an alliance PDM (Pakistan Democratic Movement). The parties are building a narrative that the last general elections were rigged and the present political setup should be dissolved to pave way for new elections. PDM since its inception, has been organizing rallies and gatherings against the incumbent government. They have been demanding the resignations from the present government and to exert pressure have been showing their street power at a time when the country is passing through the second wave of COVID-19. New elections - The Ultimate goal PDM’s ultimate goal is to pave the way for new elections, however, they plan to cast doubts on the credibility and ultimately halt the senate elections that are due in Mar’21. Quite a few options are on the table to achieve their goal, which include a long March towards Islamabad in early February and resignations from assemblies. Senate election to give the government a majority Senate elections are due in Mar’21 and over 65% of the retiring senators belong to the opposition and post elections PTI led coalition government is expected to gain majority. The majority will allow the government to focus on legislation along with passing important bills that were stalled due to minority in the senate. The announcement of resignations from provincial and national assemblies is part of the plan to halt the process. The opposition believes that dissolution of the Sindh assembly will break the Electoral College; hence the elections will be delayed. However, legal experts are of the opinion that resignations and even the dissolution of the Sindh assembly would not halt the senate election process. Despite the momentum new general elections are highly unlikely In our opinion, political activity till the senate elections will be at its peak where opposition parties will try various options to get their ultimate goals for this they will keep their supporters engaged. There could be certain patches of violence where rallies and gathering can turn into sit-ins. All in All we expect a volatile political situation till the senate elections; however, we do not see the incumbent government going anywhere.

15 Investment Strategy – 2021 Geo Politics - A major shift

In today’s connected world no country is isolated Despite the protectionist policies around the world, economies throughout the world are interconnected and geo politics have a major affect on them. Major developments are taking place around the world that will be shaping policies for the next decades. Although Pakistan is not an economic hub that could drive future policies but its location, influence over the Taliban and tilt towards China (with development in progress on CPEC) brings it into the limelight. Transition from Trump to Biden Mr. Joe Biden emerged as the winner of the Nov’20 US elections and he is set to assume power towards the end of Jan’21. USA is a major world player and change in Washington is felt around the world. Although it is too early to comment what his policies would be on China and Afghanistan, but any shift in the Afghan policy or stringent measures on China will place Pakistan in a difficult position. The end of the Afghan game If the deal goes as planned US is expected to withdraw from Afghanistan in spring next year. However, with the change in Washington things remain unclear as what will be the Afghanistan policy of the new administration. Biden, the president in waiting could simply endorse the current Afghanistan policy or he could reassess the situation and push for changes in the deal with the Taliban. However, if Biden strays away from the current policy, there are chances that the deal could end. If the deal ends violence could erupt that would have negative effects on Pakistan both politically and economically. China Pakistan Economic Corridor (CPEC) and the west The growing influence of China in Pakistan is not going well in the west and China has been accused of luring countries with debt trap. The flagship project of One Belt One Road, CPEC is another reason of opposition from the west as they believe China has military objectives with this project. However, the 1st Phase of the project has concluded and now both the countries are working on the 2nd phase. USA has been a vocal critic of the project and believes China could emerge stronger with access to waters of the Arabian sea and if new administration continues with the Trump era China policies they could target CPEC as well where Pakistan could end up in position where it would have to choose any one of them.

16 Investment Strategy – 2021 Geo Politics - A major shift

Saudi – Pak relations in hot waters The relations between Saudi Arabia and Pakistan have deteriorated a bit that has resulted in Pakistan suspending the deferred oil payment facility and repaying the USD2bn out of the USD3bn assistance and the remaining USD1bn is likely to be repaid soon. Although, the situation has not reached a point of no return but any further deterioration would be a significant negative for the country and would enhance the role of China. Israel and growing relations with the Arab states A major development that is taking place is the normalization of relations between Israel and Muslim countries whereas Turkey has appointed ambassador to Israel after two years. Although, Saudi Arabia is yet to recognize Israel but it seems they will also opt to normalize relations when the environment is conducive. The point here to consider is that news are doing rounds of pressure on Pakistan to recognize Israel, however, foreign office has denied these reports categorically. Although, Pakistan maintains a strong position regarding this issue but with Muslim countries normalizing relations, Pakistan would face immense pressure to do the same which would not go well domestically.

17 Investment Strategy – 2021 COVID-19 – Still hurting economies around the world

World yet to recover Flattening second wave COVID-19 is still affecting daily lives and after the 1st wave the world is passing through the 2nd and restriction 60,000 New Tests New Cases 25% on movement and businesses are still in place where cases are increasing at a rapid pace. Although, 15DMA new infection (RHS) Total Infection (RHS) 50,000 economies are better placed as incoming data indicates a strong rebound but the situation to revert back to 20% pre COVID levels is likely to take time. 40,000 Pakistan navigated the 1st wave 15% 30,000 Pakistan was able to navigate the 1st wave of COVID19 quite well and received appreciation around the world 10% owing to which the country was able to open up rather early. The early opening up restricted the negative 20,000 effects as compared to regional economies whereas the country also managed to improve exports due to its 5% better management of COVID-19. 10,000 Second wave flattening out - 0% With peak winters almost at the tail end, the 2nd wave of COVID-19 in Pakistan has flattened out. Active Jun-20 Jul-20 Aug-20 Sep-20 Oct-20 Nov-20 Dec-20 cases touched a high of 55.4k and currently stand at 34.8k. The overall situation in the country has improved Source: www.covid.gov.pk, Next Research without imposing a blanket lockdown and we expect authorities to manage the situation with targeted ones. Signs are improving so far However, our trade partners mainly UK, US and Europe are still battling with the second wave where Recovery rate Active/Total cases Death rate (RHS) lockdowns are still in place and if the situation fails to improve, trade volumes can be affected. 100% 2.2% Vaccine updates 2.1% 80% Companies have rushed up in order to develop effective vaccines for COVID-19 that has brought the world to 2.0% a standstill. Protocols were relaxed as a result some companies have rolled out the vaccine for use. Some of 60% 1.9% the companies that are leading the vaccine race are Moderna, BioNtech and Pfizer, AstraZeneca and Johnson and Johnson. 40% 1.8% 1.7% 20% 1.6%

0% 1.5% Jun-20 Jul-20 Aug-20 Sep-20 Oct-20 Nov-20 Dec-20 Source: www.covid.gov.pk, Next Research 18 Investment Strategy – 2021 Risk factors

Second wave of COVID-19 gets worse Second wave of COVID-19 in Pakistan appears to have reached its peak and the spread is flattening out. But the risk of resurgence cant be ruled out. The vaccine is not expected to be applied amongst masses at least before 8-12 months going forward and a resurgence in cases as is witnessed in the European region would have devastating impacts on the overall economy of Pakistan and all the assumptions of growth and interest rate hike would be suspended. What if the vaccine doesn’t work? Although we at Next Capital are no experts on vaccinations and the process on its development but one thing we know for sure is that after development, testing of the vaccination is a long process. The process involves extensive research at each stage before being made available for final use. However, countries were in a rush to administer the vaccine owing to which relaxations were given by the regulators along with authorization of emergency use in some countries. We do not doubt the credibility of renowned organizations and scholars involved but what we believe is the efficacy is likely to be below what is being quoted and even if the vaccine is 100% effective, side effects are still unknown and the markets have priced-in the success of the vaccine. Global markets would most probably crash if serious side effects of the vaccines emerge. Geo-political factors get intense Global geo-politics is at a juncture that puts Pakistan at a critical spot and its actions and decisions would have significant impacts. The middle-eastern arena, US elections with the new President taking over and the US- China relations, all would have significant implications for Pakistan and these need to be observed very critically for a better investment perspective for Pakistan’s equities market. Increased political disturbance locally With Senate elections nearing, political activity at the local front has increased significantly but the situation is not alarming yet. The PDMs decision to contest senate and bi-elections is a positive step however, the situation need to be observed carefully as any further agitation and gatherings could result in panic and secondly spread of the COVID-19 virus.

19 20 Macroeconomic Outlook Improved growth outlook

Growth resumes in FY21 GDP growth to recover surpassing expectations but still low With the global outbreak of the COVID-19 pandemic and subsequent lockdowns and restrictions imposed, 8% Agriculture Industrial Services Real GDP growth estimates turned into recession for Pakistan as well that was already suffering from low disposable 4.6% 5.5% incomes amidst higher inflation, high interest rates, and taxation drive. FY20 has reported the first recession 6% 5.2% 4.1% 4.1% after FY52 (-1.8%). Provisional estimates suggest that the real GDP of Pakistan has shrunk by -0.4% in FY20 3.7% 4% 3.8% compared to revised FY19 growth of 1.9%. With the end of the first wave and post lifting of lockdowns, 2.2% Pakistan’s economy started witnessing a sharp recovery and has out-performed general estimates and 2% 1.9% expectations during the first 4 months of the ongoing fiscal year. …as key sectors portray a healthy picture during 5MFY21 0% -0.4% Having a look at the high frequency consumption and sales data, a robust recovery has been witnessed in -2% terms of YoY growth numbers. LSM for the first 4 months of the ongoing year has average at 5.7% compared to a decline of 5.8% during the same period last year. Cement dispatches (provisional) and passenger car -4% sales have also reported growth numbers of 16% and 14%, respectively for the first 5 months of FY21. Urea FY13A FY14A FY15A FY16A FY17A FY18A FY19A FY20E FY21E FY22E offtake (11MCY20) has also improved by 6% during this period. On the agriculture output side, apart from a Source: MoF, Next Research massive plunge in the cotton crop output, other major crops are expected to report healthy output. The LSM showing a "V" shaped recovery to pre-COVID levels critical factor however, remains if the general growth trends sustain during the remaining part of the fiscal 190 LSM Index Growth (YoY) (RHS) 20% year as during the first half of the previous fiscal year, the base was low due to hampered growth across the board. Further, as a result of the lockdowns imposed during the 4th quarter of FY20, higher YoY growth rates 170 10% are expected to be reported during the 4th quarter of FY21 as a result of low base effect. 150 0%

GDP growth forecast revised upwards to 2.2% from 1.2% 130 -10%

Taking account of the recent growth trends and the expected base effect in the second half of the ongoing 110 -20% fiscal year, we have revised our GDP growth forecast for FY21 from 1.2% (in Jul’20) to 2.2%. The reasons 90 -30% discussed above are the key factors behind the revision. Our revised estimates for agriculture sector, industrial sector and services sector are 1.5%, 4.4%, and 1.7%, respectively, compared to 2.7%, -2.6%, and - 70 -40% 0.6%, respectively during FY20. Key highlights of the growth this year are expected to be the LSM growth and 50 -50% the revival of services sector growth, where the latter witnessed much battering during FY20 due to the

taxation drive and the impacts of the COVID-19 pandemic, and reported its first ever (since 1952) decline Jul-15

Jan-19

Jun-18

Oct-20

Apr-17

Feb-16 Sep-16

Aug-19 Nov-17 during FY20. Mar-20 Source: PBS, Next Research 21 Macroeconomic Outlook Inflation – Raising its head again

FY21 estimates revised upwards significantly Inflation to raise its head again

Continued food inflation from last year (average 5MFY21 MoM food inflation of 2.5% compared to 2.4% 16% NCPI (RHS) MoM YoY 180 during the same period last year), coupled with higher petroleum products prices (average 32% higher over 14% 160 Jun’20) and electricity tariffs (4.9% higher over Jun’20), have resulted in average MoM inflation of 1.4% 12% 140 during 5MFY21 vs. 1.5% during the same period last year and 0.6% of 5MFY19, surpassing expectations that were based on a reversal in food inflation. Based on the recent out-turn of data points and outlook on energy 10% 120 and electricity prices, we have revised our inflation estimates upwards. Our revised inflation forecasts for 8% 100 FY21 and FY22 now stand at 9% and 7.8%, respectively. 6% 80 Uptick in headline and Core-NFNE inflation expected during 2HFY21 4% 60 Core-NFNE inflation has remained sticky during the past couple of months while the headline inflation was 2% 40 rising primarily on the back of higher food prices as a result of supply shocks, and rising energy prices 0% 20 including transport fuels and electricity tariffs. During 6MFY21 weighted average core-NFNE inflation stood at -2% - 6.4% while the average headline inflation stood at 8.6% during the same period, compared to an average Jan-19 Jun-19 Nov-19 Apr-20 Sep-20 Feb-21E Jul-21E Dec-21E headline inflation of 11.1% during the same period last year with the core-NFNE inflation standing at 8.1% Source: PBS, Next Research during the same period. Going forward, as the overall economic activity picks-up and aggregate demand Core-NFNE inflation to start inching up improves, coupled with higher international oil prices, and the base effect, we foresee both headline and 16% Headline inflation Core-NFNE (w/a) core-NFNE inflation inching upwards during 2HFY21 (from Feb’21). Our average headline and core-NFNE inflation for 2HFY21 stand at 9.4% and 6.9%, respectively. 14% More risks ahead as IMF comes back 12% 10% Our inflation forecast are based on normalization of food prices along with certain seasonality's in them. We believe that as the economic impacts of COVID-19 pandemic are reducing and hope that the pandemic ends 8% soon, the suspended structural reforms under the umbrella of the IMF that mainly focuses on fiscal 6% measures, will resume soon. These measure will focus on fiscal consolidation with higher targets for revenue collection and those would eventually be inflationary. Resolution of circular debt and deregulation of power 4% pricing would also lead to higher energy prices hampering growth and inducing inflation. Further food supply 2% shocks may continue to aggravate food prices pushing inflation estimates upwards. 0% Jan-19 Jun-19 Nov-19 Apr-20 Sep-20 Feb-21E Jul-21E Dec-21E Source: PBS, Next Research 22 Macroeconomic Outlook Reversal in the Monetary Policy stance is round the corner

SBP – A proactive institution Average Policy Rate SBP has been one institution that has acted aggressively to counter the impacts of COVID-19 on the overall 14% 12.0% economy of Pakistan. Few of the steps that the central bank has taken since Mar’20 include: 1) expansion of 12% the LTFF program, 2) introduction of loans at lower rates for investment projects in the country in these challenging times, 3) deferment and rescheduling of loans, 4) loan facility to ensure continued payments of 10% 9.0% 9.0% wages/salaries to employees, 5) subsidized loans for hospitals, and the most crucial of them all is the, 6) 8.3% 8% 625/675 bps reduction in Policy/Discount rates during Mar. 17 – Jun. 26, 2020 and maintaining real interest 7.1% 5.8% rates below zero. The introduction of Roshan Digital Accounts, Naya Pakistan Certificates and other initiatives 6% 5.8% including those for encouraging remittances through official channels and improved confidence on currency movements, are bearing fruits now. 4% Inflation to be in focus again 2% SBP/MPC maintained a view that the current monetary stance is adequate for the present status of the 0% economy considering growth and inflation. Regarding inflation SBP is of the view that major reason for the 2016 2017 2018 2019 2020 2021E 2022E surge in inflationary pressures are food prices shock and that are not interest rate sensitive and would be Source: SBP, Next Research handled through the administrative measures taken by the government, to which we also agree. The MPC of 100bps rate hike expected in Mar'21 the SBP has kept the interest rates unchanged after the last cut in Jun’20 where the inflation has remained in 16% RIR (RHS) Policy Rate YoY 600 the range of 8-9%. During this period, marked improvement has been witnessed in aggregate demand as 500 discussed earlier and significant improvements are recorded in the balance of payments where 5 consecutive 14% 400 monthly surpluses are reported in the current account balance and the FX reserves are settled at over 12% USD20.3bn (SBP import cover of ~3.5 month). With a recovery in growth trajectory and hopes of no 300 10% significant rise in COVID-19 cases, even barring any inflationary measures including power tariff hike etc. we 200 see, as discussed earlier significant surge in inflation during the latter half of FY21 with risks of upward 8% 100 adjustments in expectations under the IMF program, SBP is expected to normalize the real interest rates that 6% - are currently hovering in the negative territory even on a forward looking basis. (100) 4% (200) 2% (300) 0% (400) Jan-19 Jun-19 Nov-19 Apr-20 Sep-20 Feb-21E Jul-21E Dec-21E Source: SBP, PSX, Next Research 23 Macroeconomic Outlook Reversal in the Monetary Policy stance is round the corner

Auction profiles suggest expectations of hike in interest rates Market expecting a 100bps interest rate hike In the auctions of T-Bills and PIBs, during the past couple of months, it is evident that the market participants 31-Dec-20 30-Jun-20 are more interested in the shorter tenor instruments rather than locking their liquidity and yields on a longer 10.5% tenor paper. During the current quarter, the amount of accepted bids for 3, 6 and 12 months T-bills were PKR2,921bn, PKR241bn, and PKR88bn, respectively compared to PKR946bn, PKR674bn, and PKR427bn, 9.5% respectively during the Jul-Sep’20 quarter. Similarly participation in PIBs (fixed and floaters) has also greatly decreased. We believe that the general market expectations are for a hike in interest rate during the next couple of months. Secondary market yield of 10-year PIBs is hovering around 10% implying a spread of 3% 8.5% over the policy rate, which normally averages around 1.5-2%, implying expectations of a 100bps rate hike in the near term. 7.5% We maintain our expectation of 200bps hike during 2021 In our mid-year strategy report in Jul’20, we have highlighted our view of reversal in the SBP’s monetary 6.5% policy stance during the 4QFY21 and expected a hike in interest rates by up to 200bps. We maintain our view 3M 6M 1Y 3Y 5Y 10Y 15Y 20Y regarding the hike in interest rates during 2021, the timing may however, vary depending up on the COVID- Source: MUFAP, Next Research 19 spread, arrival of vaccine, and growth and inflation trajectory. In our base case, we have assumed 100bps hike in Mar’21 policy followed by 50bps hikes in each of the May and July 2021 policies.

24 Macroeconomic Outlook External account in a comfortable spot

Significant improvements in Current Account of the Balance of Payments Current Account comfortable in FY21

Pakistan has been witnessing a significant improvement in its Current Account Balance of the Balance of 1.0 CAB (USDbn) (RHS) CAB (%age of GDP) 5 Payments during the past one and a half year where the country posted its first monthly Current Account - Surplus in Oct’19 after many years. In FY20, the country reported a CAD of USD3bn compared to a deficit of - (1.0) 0.1 USD13.4bn. During 5MFY21 Pakistan witnessed a current account surplus of USD1.6bn (5 straight surpluses) (0.4) (1.1) (5) (2.0) (1.1) (1.3) (1.0) compared to a deficit of USD1.7bn during the same period last year. The sole reason for this improvement is (1.7) 26.9% improvement (USD2.5bn) in remittances from overseas Pakistanis coupled with some improvement in (3.0) (2.2) (2.1) (2.0) (10) balance of primary income (USD252mn). Trade deficit in goods increased by 6.9% (USD553mn) with a decline (4.0) (15) of 7.1% in exports with only 1% reduction in imports. Improvement of 38% (USD568mn) in the trade deficit in (4.1) (5.0) services, with a reduction of 18.4% in imports and only a 5.5% reduction in exports of services, resulted in a (4.8) (20) (6.0) flattish trade balance in goods and services combined. Going forward, we believe trade deficit would increase (6.1) while remittances would normalize at averages lower than the current, and hence current account would re- (7.0) (25)

enter the deficit zone. We foresee a CAD of USD1.3bn (0.5% of GDP) for FY21.

FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 FY22E Overseas Pakistanis making major contributions FY21E Source: SBP, Next Research During the pandemic, two things were in great favour of Pakistan: 1) significant plunge in international oil Significant jump in remittances by overseas Pakistanis (USDmn) prices, and 2) significant increase in home remittances from overseas Pakistanis. During the past 6 months Saudi Arabia USA UK (Jun-Nov’20) average monthly remittances stood at USD2.4bn compared to USD1.8bn during the same period 3,000 60% last year, marking an improvement of 30.5%. During 5MFY21, remittances have increased by 26.9% UAE EU Others YoY Growth (RHS) (USD2.5bn) to USD11.8bn compared to USD9.3bn during 5MFY20. In terms of USD, remittances from Saudi 2,500 40% Arabia and UK reported the highest increase of USD733mn and USD542mn, respectively (28.2% and 53.7%, 2,000 respectively). Remittances from EU countries surged by 37.3% (USD278mn) led by Belgium, Italy and France 20% (in USD terms). We attribute this phenomenal surge in remittances to a lot of factors including more 1,500 0% utilization of official channels with travel restrictions and initiatives of the SBP in this regard, and transfer of 1,000 savings and residence by overseas Pakistanis with the global cut-down in employment levels. Going forward, -20% being conservative, we have incorporated a slowdown in remittances with a decline of 5% during FY22, but it 500 would still make a healthy contribution to the overall balance of payments of the country. Going forward we - -40%

do not rule out the possibility of some of the remittances flows moving to Roshan Digital Account.

Jul-20

Jan-20

Jun-20

Oct-20

Apr-20

Feb-20 Sep-20

Dec-19

Aug-20

Nov-19 Nov-20

Mar-20 May-20 Source: SBP, Next Research 25 Macroeconomic Outlook External account in a comfortable spot

Trade deficit to expand going forward Gross external funding requirements to soar in FY22 Contrary to our previous expectations of a flattish goods import bill during FY21, speedy economic recovery USDbn FY18 FY19 FY20 FY21E FY22E and surge in international prices of oil and other commodities, coupled with higher imports of cotton, wheat, CAB (19.2) (13.4) (3.0) (1.2) (6.1) sugar and other food items, are expected to result in an 11.4% increase in import bill during FY21 where FDI 2.8 1.4 2.6 1.8 2.0 5MFY21 imports have gone down by 1% over the same period last year. Goods exports so far during 5MFY21 Portfolio Investment* 2.2 (1.4) (0.5) (0.0) 0.0 have gone down by 7.1% as a result of the impacts of the pandemic in most of the export destinations of the Debt repayments (5.1) (7.3) (9.1) (7.6) (7.4) country. With the overall situation improving and exports reviving, we see a continued rebound in exports of To IMF (0.1) (0.4) (0.7) (1.0) (1.0) the country and believe that FY21 exports would be able to register a growth of 8.8% reaching USD24.5bn Others (0.7) 2.3 0.6 1.1 0.0 compared to USD22.5bn last year and USD24.3bn of FY19. Therefore the trade deficit in goods is expected to widen during the remaining part of FY21 taking the full year deficit to USD22.7bn compared to USD19.9bn Gross funding requirement (20.0) (18.9) (10.1) (7.0) (12.5) during FY20, which is still significantly lower than USD27.6bn of FY19. Source: SBP, MoF, Next Research *New Eurobonds expected to be issued to finance maturing External account at a comfortable spot for now, IMF inevitable going forward Eurobonds in FY21 and FY22 SBP reserves are standing at around USD13.2bn that are enough to cover around 3.5 months of imports (based on last 12 months average). However, as global and domestic economies return to their normal pace during the course of 1-1.5 years, Pakistan’s external funding requirements would get enlarged with widening External account comfortable for now CAD (2% of GDP estimated for FY22), and soaring debt repayments. Being in an IMF program is important not 25 SBP FX res. (USDbn) 10 only for obtaining its financing for BOP support but its important for obtaining a comfort for other lenders to 9.3 FX res. with Banks (USDbn) extend financing facilities to Pakistan. The recent appreciation in the PKR against the USD, can be attributable 20 8 to the handsome flow of remittances. However, going forward, while we see some deterioration in balance SBP import cover (months) (RHS) of trade and current account balance, continued flows in remittances and the new Roshan Digital Accounts 6.0 15 6.2 6 are likely to prevent any abrupt movement in domestic currency. We expect a natural annual PKR 5.2 devaluation of 4% going forward. 5.3 10 5.0 5.0 4 3.9 4.0 3.5 3.4 3.4 5 3.2 2 2.9 2.6 2.1 1.8 1.7

- -

FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 FY21E Source: SBP, Next Research 26 Macroeconomic Outlook Fiscal challenges remain, here comes the IMF again

Lower non-tax revenue and higher current expenses resulted in 1QFY21 fiscal deficit of 1.1% of GDP Fiscal deficit for FY21 estimated at 8.1% of GDP, +11%YOY Pakistan’s fiscal account posted a deficit of PKR484bn (1.1% of GDP) during 1QFY21 compared to a deficit of Fiscal Deficit (PKRbn) %age of GDP (RHS) - 0% PKR286bn (0.7% of GDP) during 1QFY20. Primary balance surplus during 1QFY21 was PKR257bn (0.6% of (500) GDP) during 1QFY21 compared to a surplus of PKR286bn (0.7% of GDP) during 1QFY20. Higher deficit is -2% attributable to lower non-tax revenues owing to absence one-offs from the PTA revenues and lower SBP (1,000) profits, and higher current expenses. With most of the stimulus for growth amidst the pandemic expensed (1,500) -4.6% -4% out in 4QFY20 and 1QFY21, we see FY21 fiscal deficit at PKR3.7bn (8.1% of GDP) compared to PKR3.4tn (8.1% (2,000) -6.2% -5.5% of GDP) last year. Primary balance is also expected to report a deficit of PKR708bn (1.5% of GDP) compared -6.8% (2,500) -5.3% -5.8% -6% to PKR757bn (1.8% of GDP last year). Spending for procurement and distribution of COVID-19 vaccines and -6.5% (3,000) -6.5% reimbursement of outstanding amount from the circular debt would increase the deficit amount and hence -8% raise the borrowing requirements going forward. (3,500) -8.2% -9.1% -8.1% -6.3% -8.1%

Revenues still short of target (4,000) -10%

FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 FY22E FBR revenues increased by 5%YoY during 1HFY21 (PKR2,204bn), falling short of target by only PKR6bn, which FY21E is 45% of the annual tax collection target of PKR4.9tn. While we see economic recovery in 2HFY21 continuing, Source: MoF, Next Research the remaining target implies a YoY growth of 42% during 2HFY21, which although seems unachievable but FBR performance set to recover the shortfall is expected to be much thinner. FBR Collection %age of GDP 6,000 10.9% 12% Budget FY22 – Consolidation vs growth 11.1% 10.7% 5,000 10.1% 11% FY22 budget is expected to be an effort to strike a balance between fiscal consolidation and stimulating 10.0% 10.5% 9.6% growth. With IMF program resumed, we see structural reforms agenda dominating the FY22 budget. 4,000 9.4% 10% Aggressive revenue targets, culmination of subsidies and tax exemptions, and increase in electricity tariffs 8.9% 9.0% 8.6% 9.4% would be initiated in the near future. 3,000 8.5% 9% Deficit financing to remain a challenge 2,000 8%

With revenues expected to fall slightly short of target, and current expenditure targeted at levels higher than 1,000 7% the previous year, we see development spending to suffer this year as well. The federal government has targeted a PSDP spending of PKR650bn during FY21 compared to PKR622bn (initial target PKR700bn) during - 6%

FY20. We believe that spending under the PSDP program during FY21 would however achieve a higher

FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 FY22E utilization compared to FY20. Additionally, we believe that the government would continue its borrowing FY21E spree from domestic and international markets to fund the twin deficits. Source: MoF, Next Research 27 Macroeconomic Outlook

Key Economic Indicators FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 FY21E FY22E General Nominal GDP (USDbn) 225 231 244 270 279 305 315 279 264 286 313 Real GDP Growth 3.8% 3.7% 4.1% 4.1% 4.6% 5.2% 5.5% 1.9% -0.4% 2.2% 3.8% Inflation (Average) 11.0% 7.4% 8.6% 4.6% 2.9% 4.2% 4.7% 6.8% 10.7% 9.0% 7.8% Policy Rate (period end)* 12.0% 9.0% 10.0% 6.5% 5.8% 5.8% 6.5% 12.3% 7.0% 8.5% 9.0% Balance of Payments Current Account (USDmn) (4,658) (2,496) (3,130) (2,795) (4,867) (12,621) (19,195) (13,434) (2,970) (1,200) (6,107) Current Account %a of GDP -2.1% -1.1% -1.3% -1.0% -1.7% -4.1% -6.1% -4.8% -1.1% -0.4% -2.0% Imports (USDmn) 40,370 40,157 41,668 41,357 41,255 48,683 55,671 51,869 42,417 47,242 51,324 Imports Growth 12.8% -0.5% 3.8% -0.7% -0.2% 18.0% 14.4% -6.8% -18.2% 11.4% 8.6% Exports (USDmn) 24,718 24,802 25,078 24,090 21,972 22,003 24,768 24,257 22,507 24,495 25,987 Exports Growth -2.6% 0.3% 1.1% -3.9% -8.8% 0.1% 12.6% -2.1% -7.2% 8.8% 6.1% Remittances (USDmn) 13,186 13,922 15,837 18,721 19,917 19,351 19,914 21,740 23,131 26,584 25,194 Remittances Growth 17.7% 5.6% 13.8% 18.2% 6.4% -2.8% 2.9% 9.2% 6.4% 14.9% -5.2% SBP FX Reserves (period end) (USDbn) 11 6 9 14 18 16 10 7 12 13 14 PKR/USD (period end) PKR 94.42 98.91 98.65 101.73 104.65 104.79 121.29 162.01 168.05 163.05 169.67 Fiscal Account Total Revenues PKRbn 2,567 2,982 3,637 3,931 4,447 4,937 5,228 4,901 6,272 6,635 7,569 Total Revenues % of GDP 12.8% 13.3% 14.5% 14.3% 15.3% 15.5% 15.1% 12.9% 15.0% 14.3% 14.5% FBR Collection PKRbn 1,881 1,936 2,266 2,588 3,112 3,361 3,842 3,829 3,998 4,631 5,652 FBR Collection % of GDP 9.4% 8.6% 9.0% 9.4% 10.7% 10.5% 11.1% 10.1% 9.6% 10.0% 10.9% Primary Balance PKRbn (481) (843) (241) (153) (86) (515) (760) (1,354) (757) (721) 391 Primary Balance % of GDP -2.4% -3.8% -1.0% -0.6% -0.3% -1.6% -2.2% -3.6% -1.8% -1.6% 0.8% Overall Balance PKRbn (1,370) (1,834) (1,389) (1,457) (1,349) (1,864) (2,260) (3,445) (3,376) (3,744) (2,984) Overall Balance % of GDP -6.8% -8.2% -5.5% -5.3% -4.6% -5.8% -6.5% -9.1% -8.1% -8.1% -5.7% *Discount Rate till FY14, Target/Policy Rate onwards Source: SBP, PBS, MoF, Next Research 28 29 Commercial Banks Banks – Valuations yet to catch-up

Investment Thesis Commercial Banks Over-weight We maintain an over-weight stance on the banking sector where the sector enjoys exposure to the growth Market Cap (PKR bn) 1,371 story of the economy on solid footings of strong asset quality coupled with attractive valuations and Market Cap (USD mn) 8,575 expanding ROEs. Weight in KSE-100 Index 23% Balance Sheet expansion and uptick in interest rates to restrict NIMs compression in CY21 Listed Companies 20

We see the NIMs of our banking sector universe stabilizing after a slight dip further during 4QCY20. Average Commercial Banks Snapshot NIMs for our universe are estimated at 3.5% for CY21 (-66bps) compared to 4.2% of CY20 and 3.9% of CY19. TP Rating P/E Div. Yield P/B Going forward with the expected growth in Balance Sheets and uptick in interest rates (200bps in CY21 HBL 172.00 Buy 5.5 9.3% 0.7 expected), NIMs are expected to remain strong. Based on interim data, deposits of banking system are UBL 170.00 Buy 7.5 9.5% 0.8 expected to close CY20 with a growth of 18%YoY. Average deposits during the year are also estimated to MCB 210.00 Buy 7.8 10.3% 1.2 have grown by 16%YoY compared to 9%YoY in CY20. We expect this healthy trend to continue with the BOP 14.00 Buy 3.4 8.1% 0.4 increasing documentation and revival of growth of the economy. BAFL 45.00 Buy 5.8 8.5% 0.6 MEBL 125.00 Buy 9.9 5.7% 1.9 Significantly improved asset and credit quality BAHL 79.00 Buy 7.2 5.0% 0.9 With a healthy double-digit growth in deposits, advances have been a laggard resulting in significant rise in investments by banks in government papers. Advances of the sector are estimated to grow by 2.2% in CY20 KSE-100 Index vs.. Commercial Banks while investments are expected to increase by 31.7%. On the credit quality side, banks amidst the pandemic 20% KSE100 INDEX BANKS and the relaxations provided by the SBP for loan deferments and rescheduling, have been aggressive booking general provisions to create a buffer against future losses. Credit charge for CY20 of our coverage universe is 10% estimated at 141bps and that is expected to come down to 72bps during CY21 and improve further as 0% economy picks-up with improving advances growth. While the infection ratio of our universe has inched up to 7.2% (Sep’20) compared to 6.6% in CY19, coverage ratio has significantly improved from 91% in CY19 to 97% -10% in Sep’20. With a strong coverage ratio and improving economic outlook, we see IFRS-9 implementation -20% lesser than a material risk for the banking sector at general. -30% Attractive valuations -40% We see ROEs of our coverage universe of banks expanding in the future and heading north of 17% in the next

five years (CY21E ROE 13.3%) despite a dip in earnings and ROEs during CY21. Our banking sector universe is Jul-20

Jan-20

Jun-20

Oct-20

Apr-20

Feb-20 Sep-20

Dec-19 Dec-20

Aug-20

Nov-20 Mar-20 trading at attractive CY21E P/B and PER of 0.9x and 7.1x, respectively, with an estimated 3-year earning CAGR May-20 Source: PSX, Company Account, Next Research *Consolidated of 15% in our coverage universe. Price data as of Dec 31, 2020 30 Commercial Banks Banks – Valuations yet to catch-up

Bumper dividends in sight with CY20 results Expansion in ROEs from 2022 MCB, HBL, and UBL from our coverage universe have announced interim cash dividends for 1QCY20, have 17% 16.0% suspended their payouts for 3QCY20 in line with the directives of the SBP amidst the pandemic. Healthy 16% 15.8% capital adequacies and asset quality of these banks, makes us believe that they would maintain a healthy cumulative payout ratio for CY20, resulting in a bumper cash dividend with the full year results. During CY21, 15% MCB, UBL, and HBL are estimated to have dividend yields of 16%, 15%, and 15%, respectively. 14% 13.7% Risk factors 13.3% 13% 1) Risks to growth amidst the second wave of the pandemic, 2) worst than expected asset quality 11.9% 12% deterioration, and 3) regulatory risks including adverse impacts of implementation of TSA and increase in tax 11.4% incidence on income from government papers. 11%

10% 2017 2018 2019 2020E 2021E 2022E Source: Company Accounts, Next Research

31 Oil & Gas Exploration Companies A long term bet

Investment Thesis Oil & Gas Exploration Companies Over-weight E&P sector has underperformed the market mainly on the back of depressed international oil prices and Market Cap (PKR bn) 983 concerns related to the secondary public offerings of OGDC and PPL. However, with gradual increase in oil Market Cap (USD mn) 6,151 prices, we expect the sector to post decent earnings growth from FY22 and the sector is currently trading at Weight in KSE-100 Index 11% FY21/22 PER of 5.5x/4.9x. Further, with chances of circular debt issue getting resolved, E&P companies are Listed Companies 4 set to benefit massively. Lastly, GoP plans to auction new blocks that could result in higher exploration activities. We remain upbeat on the sector with an over-weight stance. Oil & Gas Exploration Companies Snapshot Production witnessed a decline for both oil and gas TP Rating P/E Div. Yield P/B Production of both oil and gas witnessed a decline in FY20 that can be attributed to slowdown in economic OGDC 155.00 Buy 4.9 10.1% 0.6 activity and lockdown due to COVID-19, and natural depletion of fields. The production of oil in FY20 was 76,739BOPD compared to 89,030BOPD; a decline of 13.8% whereas gas production stood at 3,597MMCFD a PPL 140.00 Buy 5.1 3.3% 0.6 decline of 8.6% compared 3,936MMCFD of FY19. During FY20, 92 wells were planned of which 52 were POL 485.00 Buy 7.2 6.6% 2.8 exploratory and 40 were appraisal/development while actual spudded wells were 58 of which 25 were exploratory and 33 were appraisal/development.

Exploration targets for FY21 KSE-100 Index vs.. Oil & Gas Exploration Companies

For FY21, companies have planned a total of 80 wells of which 44 are exploratory and 36 20% KSE100 INDEX E&Ps appraisal/development. As of November, a total of 13 wells have been spudded that includes 8 exploratory 10% wells and 5 development/appraisal wells. 0% Circular debt an issue holding back payouts and investments -10% Payouts by E&P companies have reduced significantly (ex. POL) and investment plans have also been altered -20% due to liquidity constrains arising from the circular debt. Being at the upstream these companies are in fact funding the circular debt to a great extent, which is negatively affecting their performance. However, GoP has -30% been trying to devise a mechanism to restrict, reduce and eliminate the circular debt for which hopes are -40% st high. As a 1 step, the Govt has engaged IPPs and recent reports suggest a workable solution has been agreed -50% upon in principle. The resolution of the issue will ease liquidity, which will not only improve payout but also

result in new investments and aggressive exploration thus enhancing reserves life and production levels in Jul-20

Jan-20

Jun-20

Oct-20

Apr-20

Feb-20 Sep-20

Dec-19 Dec-20

Aug-20

Nov-20 Mar-20 the medium-long term. May-20 Source: PSX, Company Accounts, Next Research

Price data as of Dec 31, 2020 32 Oil & Gas Exploration Companies A long term bet

Linked to USD/PKR parity Revenues of the E&P companies are linked to USD/PKR and any depreciation in PKR has a positive impact on E&P companies earnings whereas appreciation dents the revenues. We assume USD/PKR to remain stable in the near time with normal depreciation in the longer run. New Blocks to be offered but delays are imminent After a significant gap, the government plans to auction 27 new exploration and production blocks, the advertisement of award of 20 E&P blocks was to be given in October and December however, anything tangible is yet to be seen. The government plans to ramp up exploration activities in the country in view of the depleting reserves. For this purpose, a new Exploration & Production policy is also in the making to lure new investments in he sector. International oil prices on the rise International oil prices are on an uptrend with the development and initiation of administration of COVID-19 vaccines that has resulted in a gradual resurgence of demand along with announcements on output cuts by OPEC+ countries. We have revised up our international oil prices assumptions to USD50/bbl for the ongoing quarter followed by USD55/bbl as our long-term assumptions. Key Risks Key risks to our investment case include 1) failure and/or slower than expected progress in E&P activities, 2) unfavorable law and order situation and geo-political landscape, and 3) volatility in oil prices and exchange rate.

Price data as of Dec 31, 2020 33 Cement Favorable environment to unleash growth

Investment Case Cement Over-weight Cement dispatches have witnessed a phenomenal growth post-lockdown, which has forced us to slightly Market Cap (PKR bn) 615 revise up our growth assumption. Moreover, with Government’s support to the industry, we remain upbeat Market Cap (USD mn) 2,849 on the demand prospects. With increasing demand, the industry has regained much of its pricing power but is Weight in KSE-100 Index 10% under immense scrutiny. Improved sector dynamics and taking in account 1QFY21 financial performance Listed Companies 22 along with management guidance, we revisit our investment case and upgrade our stance to over-weight from market-weight. Cement Snapshot Post opening, sales staged a strong comeback and the trend is likely to continue TP Rating P/E Div. Yield P/B Cement sales have staged a strong comeback post re opening of the economy, and in 1HFY21 local cement LUCK 805.26 Buy 21.2 1.4% 2.0 dispatches have improved 15.8%YoY. We are projecting local sales to post a growth of 13%YoY in FY21 on the DGKC 146.92 Buy 19.7 1.0% 0.7 MLCF* 54.49 Buy 19.2 1.6% 1.3 back of robust outlook. We place positive outlook on cement demand on the back of amnesty scheme FCCL 25.89 Buy 12.0 5.4% 1.4 announced by the GoP (extended till Jun’21), resilient private sector construction, mega projects, and the CHCC 143.17 Hold 29.2 0.7% 2.5 flagship project of the present government that is Naya Pakistan Housing Scheme. KOHC 224.82 Hold 14.8 2.7% 2.0 Amnesty a win-win for all stakeholders There have been many amnesty schemes in the past but this time around it has been well thought, to revive KSE-100 Index vs.. Cement the economy. The major feature of this scheme is no questions asked on sources of income in the 80% KSE100 INDEX CEMENT construction sector till Jun’21. As per news reports, projects worth PKR186bn have been registered with the FBR, while projects in the process of registration amount to PKR116bn. The benefits of the scheme are likely 60% to reflect in numbers during 2HFY21. 40%

Private sector construction remains strong 20%

Private sector construction has remained strong and in our opinion higher remittances and excess cash in the 0% rural economy are the main factors. Remittances have stayed strong despite COVID-19 lockdowns whereas GoP has been supporting the agriculture sector. In order to reduce the input cost, GoP slashed GIDC, which -20% resulted in cost reduction of Urea by PKR400/bag that translates into an annual cost saving for the agriculture -40%

sector of more than PKR40bn. On top of that a PKR50bn agriculture package was announced to support the

Jul-20

Jan-20

Jun-20 Oct-20

sector. In view of the above listed factors we are of the opinion that private sector construction activities are Apr-20

Sep-20 Feb-20

Dec-19 Dec-20

Aug-20

Nov-20 Mar-20 likely to stay strong. May-20 Source: PSX, Company Accounts, Next Research *Consolidated Price data as of Dec 31, 2020 34 Cement Favorable environment to unleash growth

Infrastructure push along with low cost housing Penalty imposed by CCP Company Penalty Shares Outstanding Per Share Pakistan is witnessing construction of large dams, although the construction is in its initial stages but the long term prospects for cement demand remain strong. Moreover, two mega projects Ravi Urban City and Bundle LUCK 1,272 323 3.9 Island project hold the potential to create huge demand if materialized. Further, under Naya Pakistan BWCL 1,041 596 1.7 Housing Scheme the Govt. plans to build and facilitate low cost houses and for this, the government has DGKC 933 438 2.1 announced subsidized markup rates and tax rebates for banks to facilitate the construction. Moreover, SBP MLCF 586 1,098 0.5 has assigned disbursement targets for commercial banks. ACPL 374 137 2.7 Exports to keep South utilization levels high PIOC 364 227 1.6 Exports are likely to play an important role in keeping the utilization levels of South based plants high, FCCL 266 1,380 0.2 whereas after the ban on exports to India, Afghanistan is the sole destination for exports in North. Exports to CHCC 226 194 1.2 Afghanistan are picking up and could further increase once all parties reach an agreement on the future of FECTC 174 50 3.5 the country. Further, the anti-dumping duty imposed in South Africa on Pakistani origin cement has expired KOHC 103 201 0.5 but we believe the duty to be extended. GWLC 39 400 0.1 Another notice by the CCP FLYNG 12 176 0.1 The price increase in April’20 was taken up by the CCP and since then CCP has been investigating any Source: CCP, Company Accounts, Next Research collusion between manufacturers and conducting raids. However, despite Lahore High Court dismissing petitions challenging the establishment of CCP the penalty imposed in 2009 is yet to be paid and manufacturers are mulling available legal options however, the uncertainty remains. Are we heading into another expansionary phase? In view the future expected demand there is a high possibility that utilizations level in North will be above 90% in FY24. Based on this view, manufacturers have started forming their plans for the next round of expansion. In our opinion, one thing different this time around is that, there will be more green field projects. We believe, manufacturers will start announcing their plans officially towards the end of FY21 or early FY22. Key Risks Key risks to our thesis include 1) complete lockdown amidst the second wave of COVID-19, 2) higher than expected PKR devaluation against USD, and 3) volatility in international coal and energy prices.

Price data as of Dec 31, 2020 35 Engineering - Long Steel All set to capitalize the construction boom

Investment Thesis Engineering Over-weight Long steel sector will remain in the limelight in line with the construction theme as we believe CY21 will be Market Cap (PKR bn) 160 the year of construction. Fundamentals of the sector are intact and our liking is based on economic recovery, Market Cap (USD mn) 998 GoP’s promoting construction and conversion from substandard to standard bars. Long steel stocks have Weight in KSE-100 Index 1% witnessed a decent price run-up, which has limited the upside of long steel stocks under our coverage, but we Listed Companies 20 remain over-weight on the sector as if things materialize as planned the sector will provide good returns. No questions on growth The sector has been in the limelight since the announcement of construction package and there are no Engineering Snapshot questions or doubts on growth in the sector. Long steel is not as organized as Cement but taking cements TP Rating P/E Div. Yield P/B numbers as a proxy (1:10) we can safely assume growth in demand for Rebars has been in the double digits. Further we expect demand to originate from 1) amnesty scheme 2) Naya Pakistan Housing 3) uptick in private ASTL 52.85 Hold 18.2 1.1% 1.2 sector construction and 4) other mega projects. Invest and get documented The Govt is luring the undocumented money into formal channels and for this GoP has announced an amnesty scheme/construction package. The main attraction of this package is no questions will be asked on KSE-100 Index vs. Engineering sources of investment for a certain time period. The response to the scheme has been phenomenal with 125% KSE100 INDEX Engineering around PKR186bn worth of projects have been registered and another PKR116bn are in the pipeline. The said 100% scheme is likely to give a boost to construction activities and generate demand for Rebars. In our opinion the incremental demand from the scheme will reflect in numbers during 2HFY21. 75% Naya Pakistan Housing Development 50% 25% The flagship project of the incumbent government is the Naya Pakistan Housing scheme where the government plans to build and facilitate low cost housing. Subsidized markup rates for this project have been 0% announced where SBP is playing an active role of facilitating and promoting housing finance through -25% commercial banks. Targets for housing loans have been assigned with timelines that indicates the seriousness -50%

in developing this market.

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Jan-20

Jun-20

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Apr-20

Feb-20 Sep-20

Dec-19 Dec-20

Aug-20

Nov-20

Mar-20 May-20 Source: PSX, Company Accounts, Next Research Price data as of Dec 31, 2020 36 Engineering - Long Steel All set to capitalize the construction boom

Growth in remittances and agriculture to support the sector Private sector construction has remained resilient where graded rebars are preferred in construction by individuals. With access to financing we expect private construction activities to remain upbeat. Moreover, with marketing and educational campaigns rebars manufacturers are trying to shift users from sub-standard to quality rebars. Although the process of migration will take time but it will keep expanding the market of quality rebars. Further, higher remittances and better farm economics have played a key role in higher level of construction. Initiation of mega projects Large infrastructure projects are planned and mobilization of labor has started on some projects moreover, the Govt plans to build new cities. Although, the development of new cities is a very ambitious plan but we remain optimistic. Together with spending on infrastructure and water reservoirs we believe significant demand will be generated. Any cost pressure will be passed on International scrap prices have been on the rise as Governments around the world to negate the affects of COVID-19 are focusing on infrastructure spending. Infrastructure spending has increased the demand for scrap resulting in higher price. Moreover, port congestion throughout Asia has resulted in higher freights costs that are adding to the cost of materials. Once, things normalize we foresee a reversal in scrap prices but till than we believe input cost pressures to be passed on the end customers. Key Risks 1) Lockdown due to second wave of COVID-19, 2) rising raw material prices and inability to pass on the cost and 3) Oversupply

Price data as of Dec 31, 2020 37 Automobile Assembler Economic recovery to expand market size

Investment Thesis Automobile Assembler Market-weight Post lockdown automobile sector has witnessed a sharp recovery that has come as a surprise with unit sales Market Cap (PKR bn) 340 beating expectations. Our initial view of a gradual recovery in unit sales has been negated by the recovery Market Cap (USD mn) 2,125 that was fuelled by low interest rates, better farm economics and return of deferred purchases. Moreover, Weight in KSE-100 Index 3% the appreciation of PKR against the USD has provided relief to the strained gross margins. On the basis of Listed Companies 12 above factors we revisit our investment case on the sector and upgrade our stance from under-weight to market-weight. Automobile Assembler Snapshot Post lockdown, demand surge surprised everyone TP Rating P/E Div. Yield P/B Automobile sector was the hardest hit first due to the taxation drive and then due to the COVID-19 related lockdown. However, post re-opening of the economy sales have recovered faster than expected. The demand INDU 1,520.26 Buy 9.3 7.1% 2.0 has surprised even the management of OEMs and one reason for this increase is purchases by customers that PSMC 240.56 Hold 23.8 1.3% 0.8 were deferred due to uncertainty caused by lockdowns. Passenger car sales during 5MFY21 stood at 55,779 units an increase of 14%YoY whereas Jeeps and Pickups sales were up 107%YoY/48%YoY.This sharp recovery HCAR 333.15 Hold 35.5 0.8% 2.6 in sales is on the back of low interest rates that were slashed during the lockdown along with better farm economics. KSE-100 Index vs. Automobile Assembler Lower Interest rates to keep the demand intact 30% KSE100 INDEX AUTOS SBP drastically slashed policy rate from 13.25% to 7% to counter the negative effects of COVID-19; moreover, since then rates have been stable that has provided the much needed support to the automobile sector. Car 15% financing accounts for around 35-40% of the sales and with interest rates at these levels we expect financing to grow. However, in our opinion interest rates will start inclining from Mar’21 onwards, but we do not 0% foresee a significant dent to financing demand till the rates remain below 10%. As of Nov’20, the stock of -15% outstanding loans for automobile purchases stood at PKR245.6bn that was PKR211.1bn as of Jun’20. Farm economics to remain healthy -30%

Agriculture sector registered a growth of 2.7% in FY20 whereas we are expecting it to grow 1.5% in FY21. -45%

Higher crop support prices and lower cost of inputs as a result of elimination of GIDC and agriculture support

Jul-20

Jan-20

Jun-20 Oct-20

package has benefitted the farmers. Rural economy is a major demand center and with expectations of it to Apr-20

Sep-20 Feb-20

Dec-19 Dec-20

Aug-20

Nov-20 Mar-20 grow we believe the demand from rural economy to support the overall sales of the sector. May-20 Source: PSX Company Accounts, Next Research Price data as of Dec 31, 2020 38 Automobile Assembler Economic recovery to expand market size

Competition to intensify in 2HFY21 Electric vehicle policy (EV) The dominance of Japanese players is at risk owed to the entry of Korean and Chinese OEMs where KIA has Recently ECC approved the EV policy to facilitate investment in this segment and promote use performed better than expectations. The industry witnessed several new offerings mainly KIA Sportage and of cleaner fuel. The policy will remain in force till June 30, 2026 and the salient features of the policy approved by ECC are Picanto, and Hyundai Tucson, which were well received by the market. Going forward, during 2HFY21, several new cars are expected to hit the market as AIDP-II will be expiring in Jun’21. As new players have 1. No Additional Customs Duty (ACD), Regulatory Duty (RD) or Value Added Tax (VAT) on EV specific parts for Completely Knocked Down units. made inroads, Indus Motor has also geared up and is launching Toyota Cross (CBU). Moreover, MG has also entered the market, which is likely to intensify the competition. 2. Customs Duty (CD) @ 1% on CKD units. Passing on the costs will be tough 3. 25% CD, on import of Completely Built Units (CBU) 4. Duty free import of plant and machinery for EV’s. OEMs in the past had complete pricing power, which they exercised at their discretion, however, the situation has changed and now passing on the complete input cost pressures would be difficult owed to 5. Import of CKD in small cars and sport utility with 50kWh battery or below, and Light Commercial Vehicles (LCVs) with 150kWh battery would be exempted from Sales Tax, competition. One of the major factors that led to cost pressures is the depreciation of PKR against the USD, and VAT on imports, but with 1% Sales Tax on Sales. as of now the pair has stabilized in the range of 160-161 but we believe PKR to depreciated in line with its historical trends, which would create input cost pressures and OEM’s will face a tough task passing on the Source: News Papers, Next Research costs. Automobile development policy 2016-21 The AIDP 2016-21 is set to expire in Jun’21 and as per reports groundwork for the development of new policy has started. Japanese OEMs lobbied hard to get a share in the existing policy but were left out. However, with discussion for the new policy started we expect whatever the incentives offered will be for the entire industry. To note, PSMC had been lobbying for incentives to set up a new plant and we expect the stalled investment could be revived post approval of the new policy. Key Risks Key risks to our thesis include 1) volatility in USD and JPY, 2) failure to pass on incremental costs, 3) increase in steel prices and 4) significant increase in interest rates.

Price data as of Dec 31, 2020 39 Engineering - Flat Steel An oversupplied market

Investment Theme Engineering Market-weight Outbreak of COVID-19 and subsequent lockdown along with an oversupplied market has deteriorated sector Market Cap (PKR bn) 160 dynamics. The sector is oversupplied that is due to a significant decline in market size. Economic recovery is Market Cap (USD mn) 998 likely to beat expectation but will still remain in range not sufficient to stimulate significant demand for flat Weight in KSE-100 Index 1% steel. Flat steel demand in our opinion will recover in FY21 but will still remain below the level of FY19. Listed Companies 20 Despite expectation of a recovery in demand we have an market-weight stance on the sector based on the above listed factors relatively unattractive valuations of the companies. Economic recovery to generate demand Engineering Snapshot Post opening up, Pakistan has witnessed a V shaped recovery where all segments of the economy have TP Rating P/E Div. Yield P/B witnessed an upsurge in demand. Automobiles, one of the major demand drivers along with White goods are witnessing a significant recovery resulting in demand for flat steel. With no chances of a blanket lockdown ASL 19.88 Hold 9.1 0.0% 1.8 nd during the 2 Wave of COVID-19, demand will keep on rising and with expectations of a construction boom ISL 85.09 Hold 14.5 2.8% 2.7 we foresee a significant recovery in demand. …..however market size to remain below FY19 levels in FY21 Flat steel market size in FY20 was around 0.9mn tons, a significant contraction from c. 1.3mn tons of FY19. KSE-100 Index vs. Engineering The demand as per our expectations is likely to remain in the range of 1.1-1.2mn tons on the back of recovery 120% KSE100 INDEX Engineering in automobiles, white goods and construction as discussed above. 90% The market is still oversupplied 60% Installed capacity surpasses the demand and the situation is likely to persist in FY21 as well. However, the new capacity of STPL has been delayed, which will ease the expected pressure in the market. Further, imports 30% have also seen a decline as per market sources that is further easing off the pressure from the already over 0% supplied market. -30% …..but we do not see price competition -60% Despite the oversupplied market we do not expect any sort of price competition as main players have

avoided it in the past. Moreover, with imports under control, companies have been passing on the input cost

Jul-20

Jan-20

Jun-20

Oct-20

Apr-20

Feb-20 Sep-20

Dec-19 Dec-20

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Nov-20 Mar-20 pressures onto final customers and we expect the same in the future as well. May-20 Source: PSX, Company Accounts, Next Research Price data as of Dec 31, 2020 40 Engineering - Flat Steel An oversupplied market

Anti Dumping Duty on CRC set to expire The antidumping duty imposed on imports of CRC from China and Ukraine, which supported the local industry is set expire in Jan’21. In our opinion, the local industry will strive hard to get the anti-dumping re imposed for additional 5 years and will go for a sunset review and all imports during the review period will be charged for anti dumping. We expect that the industry will get the duty imposed for another 5 years as well. Key Risks Key risks to our thesis include 1) complete lockdown 2) volatility in exchange rate, and 3) influx of imported products

Price data as of Dec 31, 2020 41 Fertilizer Stable yield and earnings

Investment Thesis Fertilizer Market-weight The settlement of Gas Infrastructure Development Cess (GIDC) has brought much needed clarity on the Market Cap (PKR bn) 501 sector and the sector provides high dividend yield with stable earnings along with support of the government. Market Cap (USD mn) 3,132 We maintain our investment case on the sector with a market-weight stance. Weight in KSE-100 Index 12% The sector to post decent growth Listed Companies 6 Agriculture sector despite all the challenges in FY20 managed to grow by 2.7% and we expect it to grow by 1.5% in FY21. Although cotton production is expected to witness a massive decline (as of Dec.31’20 the Fertilizer Snapshot arrivals are down by 34%YoY), we expect other crops to perform well. Moreover, the increase in crop support TP Rating P/E Div. Yield P/B prices is likely to have a positive effect on farmer incomes. The PKR50bn agriculture package is further likely to create space for the farmers, which includes a PKR1.5bn subsidy for farm tractor and a PKR1,000/bag FFC 122.64 Buy 7.1 10.1% 3.0 subsidy on DAP for Rabi season. Although, the disbursement of PKR50bn package has been on the slower side EFERT* 67.32 Buy 5.7 17.0% 1.9 but we believe the package if fully materialized will improve the farm economics and benefit the sectors associated with it. Gas Infrastructure Development Cess (GIDC) The issue of GIDC was finally settled where after the review petition the companies were directed to pay the KSE-100 Index vs.. Fertilizer outstanding amount in 48 installments. Although, companies failed to convince the court on their stance but 10% KSE100 INDEX FERTILIZER managed to get a significant time, which will ease of the expected pressure on cash flows. To note, fertilizer companies have accounted GIDC on their books and payments will only have impact on cash flows. 0%

Price saw a decline, but are on the rise again -10% GoP eliminated GIDC that has resulted in reduction in price of Urea by around PKR400/ bag, which has an -20% annualized impact of more than PKR40bn (approx). The selling prices in Jan’20 were hovering around PKR2,019/bag, which declined to around PKR1,667/bag (average) in April and are currently at PKR1,679/bag -30% (average). Key Risks -40%

Key risks to our thesis include 1) increase in cost of feed and fuel gas, 2) inability to pass to the incremental Jul-20

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Nov-20 Mar-20 cost to customers, 3) higher inventory level, and 4) abrupt decline in DAP prices. May-20 Source: PSX, Company Accounts, Next Research *Consolidated Price data as of Dec 31, 2020 42 Power Generation & Distribution Settlement in sight

Investment Thesis Power Over-weight Though power sector is not in our coverage but the recent developments pertaining to the sector gives us a Market Cap (PKR bn) 289 hope that long pending issues will be resolved, which would be a long term positive for the sector. The core Market Cap (USD mn) 1,805 issue of circular debt if resolved would ease the liquidity constrains that would enable the companies to Weight in KSE-100 Index 5% declare regular payouts that have currently dried out. Within the IPPs space, we prefer HUBC with its Listed Companies 17 diversified projects in the energy spectrum warranting a long-term growth. Brining the cost of electricity down The government in order to control the rising burden of capacity payments and to bring the cost of electricity down, signed MoUs with IPPs where the power producers agreed to revise tariffs downwards provided their outstanding dues are cleared. The expected cost saving from this exercise is likely to be around PKR836bn in the next 10-12 years. The concerned authorities are working with the IPPs to conclude the MoUs into final agreements. Circular debt an issue affecting the entire energy chain Circular debt has been haunting the entire power sector and the resolution of it is one of the main conditions of IMF. As per reports the circular debt has reached PKR2.3tn. There are various options circulating to reduce KSE-100 Index vs. Power Generation & Distribution the entire debt, which include equity swaps and dividend payments also. One of the conditions for the 10% KSE100 INDEX POWER resumption of IMF program is hike in electricity prices and curtailment of circular debt. News flow suggests Govt has agreed to increase the base tariff that will be helpful in further piling up a circular debt. The new 0% SAPM on power is tasked to map payables and receivables of various companies in the energy chain and to -10% come up with solutions. -20% A workable solution with IPPs agreed -30% A meeting of advisor on finance and representatives of IPPs have reportedly reached an agreement of mode of payment that will effectively turn MoUs into final agreements. It has been agreed that the outstanding -40% amount will be paid in 3 tranches till Dec’21. Under the agreement 1/3rd of the amount will be paid in cash -50%

and the rest in the form of Pakistan investment bonds at floating rate.

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Price data as of Dec 31, 2020 43 Power Generation & Distribution Settlement in sight

Developing a competitive trading bilateral contract market (CTBCM) NEPRA has floated a draft to liberalize the electricity trading market and plans to do it the next 18 months. The proposed mechanism will enable the buyer and seller to trade electricity and finish the role of a single buyer. Once the competitive market is developed IPPs will be shifting from Take or Pay basis to Take and Pay basis. Promoting the use of electricity to improve consumption To cover the burgeoning capacity payment the government is trying to increase the use of electricity especially in winters when the consumption is usually low. Recently, GoP has announced an electricity package that incentivizes incremental use of electricity. Moreover, peak rates have also been abolished. Time to revamp the entire sector Power sector has been bleeding and DISCOS have been one of the reasons, now with the new SAPM on power there is talk about reforming them. Privatization of DISCO’s could take long so the idea floated is to opt for public private partnership at the provincial level whereas if we talk about the entire sector IPP renegotiation followed by DISCO reforms, improving electricity demand and closing inefficient plants. Key Risks Risks to the reforms include 1) Failure to convert MoUs into agreements 2) Low electricity demand and 3) failure to curtail circular debt.

Price data as of Dec 31, 2020 44 Textile Composite A calamity turned into opportunity

Investment Thesis Textile Composite NC Textile sector is not in our coverage but we expect the sector to witness significant growth in view of the Market Cap (PKR bn) 305 government support to revive the manufacturing sector in shape of subsidies and other benefits and also Market Cap (USD mn) 1,906 owing to the upcoming Textile Policy. Apart from the Government support, US-China tension and orders Weight in KSE-100 Index 3% diverted from Bangladesh and India will aid in keeping the sector in full swing. Amongst the textile Listed Companies 56 composites, NML is our preferred play with a diversified business model including domestic retail business and an investment portfolio spanning across banking, cement, power, hospitality and other sectors with an undiscounted value of PKR133/share. Textile exports are picking up Initially textile sector was also affected by the COVID-19 lockdown however, the early opening up of the economy and the sector helped Pakistan and its textile sector. Textile sector at one end started exporting safety products related to textile and on the other hand the country received orders diverted from India and Bangladesh where COVID situation worsened. Pakistan textile sector is currently operating close to full utilization as reported by various media outlets and APTMA members. In the 5MFY21 textile exports clocked in at USD6.04bn as compared USD5.76bn of 5MFY20. KSE-100 Index vs. Textile Composite The new textile policy and rationalization of duties on raw materials 20% KSE100 INDEX TEXTILE CO. APTMA has been demanding a long term textile policy for planning investments and improve their global market share. The GoP has finally drafted the Textile Policy 2020-2025 with consultations with the industry 10% and the industry is quite optimistic and satisfied with the draft and believes that if implemented, will play a 0% vital role in increasing the textile exports. As per the draft, electricity will be provided at 9 cents/kWh while RLNG at USD6.5/MMBtu; and system gas at PKR786/MMBtu during the policy period. The Govt. will continue -10% with the Long-Term Financing Facility (LTFF) and Export Financing Scheme (EFS) at the current rates. -20% Moreover, the Ministry of commerce has been in constant exercise to rationalize duties on raw materials and for this NTC has been working where duties have been revised on a number of inputs. The realization at the -30% highest of level to reduce the cost of manufacturing will lead to more competitiveness of textile products that -40%

could help in increasing exports.

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….however the ever decreasing cotton output could hamper the expectations The production target of cotton for the current season is set at 10.89mn bales, however initial output indicates that the target output will not be met. As of 31st Dec’20, the total arrivals of seed cotton were 5.4mn bales compare to 8.1mn bales during the same period last year. The dwindling cotton production poses serious threats to the achievement of the set targets. Entering into the brand licensing space Alkaram Textile is the first home textile company of Pakistan to enter the brand licensing space where it has signed a 6 year agreement for home textiles with Gap inc. for North America and Mexico. This is a positive development and indicates interest in Pakistan. The said development opens up avenues for similar textile companies and we could witness similar agreements in the future. FBR releasing refunds at a faster pace Post COVID-19, FBR has started releasing refunds at a faster pace that has eased the liquidity positions of the companies. The disbursement of refunds is likely to remain high, which will positive benefit the companies. GSP+ status intact for now Pakistan has managed to satisfy the EU commission as a result of which the GSP+ status is available. Moreover, positive vibes are coming from the UK where Pakistan is likely to reap benefits of GSP+ post Brexit as well. Key Risks Key risks to our investment case include 1) appreciation in PKR against the USD, 2) discontinuation of GSP+ status, and 3) increase in cotton prices.

Price data as of Dec 31, 2020 46 47 Habib Bank Limited (HBL) Regulatory issues subside. Valuations open up

Investment Thesis HBL BUY Current Price 132.28 HBL is amongst our top picks for the year with its turnaround story as all the negatives are bygones and investment in business transformation is expected to bear fruits. All of the above are expected to lead to a 3- Target Price 172.00 year earnings CAGR of 36% (despite absence of capital gains in CY21 and CY22). HBL trades at an attractive Absolute / Relative Index -16%/-23% CY21E P/B and PER of 0.7x and 5.5x, respectively. With a Dec’21 target price of PKR172/share (30% upside) Market cap (PKRbn) / (USDmn) 194.0/1,214.0 and a dividend yield of 14%, the stock is offering a total return of 44%. 12m ADTV (USDmn) / (shares mn) 1.3/1.9 Regulatory risks are over Free float 50% Index Weight (KSE-100) 5.1% During CY20, HBL marked the end to its almost 4-year long issue of the New York branch, which was closed in KATS / Bloomberg / Reuters HBL / HBL PA / HBL.PSX Mar’20 and the US Authorities have ended their enforcement actions in Sep’20. This has ended the risk of look-back and follow-up penalties on the bank and bringing the end of unusual legal and consultancy charges. Valuation 2019A 2020A 2021E 2022E Asset quality has improved significantly EPS 10.45 21.79 24.25 24.94 HBL loan book has been resilient with a robust quality. Out of the total of PKR8.9bn provisions charged during DPS 5.00 10.75 12.25 12.50 9MCY20, PKR6bn were booked under the general provisioning head creating a buffer against creation of new PER 12.65 6.07 5.45 5.30 bad loans (general provisions now at 0.9% of average net advances vs. 0.3% in Dec’19) as the SBP’s P/BV 0.86 0.73 0.71 0.65 relaxations amidst the pandemic are nearing their end. The banks total infection ratio has almost remained flat at 6.7% in Sep’20 compared to 6.6% in Dec’19 while improving from 7% in Dec’18. Total coverage now Dividend Yield 3.78% 8.13% 9.26% 9.45% stands at 100% compared to 93% in Dec’19 and 89% in Dec’18. PIB holdings as percentage of deposits have KSE-100 INDEX vs. HBL increased from 19% in Dec’18 to 32% in Sep’20 (26% in Dec’19) supporting NIMs and improving asset quality. 15% HBL KSE-100 INDEX Risk factors 0% 1) Risks to growth amidst the second wave of the pandemic, 2) worse than expected asset quality deterioration, and 3) regulatory risks including adverse impacts of implementation of TSA and increase in tax -15% incidence on income from government papers, and any other New York like development in its international -30% operations, 4) continued foreign selling sup-pressing valuations.

-45%

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Price data as of Dec 31, 2020 48 United Bank Limited (UBL) Domestic performance out weighs middle East risk

Investment Thesis UBL BUY Current Price 125.86 UBL is amongst our top picks from the banking sector. Our view is premised on UBL’s strong domestic franchise, tech focus, new leadership, one of the highest current account ratios, exposure to high yielding Target Price 170.00 PIBs cushioning NIM compression, and exposure being reduced in the Middle East. The bank trades at an Absolute / Relative Index -23%/-31% attractive CY21E P/B and PER of 0.8x and 7.5x, respectively and offers a capital upside of 35% to our Dec’21 Market cap (PKRbn) / (USDmn) 154.1/964.0 target price of PKR170/share along with a dividend yield of 14%, taking the total expected return to 49%. 12m ADTV (USDmn) / (shares mn) 1.1/1.4 Middle Eastern portfolio being reduced Free float 40% Index Weight (KSE-100) 3.2% UBL is on a consistent drive to reduce the portfolio in the Middle Eastern region and it now stands at just over KATS / Bloomberg / Reuters UBL / UBL PA / UBL.PSX USD500mn compared to USD1.7bn in Dec’17. While the risk of further deterioration in these advances amidst the pandemic and overall slowdown, the bank is 90% covered against its existing NPLs (both domestic and overseas). Valuation 2019A 2020A 2021E 2022E EPS 15.60 15.97 16.68 27.37 Investment portfolio, deposit mix, and rise in interest rates to restrict NIMs compression DPS 12.00 11.00 12.00 19.00 UBL’s legacy low yielding PIBs are set to mature this year while the PIBs portfolio is being built-up at higher PER 8.07 7.88 7.54 4.60 yields and floating rates (53% of total PIBs) are set to strength NIMs where the interest rates have declined P/BV 0.81 0.75 0.75 0.71 by 625bps during 1HCY20. In line with our assumptions of a 200 bps increase in interest rates, maturing/floating PIBs would be reinvested/repriced at higher yields higher than current. Further CA ratio of Dividend Yield 9.53% 8.74% 9.53% 15.10% over 40% is also expected to cushion NIMs going forward. KSE-100 INDEX vs. UBL UBL KSE-100 INDEX Cost efficiencies 15% During 9MCY20, UBL has displayed marked improvement in its cost/income ratio that currently stands at 43% 0% compared to 50% for CY18 and CY19. We expect the new leadership to focus on minimizing this ratio with -15% focus on technology and enhancing the bank’s fee income. -30% Risk factors -45% 1) Risks to growth amidst the second wave of the pandemic, 2) worse than expected asset quality -60%

deterioration, and 3) regulatory risks including adverse impacts of implementation of TSA and increase in tax

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incidence on income from government papers, 4) further asset quality deterioration in the Middle East, 5) Aug'20

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Mar'20 May'20 continued foreign selling suppressing valuations. Source: PSX, Company Accounts, Next Research

Price data as of Dec 31, 2020 49 Oil & Gas Development Company Limited (OGDC) The E&P giant

Investment Thesis OGDC BUY Current Price 103.77 OGDC is one of our top picks, which offer a capital upside of 49% to our Dec’21 target price of PKR155/share. Along with a handsome upside, the stock also offers a FY21 dividend yield of 10%. Our liking on the stock is Target Price 155.00 based on hopes of circular debt resolution, rising oil prices, and huge exploration potential of the country. Absolute / Relative Index -27%/-35% Market cap (PKRbn) / (USDmn) 446.3/2,792.3 Massive operations 12m ADTV (USDmn) / (shares mn) 2.1/3.0 OGDC holds around 37% of the total area under exploration and the company has 43 owned and operated Free float 15% joint venture exploration licenses along with working interests in 7 exploration blocks. The company has the Index Weight (KSE-100) 3.5% largest portfolio of net hydrocarbon reserves in Pakistan, 44% of oil and 37% of gas as of Jun’20. During FY20 KATS / Bloomberg / Reuters OGDC / OGDC PA / OGDC.PSX company acquired 3,407 Line Km 2D seismic data, which was 2.6x higher from FY19 whereas 15 exploratory wells and 5 development/appraisal wells were drilled. During FY21, the company plans to drill 45 wells including 26 exploratory and 12 development/appraisal wells. The company has various ongoing and planned Valuation 2019A 2020A 2021E 2022E development projects to augment production capacities, which include Khewari development project that is EPS 27.53 23.27 20.96 24.22 likely to add 25mmscfd of gas, Gundanwari and Chabaro expected to add 18mmcfd of gas/25bpd of oil, DPS 11.00 6.75 10.50 12.50 Qadirpur compression project to add 280mmscfd of raw gas and Uch compression to add 460mmcfd raw gas. PER 3.77 4.46 4.95 4.28 Circular debt resolution on the cards P/BV 0.71 0.65 0.60 0.56 Government is actively working to resolve the circular debt issue, which will ease the liquidity position of the Dividend Yield 10.60% 6.50% 10.12% 12.05% company and allow the company to aggressively pursue exploration. As of Sep’20 the company trade debts KSE-100 INDEX vs. OGDC were at PKR342bn out of which PKR286bn were overdue. OGDC KSE-100 INDEX 15% Secondary public offering (SPO) in the doldrums 0% The stock has underperformed the market despite trading at attractive multiples. One of the reasons for this -15% is the planned SPO of the company that has kept investors at bay. However, we believe that the SPO would -30% not be happening at through away prices that they are currently. -45% Key Risks -60%

Key risks to our investment case include 1) failure and/or slower than expected progress in E&D activities, 2)

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greater than expected unsuccessful drillings, 3) unfavorable law and order situation and geo-political Aug'20

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Mar'20 May'20 landscape, and 3) unfavourable movements in oil prices and exchange rate. Source: PSX, Company Accounts, Next Research

Price data as of Dec 31, 2020 50 Pakistan Petroleum Limited (PPL) Sailing through in times of liquidity constrains

Investment Thesis PPL BUY Current Price 90.33 PPL has underperformed the market despite trading at a FY21/22 PER of 5.1x/4.7x. However, the stock is likely to remain in the limelight on the back of resolution of circular debt, improving demand for both oil and Target Price 140.00 gas and aggressive exploration once the circular debt issue is even partially resolved. The stock offers an Absolute / Relative Index -34%/-42% upside of 55% from our target price of PKR140/share along with a dividend yield of 3.3%. Market cap (PKRbn) / (USDmn) 245.8/1,537.7 Portfolio and planned explorations 12m ADTV (USDmn) / (shares mn) 2.4/3.8 Free float 24% PPL along with its subsidiaries has a portfolio of 48 exploration blocks of which 28 are operated by the Index Weight (KSE-100) 3.2% company. The company drilled 14 development wells during FY20 of which 6 were drilled in operated areas KATS / Bloomberg / Reuters PPL / PPL PA / PPL.PSX while 8 were drilled in partner operated areas. During the year flows from Sui and Adhi decreased due to natural decline while Kandhkot production decreased due to lower than committed offtakes by GENCO-II. For FY21, the company plans to drill 10 wells in total of which 5 planned wells are development and 5 are Valuation 2019A 2020A 2021E 2022E exploratory. The company has pinned high hopes on the frontier block after discovery in Margand and plans EPS 22.65 18.47 17.63 19.25 to focus on the frontier block that they believe could entail huge reserve but the block lies in a high risk area. DPS 2.00 1.00 3.00 5.00 Circular debt restricting exploration plans PER 3.99 4.89 5.12 4.69 P/BV 0.82 0.71 0.64 0.58 The company has been facing an acute liquidity crisis that has restricted the company to pursue a more aggressive approach to exploration activities. However, as the government engages to resolve this issue the Dividend Yield 2.21% 1.11% 3.32% 5.54% company is set to benefit. The total outstanding receivables of the company is PKR326bn of which PKR295bn KSE-100 INDEX vs. PPL are overdue as of Sep’30. Once the company starts receiving its trade debts it could employ an aggressive PPL KSE-100 INDEX approach towards exploration to replenish the existing depleting reserves. 15% Secondary public offering (SPO) in hot waters 0% -15% Despite trading at attractive multiples the stock has underperformed that is in part due to planned SPO of the company that has kept investors at bay. However, we believe that the SPO would not be happening at -30% through away prices that they are currently. -45%

Key Risks -60%

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Key risks to our investment case include 1) failure and/or slower than expected progress in E&D activities, 2) Feb'20

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Nov'20 Mar'20 greater than expected unsuccessful drilling, 3) unfavorable law and order situation and geo-political May'20 Source: PSX, Company Accounts, Next Research landscape, and 3) adverse movement in oil prices and exchange rate. Price data as of Dec 31, 2020 51 Lucky Cement Limited (LUCK) Time to look beyond cement

Investment Thesis LUCK BUY Current Price 696.09 LUCK with its operational efficiencies managed to keep its bottom-line green when all other players were struggling and posting losses. Our liking for the stock stems from a diversified investment portfolio and Target Price 805.26 operational excellence. The stock currently provides an upside of 15.6% to our Dec’21 SoTP based target Absolute / Relative Index 62%/55% price of PKR805/share implying a total return of 17%. Market cap (PKRbn) / (USDmn) 225.1/1,408.3 Post expansion LUCK is the largest manufacturer in Pakistan 12m ADTV (USDmn) / (shares mn) 3.7/1.1 Free float 40% LUCK apart from having presence in both the zones is now the largest cement producer of Pakistan. The Index Weight (KSE-100) 4.7% capacity based market share of the company in South and North is 30% and 13%, respectively, whereas the KATS / Bloomberg / Reuters LUCK / LUCK PA / LUCKY.PSX cumulative market share is 17%.

Construction activity to remain elevated Valuation 2019A 2020A 2021E 2022E The government recently extended the deadline for availing amnesty that is positive for the Sindh based EPS 32.44 10.34 32.82 40.96 builders and developers as they were reportedly facing delays in getting their project approved. The pace of DPS 6.50 - 9.85 12.29 approvals in Punjab and KPK was higher and the decision to extend the deadline will jack up construction PER 21.5 67.3 21.2 17.0 activities in the South zone as well towards the end of FY21. P/BV 2.4 2.3 2.0 1.9 Lucky Motors accelerating Dividend Yield 0.9% 0.0% 1.4% 1.8%

Lucky Motors (formerly Kia Lucky Motors) has performed exceptionally well in a market that was hungry for KSE-100 INDEX vs. LUCK options. The company registered an operational profit of PKR1.5bn in 1QFY21 and based on that we believe 80% that the company will start positive contributions to the overall profitability of the group very soon. LUCK KSE-100 INDEX 60% Coal power plant facing slight delays 40% The 660MW coal fired power plant is facing delays and is expected to achieve commercial operations in 20% 4QFY21. The power plant is likely to add PKR33.45/share to consolidated earnings of Lucky Cement in FY22. 0% In line with MoU’s with IPP’s ,in the larger national interest, sponsors of Lucky Electric are reportedly ready to -20% renegotiate their existing PPA, which could have a negative impact on our earnings estimates. -40%

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Nov'20 Mar'20 Key risks include 1) fiscal constraints limiting disbursement of PSDP, 2) increase in cost of utilities and May'20 Source: PSX, Company Accounts, Next Research company’s inability to pass on to customers, and 3) higher than expected PKR devaluation Price data as of Dec 31, 2020 52 Maple Leaf Cement Factory Limited (MLCF) Efficiencies matter

Investment Thesis MLCF BUY Current Price 45.01 MLCF post expansion aggressively gained market share whereas with improved sector dynamics the company is all set to leverage its operational efficiencies to level the ground for future growth. We have a Buy rating on Target Price 54.49 the stock with a Dec’21 target price of PKR54.49/share implying a total return of 23%. Absolute / Relative Index 95%/87% Market cap (PKRbn) / (USDmn) 49.4/309.3 1QFY21 in green after a tough FY20 12m ADTV (USDmn) / (shares mn) 3.1/15.1 MLCF managed to post profit in 1QFY21 after 4 quarters of losses, on the back of improved margins. Price Free float 45% stability and lower coal price were the main reasons for this improvement. We expect the positive Index Weight (KSE-100) 1.2% momentum to continue on the back of robust cement demand and pricing power to pass on the incremental KATS / Bloomberg / Reuters MLCF / MLCF PA / MPLF.PSX input cost pressures.

MLCF stands out on energy efficiencies Valuation 2019A 2020A 2021E 2022E MLCF is one of the most efficient players in terms of energy as the company is majorly reliant on in house EPS 2.24 (3.24) 2.34 3.95 power generation. The company relies on WHR, and coal based captive power plant, which produce DPS 0.50 - 0.70 2.37 electricity at cost that is significantly lower than the cost from the grid PER 20.09 (13.89) 19.21 11.40 Expanding WHR capacity P/BV 1.53 1.43 1.33 1.23 MLCF is currently expanding its WHR capacity to 25MW from currently installed 16MW. The company is Dividend Yield 1.11% - 1.56% 5.26% targeting commercial operation of the new capacity in 1QFY22 with a total investment of PKR1.8bn. Post CoD KSE-100 INDEX vs. MLCF MLCF is likely to further gain efficiencies in energy. 110% MLCF KSE-100 INDEX Contract with railways provides low cost transportation 85% 60% The company’s long term contract with Pakistan Railways provides it with low cost transportation for coal for 35% internal use and cement for export, which also shields the company from implementation of axle load. 10% Key Risks -15% -40% Key risks include 1) fiscal constraints limiting disbursement of PSDP, 2) increase in cost of utilities and -65%

company’s inability to pass on to customers, and 3) termination of contract with Pakistan Railways

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Price data as of Dec 31, 2020 53 Indus Motor Company Limited (INDU) Geared up for the battle

Investment Thesis INDU BUY Current Price 1,197.96 Healthy balance sheet, improving gross margins and recovery in unit sales, makes INDU an attractive investment proposition where the company’s strong brand equity is likely to restrict the negative effects of Target Price 1,520.26 expected competition in the coming years. The company makes it to our Top Picks for the next year with a Absolute / Relative Index 3%/-4% Dec’21 target price of PKR1,520/share providing an upside of 27% and a dividend yield of 7.1%. Market cap (PKRbn) / (USDmn) 94.2/589.1 Yaris leading the sales recovery 12m ADTV (USDmn) / (shares mn) 0.2/0.03 Free float 17% Unit sales of the company witnessed a sharp recovery where in 5MFY21, sales stood at 22.1k units rising Index Weight (KSE-100) 0.8% 87%YoY. Yaris has led the recovery with 11.4k units whereas Fortuner and Hilux sales have remained upbeat KATS / Bloomberg / Reuters INDU / INDU PA / INDM.PSX as well. The recovery has been fuelled by massive cut in interest rates, as around 35-40% sales are financed. Although we expect end to expansionary monetary policy, the rates are likely to remain under 10% that could further boost the share of financing. Further, INDU has strong brand equity in rural areas and holds a Valuation 2019A 2020A 2021E 2022E significant and loyal market share there. With improved farm economics on the back of better crop support EPS 174.49 64.66 128.84 161.31 prices, reduced input costs and agriculture package, the demand from rural segment has played a critical role DPS 115.00 30.00 84.50 115.00 in sales recovery, we believe. PER 6.87 18.53 9.30 7.43 Competition in the Sedan segment around the corner P/BV 2.35 2.29 2.04 1.89 AIDP- II is set to expire in Jun’21 and new entrants in order to avail benefits in our view are likely to offer Dividend Yield 9.60% 2.50% 7.05% 9.60% news cars before the policy expires. The only category left to experience competition is the Sedan segment KSE-100 INDEX vs. INDU and during 2HFY21 we are expecting new cars in this segment as well. However, keeping in view Toyota’s 30% INDU KSE-100 INDEX strong brand equity and influence in the rural market, we believe the company is better equipped to face 20% competition as compared to its peers. 10% 0% Healthy balance sheet -10% The company maintains a healthy balance sheet with around PKR66bn in short term investments, which are -20% -30% likely to push up other income. However, these investments are likely to decline once the production of the -40% company improves further that is currently affected by shortage of parts due to port congestions across Asia. -50%

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Aug'20

Nov'20 Mar'20 1) Competition eating up market share, 2) PKR devaluation and failure to pass on costs, and 3) plant closure May'20 Source: PSX, Company Accounts, Next Research due to shortage of parts Price data as of Dec 31, 2020 54 Next Valuation Summary

Prices TPs EPS DPS PER (x) Dividend Yield P/B (x) Sector/Company Stance 31-Dec-20 Dec-21 2019 2020 2021 2022 2019 2020 2021 2022 2020 2021 2022 2020 2021 2022 2020 2021 2022 Oil & Gas E&P 1 OGDC Buy 103.77 155.00 27.53 23.27 20.96 24.22 11.00 6.75 10.50 12.50 4.5 4.9 4.3 6.5% 10.1% 12.0% 0.6 0.6 0.6 2 PPL Buy 90.33 140.00 22.65 18.47 17.63 19.25 2.00 1.00 3.00 5.00 4.9 5.1 4.7 1.1% 3.3% 5.5% 0.7 0.6 0.6 3 POL Buy 395.41 485.00 59.44 57.69 55.26 61.46 50.00 50.00 26.25 40.00 6.9 7.2 6.4 12.6% 6.6% 10.1% 2.8 2.8 2.4 Banks 4 HBL Buy 132.28 172.00 10.45 21.79 24.25 24.94 5.00 10.75 12.25 12.50 6.1 5.5 5.3 8.1% 9.3% 9.4% 0.7 0.7 0.6 5 UBL Buy 125.86 170.00 15.60 15.97 16.68 27.37 12.00 11.00 12.00 19.00 7.9 7.5 4.6 8.7% 9.5% 15.1% 0.8 0.8 0.7 6 MCB Buy 185.28 210.00 20.14 25.92 23.84 27.97 17.00 21.00 19.00 22.50 7.1 7.8 6.6 11.3% 10.3% 12.1% 1.1 1.2 1.1 7 BOP Buy 9.27 14.00 3.12 3.14 2.75 3.54 0.75 1.00 0.75 1.00 3.0 3.4 2.6 10.8% 8.1% 10.8% 0.5 0.4 0.4 8 BAFL Buy 35.33 45.00 7.14 6.29 6.06 8.66 4.00 2.75 3.00 4.25 5.6 5.8 4.1 7.8% 8.5% 12.0% 0.7 0.6 0.6 9 MEBL Buy 104.44 125.00 10.77 15.69 10.51 15.40 4.46 5.50 6.00 9.50 6.7 9.9 6.8 5.3% 5.7% 9.1% 2.1 1.9 1.7 10 BAHL Buy 69.60 79.00 10.05 15.23 9.64 10.43 3.50 5.50 3.50 3.50 4.6 7.2 6.7 7.9% 5.0% 5.0% 1.0 0.9 0.8 Cements 11 LUCK Buy 696.09 805.26 32.44 10.34 32.82 40.96 6.50 - 9.85 12.29 67.3 21.2 17.0 0.0% 1.4% 1.8% 2.3 2.0 1.9 12 DGKC Buy 114.58 146.92 3.67 (4.93) 5.82 10.88 1.00 - 1.16 2.18 (23.3) 19.7 10.5 0.0% 1.0% 1.9% 0.8 0.7 0.7 13 MLCF Buy 45.01 54.49 2.24 (3.24) 2.34 3.95 0.50 - 0.70 2.37 (13.9) 19.2 11.4 0.0% 1.6% 5.3% 1.4 1.3 1.2 14 FCCL Buy 21.67 25.89 2.05 (0.04) 1.80 2.24 1.50 - 1.17 1.79 (503.5) 12.0 9.7 0.0% 5.4% 8.3% 1.5 1.4 1.3 15 CHCC Hold 146.19 143.17 9.07 (9.74) 5.00 8.90 1.00 - 1.00 3.56 (15.0) 29.2 16.4 0.0% 0.7% 2.4% 2.8 2.5 2.2 16 KOHC Hold 219.24 224.82 12.29 (2.21) 14.77 20.78 2.50 - 5.91 8.31 (99.2) 14.8 10.5 0.0% 2.7% 3.8% 2.4 2.0 1.8 Fertilizers 17 FFC Buy 108.50 122.64 13.45 14.45 15.25 15.01 10.80 10.42 10.98 11.37 7.5 7.1 7.2 9.6% 10.1% 10.5% 3.4 3.0 2.7 18 EFERT Buy 63.23 67.32 12.63 11.98 11.10 10.62 13.00 11.75 10.75 10.25 5.3 5.7 6.0 18.6% 17.0% 16.2% 1.9 1.9 1.9 Autos 19 INDU Buy 1,197.96 1,520.26 174.49 64.66 128.84 161.31 115.00 30.00 84.50 115.00 18.5 9.3 7.4 2.5% 7.1% 9.6% 2.3 2.0 1.9 20 PSMC Hold 241.95 240.56 (35.49) (31.02) 10.16 23.29 - - 3.05 6.99 (7.8) 23.8 10.4 0.0% 1.3% 2.9% 0.9 0.8 0.8 21 HCAR Hold 328.11 333.15 26.97 4.77 9.25 24.85 12.15 1.00 2.78 7.45 68.7 35.5 13.2 0.3% 0.8% 2.3% 2.8 2.6 2.2 Steels 22 ASTL Hold 48.26 52.85 0.11 (3.79) 2.66 4.19 - - 0.53 1.05 (12.7) 18.2 11.5 0.0% 1.1% 2.2% 1.3 1.2 1.1 23 ISL Hold 93.23 85.09 6.12 1.14 6.45 9.08 3.00 - 2.58 3.63 82.0 14.5 10.3 0.0% 2.8% 3.9% 3.2 2.7 2.3 24 ASL Hold 23.30 19.88 0.33 (0.81) 2.57 3.26 - - - - (28.9) 9.1 7.2 0.0% 0.0% 0.0% 2.2 1.8 1.4 Price data as of Dec 31, 2020 55 Next Capital Limited Contacts

Karachi Office DHA Lahore Office 2nd Floor Imperial Court Building, 63-A, Agora Eden City , Dr. Ziauddin Ahmed Road, DHA Phase VIII, Karachi, Pakistan Lahore, Pakistan UAN: +92-21-111-639-825 Tel: +92-42-37135843-8 Fax: +92-21-35632321 Fax: +92-42-37135840

Research Sales and Trading Corporate Finance & Advisory UAN: 92-21-111-639-825 Ext 113 UAN: 92-21-111-639-825 Ext 105 UAN: 92-21-111-639-825 Ext 114 Email: [email protected] Email: [email protected] Email: [email protected]

56 Next Capital Limited | Team Key Contacts

Top Management Muhammad Najam Ali Chief Executive Officer +92-(0)21-111-639-825 [email protected] Muhammad Zulqarnain Mahmood Khan Executive Director +92-(0)42-37138543 [email protected] Muhammad Zubair Ellahi Executive Director +92-(0)21-111-639-825 [email protected] Dr. Ali Akhtar Ali Managing Director – Capital Markets +92-(0)21-111-639-825 [email protected]

Research Team Shahab Farooq Director Research +92-(0)21-35222203 [email protected] Taimoor Asif Senior Investment Analyst +92-(0)21-35222204 [email protected] Muhammad Mubashir Khan Database Manager +92-(0)21-35222204 [email protected]

Sales Team (Karachi) Muhammad Zain ul Abedin Head of Institutional Equity Sales +92-(0)21-35632338 [email protected] Abdul Basit Vice President - Institutional & HNWI Sales +92-(0)21-35632330 [email protected] Muhammad Shakeel Vice President Equity Sales +92-(0)21-35632329 [email protected] Arsalan Javed Head of Foreign Sales +92-(0)21-35222205 [email protected] Adil Akhtar Manager Equity Sales +92-(0)21-35632326 [email protected]

Sales Team (Lahore) Muhammad Yaqoob Branch Manager & Vice President +92-(0)42-37135848 [email protected] Asim Aslam Vice President +92-(0)42-37135847 [email protected] Hira Majid Gillani Equity Trader +92-(0)42-37135847 [email protected] Yasir Sattar Equity Trader +92-(0)42-37135847 [email protected]

57 Annexure

Analyst Certification & Disclaimer

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 ac- count 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. Rating Definition BUY Total stock return > 15% NEUTRAL Total stock return between 0% - 15% SELL Total Stock return < 0% * Total stock return = capital gains + dividend yield Valuation Methodology: • To arrive at our period end target prices, Next Capital Limited uses different valuation methodologies including but not limited to: • Discounted cash flow (DCF, DDM) • Relative Valuation (P/E, P/B, P/S etc.) • Equity & Asset return based methodologies (EVA, Residual Income etc.) 58