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Affordability vs. Sustainability

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ECONOMICS & STRATEGY

THE JSK STRATEGIST
June 07, 2010

Federal Budget 2011: Affordability Vs. Sustainability!! A Blurry Hype Or A Leap Of Faith??
Executive Summary
At the national front, government remained excessively occupied with budgetary measures to be adopted in the finance bill, that were announced on June 5th. Capital market participants and investors, in anticipation, distanced away from large exposures as federal budget closed in, with implementation of Capital Gains Tax (CGT) on stock market transactions. Nationwide implementation Value Added Tax (VAT) regime at 15% has been deferred by three months in order to develop a productive framework for enforcement and collection mechanisms. Addressing IMF’s concerns, the removal of subsidies and a raise in power tariff by 6%, in addition to the expansion of country’s tax base remained core issues in recent budget announcements. Economic Recovery: Exceeds Expectations! Federal government revised GDP growth levels to 4.5% from a low of 4.1% sighting better than expected economic recovery for FY2010. Expansion in large scale manufacturing and growth in services sector would be the key factors contributing to economic growth with 5.6% share of manufacturing, 4.6% for services and 3.8% for agriculture sector. Also, the crippling power sector with the introduction of costly rental power plants is expected to provide significant relief to the industrial sector. Additionally, government is making all out efforts to curtail its expenditures as it targets a fiscal deficit of 4% to GDP for FY2011. National Budget: As It Is! The government in-line with the IMF’s directives is set to implement VAT regime at a flat 15%, in a period of three months, while it has raised GST to 17%, up from 16% albeit temporarily. In addition to its efforts to expand tax base and collection of revenues, it has come up with various incentives for direct investments by foreigners and domestic investors, including tax breaks. Key Policy Rate Unchanged At 12.5%, Monetary Stance Undeterred The country’s central bank announced its monetary stance on May 24th, amidst rising inflationary pressures and decided to keep the key policy rate unchanged at 12.5%. We believe that SBP’s undeterred monetary stance is based on rising concerns of fiscal deficit, inflationary pressures and due to excessive money growth in the monetary system. Global Markets: Eurozone Crisis, Spillovers Ruin Emerging Markets Debt crisis from the socialist Greece spilled over its effects down to emerging markets in May. Since its surface in mid-April, it wreaked havoc on global capital markets with the S&P 500 index declined by 9.39% only in May, whereas MSCI Europe and MSCI Emerging Markets fell by 7.09% and 8.12% respectively, to signify deepening debt wounds of some key European economies. However, amidst a tough practice of consensus building for a bail-out package from leading regional economies, markets remained in doldrums as they sparked partial recoveries in last days of May. Benchmark KSE100 Index: Promising Returns Ahead! Potential returns in post-budget sessions remain high to the tune of 18% to 22% as per our base case scenarios. Economics & Strategy

THE JSK STRATEGIST
June 2010

Contents
KSE 100: Pre-Budget Fears Cause Upheavals! Federal Budget FY2011: What Was And What Is? Federal Budget FY2011: As It Is! Capital Markets: A Dismayed May! Global Benchmarks Monitor KSE100: A Defensive Strategy With Incentive Tactics Economy: Indicators On The Upside! The Macro View Events Calendar JSK Securities Ltd Contact Details 3 4 6 7 10 11 15 17 17 18

2

Economics & Strategy

THE JSK STRATEGIST
June 2010

Federal Budget 2011: Before It Went Live!
KSE100: Pre-Budget Fears Cause Upheavals!
“In a striking similarity with 2009, KSE100 index lost almost 13% in pre-budget sessions this year” In a marked comparison between the years 2009 and 2010, country’s primary capital market, the benchmark KSE100 index faced wayward declines in pre-budget sessions for over a month. In the year 2009, benchmark index lost almost 12%, from its high of 7,902 index points till the date of budget announcements. In a similar run down this year, the benchmark KSE100 index has lost about 10% from its high of 10,677 index points, down to 9,636 points as of June 4th, 2010. Comparing between the two years, the only alteration this year was the added fears imported from Eurozone credit crisis and the resulting selling frenzy witnessed in developed and emerging markets. The global selling pressures compounded with pre-budget uncertainties dragged the benchmark index to almost 13% deep in red this year, before recovering an overall 3% just inches afore the budget date. The following chart focus on these prominent similitudes of pre-budget market trend between 2009 and this year;
KSE 100 - Run Down to Budget FY09 vs FY10 (Rebased)
Budget Announcements

120
116

112
108

104
100

96
92

88
Pre Budget Sessions - Two Months KSE 100 - 2009 Post Budget Sessions - Two Months KSE 100 - 2010

Source: KSE & JSK Research

Drifting back again to 2009, the market recovered, nay, outperformed regional benchmarks post budget announcements by 33%, supported by strong fundamentals and attractive valuations.
11,000

KSE100 Index Relative Performance

10,000
9,000

“The benchmark index recovered 33% after budget announcements to an yearly total of over 60% in 2009”

8,000

7,000
6,000

5,000 4,000
Jan Feb Mar Apr May Jun 2009
Source: KSE & JSK Research

Jul

Aug Sep 2010

Oct

Nov Dec

Tracking footsteps, our base case scenario for the benchmark index projects a well convalesced recovery to at least 11,500 index points this year with a 19.5% upside potential compared to June 4th market close. 3 Economics & Strategy

THE JSK STRATEGIST
June 2010

Federal Budget 2011: What Was And What Is?
Shifting Priorities
“IMF guidelines remain vital for economic managers” Federal government of Pakistan announced its budget for FY2011 (July-June) on June 5th. In a run-down to budget announcement dates, expectations of stakeholders from FY2011 budget remained vague. The major issues that FY2011 budget entailed were the rationalization of subsidies and deferred implementation of a new VAT regime, while eliminating the current sales tax system in three months. In line with directions dictated by the International Monetary Fund (IMF), federal government strives to broaden its tax base as it looks forward to increasing its tax to GDP ratio, which currently stands at a mere 9%, one of the lowest in world. Expenditures And Revenues: What To Expect? The key policy shift in FY2011 budget was expected to curtail expenditures with the rationalization of subsidies on power, fertilizers and sugar. This step would significantly reduce costs for the government in medium to long term, amidst declining popularity amongst the public. However, pressures would remain on account of war on terrorism in tribal belt of the country, for which the government has allocated a separate head, along with the massive defense budget. The fiscal deficit as per our expectations was to be targeted at 4.5% of GDP, however with the government’s move of subsiding implementation of VAT in three months and an increase in GST by 100 basis points, up from 16% to 17%, it plans to keep its deficit around 4%.
PKR Trillion 4.0

Budget Outlays and Growth
43%

44% 20%
22% 7%

PKR Trillion 2.0
1.6 19%

Tax Revenues and Growth
21% 22% 19%

3.0 2.0 1.0 0.0 FY07 FY08 FY09 20%

36%
28% 20%

19%

20%
15%

1.2

18% 0.8
0.4

12% 4% FY10 FY11E
Budget Outlay (LHS) Growth (RHS)

16% 14% FY07 FY08 FY09 FY10E FY11P Tax Revenues (LHS) Revenue Growth (RHS)

0.0

Source: FBR & JSK Research

At the core revenue front and against all odds, federal government has delayed the much expected implementation of IMF proposed VAT regime that was expected to increase direct revenues for the government by almost 5% in the medium term. The overall target revenue of the government is set at PKR1.7 trillion, to be collected through direct and indirect taxes. Moreover, in a bid to overcome increasing pressures from industrial sectors and household consumers to reduce power outages, that has been seriously crippling nation’s economy, economic managers took up costly plans of introducing Rental Power Plants, that is expected to affect the national treasury. With all this in sight, we believe capital markets took the toll of Eurozone effects that resulted in a decline of foreign funds at the benchmark KSE100 index. Coupled with widespread contagion, were the expectations revolving around the implementation of the upcoming CGT regime that held investor sentiments down for almost a month during pre-budget sessions. A major concern for country’s equity indices is the immediate shrinkage in volumes after the implementation of CGT. However, we believe that the implementation of CGT would purport a long-term view amongst investors, hence attracting domestic and foreign investments for longer periods. Foreign portfolio investments in the two months preceding budget announcements stood at a net PKR7.4 billion. Economics & Strategy

“FIPI stood at a net PKR7.4 billion in pre-budget sessions”

4

THE JSK STRATEGIST
June 2010

Federal Budget 2011: What Was And What is?
Focus Areas: All Out efforts We believe that federal government has focused more on providing relief to salaried classes in addition to the general public by raising minimum wage levels and increasing salaries of government employees. A major breakthrough in the outgoing fiscal year (FY2010) was the approval of 7 th National Finance Commission Award (NFC). As per NFC, a considerable amount of resources that were available with federal cabinet would now be controlled by provinces. An important development in this regard is the reduction in share of PSDP for federal government from PKR446 billion in FY2010 to PKR280 billion in FY2011. Provinces, in the meanwhile have gained from this development amidst a populist approach and the combined share of provinces is expected to increase substantially.
7th NFC Award Population Poverty/backwardness Revenue Collection/Generation Inverse population density Weightage 82.0% 10.3% 5.0% 2.7%

“The government exceeded its targets of bank borrowing of

The government’s projected bank borrowings was PKR144 billion in FY2010 to overcome revenue shortfalls but it exceeded its targets, creating strong inflationary pressures and rapid money growth. Owing to this situation, the country’s central bank kept its policy rate unchanged at 12.5% towards the end of FY2010. However, under stricter IMF monitoring and a tough stance by the central bank, we believe government borrowings would reduce or remain at the same level for FY2011. Although, government has faced significant pressures from the on-going war in its tribal areas and relies heavily on funds from the coalition support fund of the US in addition to its arrangements with the IMF. However, we believe at the outset that the government would enhance the tax base, curtail non-development expenditures and focus on PSDP while addressing IMF concerns under the Stand-by-Arrangement.
Govt Domestic Debt - Outstanding FY10
PKR Trillion 2.4 5% 2.3

7% 2% 0% -3%
-4%

3% 0%
-1%

2.2 2.1 2.0 1.9 1.8 Jul

8% 6% 4% 2% 0% -2% -4% -6%

Aug Sep

Oct

Nov Dec

Jan

Feb Mar

Govt Borrowing (LHS)
Source: SBP & JSK Research

Growth (RHS)

In addition to various measures that government took up in FY2011 budget, some specifies in line with the IMF conditionalities including, raise in power tariffs by 6%, eliminating subsidies, introduction of capital gains tax on stock market transactions after an exemption of 36 years, Implementation of VAT regime nationwide (deferred for three months), and various tax incentives for direct investments by foreigners and domestic investors. Government’s persistent borrowing from the banking system for budgetary support coupled with expected borrowings for commodity operations in Q4-FY2010 is crowding out private sector credit, causing inertia in market interest rates, running the risk of excess domestic credit creation, and increasing the debt burden for future policy makers.

5

Economics & Strategy

THE JSK STRATEGIST
June 2010

Federal Budget FY11: As it is! Finance Bill: makes its way!
“VAT implementation delayed by 3 months” The much awaited federal budget FY11 was announced on Saturday with an increase of almost 25% in expenditures and 20% in revenues over the outgoing fiscal year. However, implementation of the feared VAT regime was deferred by three months against the expectations, yet avoiding the haste in undergoing reforms under the IMF directives. Also, with an on track economic recovery, the growth target has been set at 4.5% with increased LSM growth and adoption of fiscal reforms. Federal government plans to boost its revenues with an increase in GST by 100 basis points, up from 16% to 17%, however relieving the salaried classes from excessive direct taxation. We believe, that the delay in VAT implementation is due to lack of a developed framework for enforcement of VAT through the commerce chain. In addition to its implementation, collection would remain a challenge for the government which could significantly effect government revenues in short term. In a move to avoid these shortfalls and to keep fiscal deficit at a targeted 4% of GDP, we believe the government’s decision to defer VAT implementation for 3 months is a viable action to come up with a proper framework for enforcement and collection of these taxes. Also, several incentives have been provided for domestic and foreign investors, including substantial tax exemptions. However, these exemption are limited to direct investments, that may include long-term investments in green-field projects and investments in large scale manufacturing. A major development in the finance bill 2010 is the implementation of capital gains tax on stock market transactions, much feared by the local and foreign investor segments. The rates that are applicable to these transactions vary according to the holding period of securities. In an incentive like move, securities that are held for a period of twelve or more months would be exempted from capital gains tax. We believe, this would purport a long term view in the local capital markets, which has long been used as one of the hedging havens by foreign investors.
BUDGETARY POSITION FY10 ( R ) Resources Internal Resources Revenue Receipts Capital Receipts Financing of PSDP by Provinces Change in Provincial Cash Balance External Resources Expenditure Current Expenditure PSDP Other Development Expenditure Est. Op. Shortfall Bank Borrowing 2,497 1,919 1,397 260 184 78 578 2,585 2,017 510 118 (60) 88 FY11 2,598 2,211 1,377 325 342 167 387 2,765 1,998 663 124 (20) 167 Growth 4.04% 15.22% -1.43% 25.00% 85.87% 114.10% -33.04% 6.96% -0.94% 30.00% 5.08% -66.67% 89.77%

Capital Gain Tax rates FY10-12 upto 6 months 6-12 months > 12 months
Source: KSE

FY13 12.5% 8.0% -

FY14 14.5% 8.5% -

10.0% 7.5% -

Source: Ministry of Finance

“The government also vowed to reform PSEs”

In our holistic view, the government’s key policy objectives remained calm for general public in addition to creating a favorable environment for industrial growth and expansion. The government has also targeted export sectors by reducing various duties and surcharges on imports of raw material in order to boost production of value added goods.

6

Economics & Strategy

THE JSK STRATEGIST
June 2010

Capital Markets: A Dismayed May!
Eurozone Crisis: Spillovers Penetrated
“I Fear The Greeks Even When They Bring Gifts”
Publius Vergilius Maro (Virgil), 70 - 19 BC.

“Global markets have witnessed an abysmal anguish during May ”

After the recent notorious financial crisis led by the US subprime mortgage defaults, the global economic recovery is under siege once again, only this time, its sprouting from Eurozone with Greece as its epicenter. The Eurozone crisis was simmering for quite some time now and even lessons from recent past did not sway policy makers to rout or restrict the underlying gravity of this latest debacle. With over US$6 trillion withered in ashes, global markets have witnessed an abysmal anguish with broader emerging markets universe taking a more severe blow. The global markets are keeping an observant focus on the public finances of Portugal, Ireland, Greece and Spain, most commonly called as “The PIGS”. In our view, the contentious financial regulation controls and the PIGS public profligacy, to some extent, have also led Eurozone to its current plight. Amid the unsettling and disconcerting hype, still diminutive attention is devoted to identify crucial differences between PIGS public debt and their external debt exposures. The most important points to ponder are; Debt owned and held by a nation’s own citizens has less pernicious consequences and the interest associated with the debt is paid back and returned to the domestic economy; External debt, on the other hand, is owned by non-residents, if used to finance nonproductive expenditure. As a result, non-residents receive the interest associated with such debt, eventually putting strains on domestic economy.
Eurozone Government Debt, External Debt, and Internal Investment Position at 2009 Year End

Source: Stability & Growth Program 2009/2010-2013, IMF, World Bank, BIS & JSK Research

“A bailout package of US$1 trillion was announced”

Global markets trailed a turbulent stride during May as European “Elders” tried to cautiously assist Greece and its debt ridden economy. Even a bailout package of US$1 trillion proved not more than an ephemeral resolution, failing to limit crisis spillovers to penetrate into the broader Eurozone, shifting limelight to Portugal, Spain, Ireland, Germany, Italy, Hungary and eventually to the United Kingdom. Needless to say, the subsequent credit rating downgrades of Greece, Portugal and Spain plummeted general investors confidence, triggering a global selling frenzy, intensifying its heat on to the emerging markets universe. Compounded with Economics & Strategy

7

THE JSK STRATEGIST
June 2010

Capital Markets: A Dismayed May! fears of another crisis to an already recovering and weaker global economy, investors focus swiftly transformed from equities and fixed income to alternative and less risky asset classes ensuring safe havens while preserving wealth at least, if not creating. In an attempt to regulate EU control and to extend its powers across member nations, several ideas were introduced including, would there be an EU control over national budgets? (End of individual sovereignty, in our view) or extending support for Euro, etc. In our view, one of the primary reasons that caused this havoc into an utter turmoil is the EU’s unworkable combination of a common and unified currency with independent national spending. We believe that if the situation is not curtailed astutely, Greek default could apparently replicate into Portugal default as Portuguese banks hold 23% more Greek bonds as a proportion of their capital than any other EU country. This implies that Portugal would be the next likely domino should Greece need to default or restructure. The Greece crisis and the emergence of fiscal issues within the EU have raised alarming concerns for European leaders. They need to devise a strategy where the balance between the necessity to safeguard a central element of the European economic constitution and the requisite requirement to guarantee financial stability in the European markets. Each member country has a right to assess viability of its fiscal policy. Nonetheless, a financial crisis emerging from within EU can hamper regional economic growth and more adversely, can cause a widespread contagion that can transform into a global catastrophe. In the hopeful midst of a longer term austerity plan for Europe’s debt laden economies, Germany, in an incongruous move, banned investors from naked short sales as well as naked credit-default swaps on euro-area government bonds. The ruling rippled serious concerns across all investor segments, raising alarms for European assets demand due to an imminent drought in hedging or selling these assets. Resultantly, the Eurozone plunged further, followed by a panic sell in global equities, primarily attributable to Chancellor Angela Merkel’s financial regulation publicity stunts. As investors continued to shed stocks and the debt-linked euro, US dollar, Treasury bonds and gold led the poll of favorite choices as alternative and less risky asset classes. The euro, which is used by 16 countries in Europe, fell to a four-year low to US$1.2237 before moving higher. The resultant spike in greenback, meanwhile, hit prices for commodities such as oil with crude plunging below US$70 a barrel for the first time since February.
Euro Vs US$ Year To Date Performance
1.44 1.40
1.29

“Portuguese banks hold 23% more Greek bonds”

“Germany banned naked short sales and naked credit-default swaps”

(14.87%)

1.37

Euro Vs US$ (Europe Debt Crisis)

1.33 (10.76%)

1.36

“Euro fell to a four year low to US$1.2237”

1.25

1.32
1.21

1.28 1.24 1.20 Jan-10 Feb-10 Mar-10 Apr-10 May-10 Jun-10

Apr-10

May-10

Jun-10

Source: Bloomberg & JSK Research

8

Economics & Strategy

THE JSK STRATEGIST
June 2010

Capital Markets: A Dismayed May!
“Gold hit a YTD high of US$1,238/oz.”
Gold US$/oz 1,250 1,230 1,210 1,190 1,170 1,150 1,130 1,110 1,090 1,070 1,050 Jan-10 Feb-10 Mar-10 Gold (US$/Oz) Apr-10 US$ Index May-10 76 Jun-10 80 78 82 86 84

Gold Vs US$ Index

US$ Index 88

Source: Bloomberg & JSK Research

The demand for precious metals, as mostly is the case mainly during times of extreme distress, witnessed a significant surge with gold prices leading polls and breaching year to date highs at US$1,238/oz. The gold and the greenback have developed and maintained strong correlations lately depicting investors interest in gold as a store of value and a strengthening US dollar due to a deteriorating Euro. The unique gold-dollar formation eventually forced the traditional gold-oil reciprocal movement out of the equation.
Oil (US$/bbl) 150 130 110 90 70 50 30 Jan-08 May-08 Sep-08 Jan-09 May-09 Sep-09 Jan-10 May-10

WTI Crude Oil Vs Gold

Gold (US$/oz) 1,300 1,200 1,100 1,000 900 800 700

Oil (US$/bbl)

WTI Crude Vs Gold YTD (2010)

90 85
80

Gold (US$/oz) 1,250

1,150

75 70 65
Jan-10 Feb-10 Mar-10 Apr-10 May-10 Jun-10

1,050

Oil (US$/bbl)

Gold (US$/oz)

Oil (US$/bbl)
Source: Bloomberg & JSK Research

Gold (US$/oz)

“Global markets remains uncertain”

The penetrating heat emerging from PIGS poses a daunting and deterring outlook for sovereign debt markets with clouds of uncertain glooms casted over global capital markets. Almost all of the global markets have witnessed a severe plunge during May, trimming earlier gains and ramming them deep in red zones. Having said that, it also created a window of opportunity by dragging indices and their underlying stocks to their most attractive levels by highlighting defensive stock strategies.

9

Economics & Strategy

THE JSK STRATEGIST
June 2010

Capital Markets: A Dismayed May!
GLOBAL BENCHMARKS YTD RANKED RETURNS NAME KARACHI 100 INDEX KARACHI ALL SHARE INDEX ISE NATIONAL 100 INDEX FTSE Bursa Malaysia KLCI EGYPT HERMES INDEX KARACHI 30 INDEX DAX INDEX NASDAQ COMPOSITE INDEX QE Index KOSPI INDEX BHSE ALL SHARE INDEX TADAWUL ALL SHARE INDEX BEL 20 INDEX MEXICO IPC INDEX BSE SENSEX 30 INDEX SWISS MARKET INDEX S&P 500 INDEX DOW JONES INDUS. AVG MSM30 Index KUWAIT SE PRICE INDEX TOPIX INDEX (TOKYO) NZX 50 INDEX FTSE 100 INDEX AMMAN SE GENERAL INDEX ADX GENERAL INDEX RUSSIAN RTS INDEX $ NIKKEI 225 ALL ORDINARIES INDX HANG SENG INDEX TAIWAN TAIEX INDEX CAC 40 INDEX ESTX 50 € Pr DFM GENERAL INDEX IBEX 35 INDEX SSE COMPONENT STOCK IX Athex Composite Share Pr
Source: Bloomberg & JSK Research

COUNTRY PK PK TU MA EG PK GE US QA SK BJ SR BE MX IN SZ US US OM KU JN NZ GB JO UA RU JN AU HK TA FR EC UA SP CH GR

MONTHLY CHANGE OPEN CLOSE 10,389.46 7,298.14 58,400.21 1,346.89 667.31 10,460.46 6,166.92 2,498.74 7,527.89 1,721.21 1,590.66 6,891.72 2,572.46 32,832.45 17,386.08 6,607.71 1,202.26 11,151.83 6,851.92 7,266.40 956.72 3,280.35 5,260.99 2,550.87 2,795.38 1,517.83 10,695.69 4,807.10 20,811.36 7,952.17 3,828.46 2,816.50 1,736.61 10,422.80 10,422.56 1,853.55 9,326.42 6,546.90 54,384.94 1,285.01 594.70 9,243.66 5,964.33 2,257.04 6,785.96 1,622.78 1,450.28 6,120.52 2,453.37 31,547.55 16,944.63 6,312.60 1,089.41 10,136.63 6,294.43 6,699.70 880.46 3,047.75 5,188.43 2,401.57 2,604.17 1,384.59 9,768.70 4,453.60 19,765.19 7,373.98 3,507.56 2,610.26 1,579.54 9,359.40 10,204.17 1,550.78

CHANGE (%) (10.23) (10.29) (6.88) (4.59) (10.88) (11.63) (3.29) (9.67) (9.86) (5.72) (8.83) (11.19) (4.63) (3.91) (2.54) (4.47) (9.39) (9.10) (8.14) (7.80) (7.97) (7.09) (1.38) (5.85) (6.84) (8.78) (8.67) (7.35) (5.03) (7.27) (8.38) (7.32) (9.04) (10.20) (2.10) (16.33)

YTD (%) 4.44 3.19 1.53 1.17 0.72 (0.67) (1.35) (2.20) (2.23) (2.66) (3.22) (3.22) (3.49) (3.51) (4.00) (4.24) (4.50) (4.76) (4.76) (5.10) (5.33) (6.19) (6.25) (6.49) (7.68) (8.73) (9.72) (10.90) (11.51) (12.58) (13.64) (15.23) (16.04) (26.87) (27.06) (34.37)

2009 (%) 60.05 51.46 96.64 45.17 34.24 79.57 23.85 43.89 1.06 49.65 (19.17) 27.46 31.59 43.52 76.35 18.27 23.45 18.82 17.05 (9.99) 5.63 18.94 22.07 (8.15) 14.79 128.62 19.04 33.43 52.02 78.34 22.32 21.14 10.22 29.84 111.24 22.93

2008 (%) (57.09) (54.48) (51.63) (39.33) (53.93) (67.19) (40.37) (40.54) (28.12) (40.73) (34.52) (55.19) (53.76) (24.23) (52.48) (34.77) (38.49) (33.84) (40.73) (38.03) (41.77) (32.80) (31.33) (24.94) (47.49) (72.41) (42.12) (43.01) (48.27) (46.03) (42.68) (44.37) (72.42) (39.43) (63.36) (65.50)

P/E 10.50 N/M 9.52 17.41 13.43 10.25 14.54 28.30 10.68 11.67 N/M 17.51 11.97 16.11 17.21 15.14 15.37 13.87 13.38 N/M 31.27 10.26 12.30 37.26 9.78 8.66 32.11 29.83 13.95 16.80 13.15 12.20 18.33 9.59 21.40 9.23

“The country’s benchmark KSE100 Index topped our Global Benchmark Monitor comprising 36 global benchmarks, in terms of year to date returns”

10

Economics & Strategy

THE JSK STRATEGIST
June 2010

KSE100: A Defensive Strategy With Incentive Tactics!
Mitigating Market Correlations Through Defensive Stocks
“By following a strict and disciplined fundamentally backed quantitative approach could still harness significant benefits of portfolio diversification” During times of utter turmoil, performance correlations across and within asset classes tend to reflect a strong and clear upward trend. In addition, the recent synchronized underperformance of global equity markets due to the crisis in Eurozone, the opportunities to diversify portfolios across equity markets have significantly declined. We believe that by following a strict and disciplined fundamentally backed quantitative approach could still harness significant benefits of portfolio diversification. According to our calculated approach, the markets and most of their underlying stocks are at their most attractive buy levels reflecting wide prospects of maximizing returns while maintaining broad market exposure. Domestic markets witnessed a blood bath during May with the country’s benchmark index rock bottoming to year to date lows, paring impressive gains to May close in shocking red. The KSE100 index registered a year to date high on April 15th, 2010 when it touched 10,677 index points, 13.65% higher compared to December 31st, 2009 index level. We have used this year to date high on April 15th as a high watermark in our assessment of a defensive strategy for the benchmark index and its underlying stocks. The country’s benchmark index became highly sensitive since mid April primarily due to the catastrophic events in Eurozone and its devastating interpreted repercussions in the broader emerging and frontier markets universe. However, the recent distressing statistics from China reflecting a slowdown in economic growth, strict Chinese regulation to curb emerging property bubbles and the escalating tensions between the two Koreas also augmented the negative investor sentiments in the region. On the domestic front, the ongoing brawl between the country’s judiciary and the reigning political heavy-lifters compounded with pre-budget doubts, worries circling the implementation and interpretation of the newly announced CGT regime and a dwindling security façade, casted immense clouds of uncertainty over the country’s economic and socio-political outlook. Nonetheless, our long term view of the market remains materially unaltered with our base case scenario reflecting a 19.5% upside potential from June 4th closing levels to 11,500 index points.
KSE100 Index Investment Case Scenarios
14000
Bullish Case Scenario 13,000 points, 35% Upside Potential Base Case Scenario 11, 500 points, 19.5% Upside Potential

“Domestic markets witnessed a bloodbath during May”

“Our base case scenario suggests a 19.5% upside potential for KSE100 Index from June 4th closing levels.”

13000
12000 11000 10000 9000
Current Index Level 9,636.88 points

Bearish Case Scenario 10,300 points, 6.88% Upside Potential

8000 Jan-10 Apr-10 Jul-10 Oct-10 Jan-11

Source: Bloomberg & JSK Research

11

Economics & Strategy

THE JSK STRATEGIST
June 2010

KSE100: A Defensive Strategy With Incentive Tactics!
Albeit recent southbound pulls casted heavy spells on KSE100 performance and its underlying stocks, however, this latest twist in KSE100 index performance has also created an opportunity to consider defensive stocks reflecting low betas, strong fundamentals, high liquidity and above all high dividend yield spreads. Based on our calculations and following a strict fundamental approach, we have selected the following stocks of the benchmark KSE100 index due to their attractive relative valuations, earnings growth and enterprise values.
Company Pakistan Telecommunication Ltd Fauji Fertilizer Co Ltd Hub Power Co Kot Addu Power Co Ltd Oil & Gas Development Co Ltd Pakistan Petroleum Ltd Pakistan Oilfields Ltd Bank AL Habib Ltd Allied Bank Ltd Shifa International Hospitals Ltd
Source: Bloomberg & JSK Research

Dividend Yield Current 2009 8.42 13.47 13.96 14.15 5.48 6.44 8.55 6.80 6.35 9.40 7.67 16.29 13.98 16.13 5.33 3.54 8.33 5.5 6.49 8.8 6.35 11.53 8.67 10.53 11.76 5.28 14.62 2.99 4.95 5.19 2008 5.18 23.57 9.62 13.3 7.64 8.94 4.11 4.62 8.34 4.35

EPS Growth 2009 19.04% 43.56% -28.84% 25.22% 40.58% -33.68% 22.53% 92.23% -17.32% 2008 36.96% -1.75% 59.61% -2.00% 17.52% 22.11% 8.00% 9.43% 35.40% N/M -112.16%

Enterprise Value (PKR Mn) 74,804.79 83,352.07 69,244.78 42,901.41 329,163.20 176,609.90 45,119.75 30,602.36

D/E Ratio 8.55 66.28 38.46 22.50 N/A 0.00 0.16 0.00

P/B 0.9 5.1 1.3 1.6 1.8 4.6 2.5 1.9 1.7 1.5

P/E 9.2 7.9 7.5 6.5 6.8 10.5 7.8 12.2 7.5 6.3

38,590.09 271.82 1,539.80 151.46

“Investors should take positions with a margin of safety ”

All of these defensive stocks also reflect attractive and cheap buy levels when compared against the market high watermark (April 15th) value. Our assumption is based on the premise that investors should take positions in stocks with a margin of safety i.e. at levels where stocks are less than what they are worth. We also believe that defensive stocks are likely to generate higher dividend yields while reflecting a weaker or negative correlation with the relative index. The classical valuation literature suggests that an undervalued stock is much less likely to go down than an overvalued stock. With a cheap stock, market externalities and negative sentiments will already be priced in, and investors would therefore prefer to buy undervalued companies, which will eventually push up stock prices. Under these assumptions, the undervalued and cheap stocks transform as superior defensive investments. Tracking the upside potential of these undervalued stocks, we believe that they offer excellent upside prospects even if they simply appreciate to their fair market values. However, not all stocks under the “Undervalued” category, realize their fair market values in short term due to their weak betas and liquidities. Yet the ones with strong fundamentals and low bidask spreads are the stars to aim for! On an overall basis the country’s benchmark index offer alluring prospects due to its wellbalanced position in terms of relative valuations and dividend yields against major global and regional benchmarks. The KSE100 index monthly performance bodes perfectly well with our base case scenario, however, we believe that an extended market rally supported by underlying bullish momentum in the months to come can easily elevate market levels close to our year end bullish targets.

“Undervalued stocks offer excellent upside prospects even if they appreciate to their respective fair market values”

12

Economics & Strategy

THE JSK STRATEGIST
June 2010

KSE100: A Defensive Strategy With Incentive Tactics!
Following is the comparison between the country's benchmark KSE100 index against major global benchmarks in terms of relative valuations and year to date returns...

Valuation (x)

Relative Valuation of KSE100 Vs Major Global Markets

Performance (%)

20 18
16 -3.22% -2.66%

10% 4.44% 2.28%
-2.23% 0.72% -1.35%

5% 1.17% -4.76% -6.25% -4.24%
-3.39% -4.76% 0%

14 12
10 -8.73%

-5.10% -7.68%

-4.50%

-3.22%
-6.19% -10.90% -3.51%

-2.20% -4.00% -5% -9.72% -10%
-15%

-11.51% -13.64%

-12.58%

-16.04%

8
6

-20%
-25%

-26.87% 4 2
0

-27.06% -30%

-34.48%

-35%
-40%

P/E

P/B

YTD Performance (%)

Source: Bloomberg & JSK Research

Following is a dividend yield comparison of KSE100 index compared to global benchmarks…
Dividend Yield (%)

Dividend Yields Comparison of KSE100 Vs Major Global Markets

Performance (%)

8 4.44%
0.72%

10% 5% 1.17%
-3.39% -1.35% -4.24%

7

2.28%
0%

6
-6.19% 5 -10.90%

-2.23% -6.25%

-2.66% -3.22% -4.76% -3.51% -8.73% -9.72%
-4.50%

-2.20% -4.00% -5% -10% -15% -20%
-25%

-7.68% -12.58%
-16.04%

4

-13.64%

-11.51%

3

2

-26.87%

-27.06% -30%

1

-34.48%

-35%
-40%

0

Dividend Yield

Estimated Dividend Yield

YTD Performance (%)

Source: Bloomberg & JSK Research

Due to its fundamental strength and attractiveness, we believe that by adapting a strategy which constitutes an exposure to cheap and undervalued stocks, investors are not just minimizing the downside but are also poised to accrue a comparatively higher upside as defensive investment outperforms market risks and volatility.

13

Economics & Strategy

THE JSK STRATEGIST
June 2010

KSE100: A Defensive Strategy With Incentive Tactics!
The benchmark KSE100 fell by over 10% since mid-April, nonetheless it has outperformed most of the widely followed global benchmarks. KSE100 index has consistently been ranked in the top 5 indices of our global benchmarks monitor based on YTD returns. Medium to long term upside potential remains strong with the benchmark index cumulative YTD returns in excess of its global and regional peers.
10,800 10,600 10,400
10,200

KSE100 Index Year To Date Performance
10,700

KSE100 Index

4.44%
10,200 (10.47%)

9,700
9,200

2-Apr

16-Apr

30-Apr

14-May

28-May

10,000 9,800 9,600 9,400 9,200 Jan-10 Feb-10 Mar-10 May-10

(PKR Million) 1,500 1,000 500 0
(500) (1,000)

Net Foreign Position

2-Apr

16-Apr

30-Apr

14-May

28-May

Source: Bloomberg & JSK Research

(%)
100 50 0 -50

Excess Return Over MSCI World

MSCI Pakistan Vs Global Benchmarks (Rebased)
200 180 160 140 120 100 80

(%)
100

Excess Return Over MSCI Europe

50 0 -50

(%)
100

Excess Return Over MSCI North America

60
Jan-09 Apr-09 MSCI PK
210 190 170

Jul-09 MSCI World

Oct-09 MSCI Europe

Jan-10

Apr-10 MSCI North America

50 0 -50

MSCI Pakistan VS Frontier Markets (Rebased)

(%)

Excess Return Over MSCI Frontier Markets

150 130 110 90

100
50

0
-50

70
Jan-09 Apr-09 MSCI PK Jul-09 Oct-09 Jan-10 Apr-10

MSCI Frontier Markets

Source: Bloomberg & JSK Research

14

Economics & Strategy

THE JSK STRATEGIST
June 2010

Economy: Indicators On The Upside!
Economic Resilience: IMF Monitors Closely
“GDP growth target revised upward to 4.5%” On the economic front, Pakistan has witnessed growth in some key macroeconomic indicators. Evidently, federal government sighting these improved measures has revised GDP growth target with an upside. The revised GDP growth has been set at 4.5% up from 4.1% sighting better than expected economic recovery for FY2010. Expansion in large scale manufacturing and growth in services sector would be the key factors contributing to economic growth with 5.6% share of manufacturing, 4.6% for services and 3.8% for agriculture sector.
GDP Growth 8% 5.8% 6% 4% 2% 0% FY06 FY07 FY08 FY09 FY10 FY11P 6.8%
2%

Money Supply and CPI - FY10
3%

4.1% 2.0%

4.5% 3.5%
1% 0% -1%

Jul

Aug

Sep

Oct

Nov

Dec

Jan

Feb

Mar

Money Supply Growth

CPI

Source: MoF & JSK Research

Source: SBP & JSK Research

Economy is still in its fragile recovery phase but has managed to come out strong from the worst economic scenarios. In a year clouded with recessionary effects and negative investor sentiments towards local socio-political scenario, the country has witnessed its fair share of testing times. However, an improving current account position due to lowering of trade deficit and decreasing prices of commodities in international markets have come in well for the country’s economic managers. Although, IMF still seems concerned of exceeding fiscal deficits and pressures on monetary system due to excessive government borrowing, foreign inflows have shown a marked recovery. Recovery is structured on a strong growth patch in remittances (US$7.3 billion, Jul-Apr FY2010), inflows from Coalition Support Fund (CSF) and consistent foreign portfolio (net) investments (PKR45 billion, Jul-May FY2010) in local equity markets.

Remittances and MoM Growth
US$ million 1000 800
600 400 200 0 40% 30%

PKR Billion 12 10 8

FIPI and MoM Growth
800% 600% 400% 200% 0% -200%

20% 10%
0% -10% -20%

6
4 2

0 Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May
Growth (RHS)

Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr
Remmittances (LHS) MoM Growth (RHS)

FIPI (LHS)

Source: SBP & JSK Research

Source: NCCPL & JSK Research

“IMF tranche of US$1.2 billion received in May”

International Monetary Fund voicing its concerns in release of its last tranche (US$1.2 billion) in May instructed the government to curtail bank borrowing and increase power tariffs by 6% in order to reduce fiscal pressures. However, in the face of consistent power outages and power shortfalls, government is yet to implement tariff hikes in order to avoid a public outrage. Economics & Strategy

15

THE JSK STRATEGIST
June 2010

Economy: Indicators On The Upside!
Fiscal year 2010 also witnessed a consistent growth trend in private sector credit supporting new investments and green field projects. Nonetheless, SBP maintained its monetary outlook on economy in its recent policy statement, keeping the key policy rate unchanged at 12.5%. The central bank also emphasized on the need to employ effective measures to increase the tax-to-GDP ratio as revenue deficit (difference between total revenues and current expenditure) might cross 2% of GDP in FY2010 (FY2009: 1.5% of GDP). The burgeoning domestic debt levels of government also led it to miss fiscal deficit targets of 5.1% set for FY2010 as per the agreements with the IMF. This has led the international fund agency to delay the scheduled financial assistance tranches, the last tranche flowing in with a delay of 35-40 days. However, federal government has maintained its stance as a war ally and justifies exceeding expenditures with carving out terrorism and the improving law and order situation.
%
16 14 12 10
8

Deposit & Lending Rates
PKR Trillion 3.5 3.3 3.1 2.9 2.7

Private Credit & MoM Growth - FY10
3.09%
2.35%

4% 3% 0.73% 2% 0.03% 1% 0%
-1%

1.79% 1.95%

-0.88% 2.3 -1.61%

-0.43%

2.5 2.1

-2% Jul Aug Sep Oct Nov Dec Jan Feb Mar Private Credit (LHS) Credit Growth (RHS)

Jul

Oct

Jan

Apr

Jul

Oct

Jan

Apr

Wavg Lending Rate

Wavg Deposit Rate

Source: SBP & JSK Research

Source: SBP & JSK Research

“CSF, Kerry-Lugar and IMF inflows remain vital for na-

Conclusively, we believe that the unveiled national budget FY2011 is not completely a tax laden budget, as government expects to achieve a growth of over 10% in direct and indirect taxes. The key aims of the budget is fiscal stabilization and to promote fiscal and debt sustainability at all levels. This would shift government’s focus away from incurring heavy development expenditures and making the economy viable in the long run. In the face of rising inflation and dismal power sector, the national development program would focus on application of fiscal resources to highest priority areas of energy viability and human resource development. Also the country’s economic chief has vowed to revamp public sector entities, which has long remained an untouched domain. By reforming these PSEs, government can save over PKR200 billion in a year based on very conservative estimates. We maintain our upbeat economic forecasts for the medium term and expect national economy to achieve a growth target of 4.3%, down from government forecasts of 4.5%. However, dependence on fund inflows from CSF, Kerry-Lugar bill and long term commitment of IMF remain vital for the national economy. At the same time, non-realization of these funds could pose significant risks to our thesis of growth in economy and capital markets. Hence, a downside in growth forecasts cannot be ignored if half-baked measures at the economic central front are presented and collective efforts are not established in order to create a sustainable growth path.

16

Economics & Strategy

THE JSK STRATEGIST
June 2010

The Macro View
FISCAL YEAR 2010 Macro Indicators Forex Reserves (US$ bn) Remmittances (US$ mn) Exports (US$ mn) Imports (US$ mn) Trade Deficit (US$ mn) Foreign Portfolio Inv (PKR mn) Non-Bank Savings (PKR mn) Tax Revenues (PKR mn) Private Credit (PKR bn) Banking Spread (%) Money Supply Growth Consumer Price Index (CPI) Quantum Index - LSM Jul 11,738 745 1,554 2,811 1,257 973 36,082 74,680 3,112 4.82 -0.02% 1.50% 197 Aug 14,266 781 1,467 2,171 704 7,855 19,950 86,188 3,085 4.36 0.04% 1.70% 193 Sep 14,806 806 1,599 2,447 848 10,652 6,884 102,817 3,157 4.70 1.98% 0.50% 184 Oct 14,239 758 1,627 2,748 1,121 3,182 25,602 107,956 3,214 4.52 0.59% 1.00% 197 Nov 13,735 743 1,431 2,191 760 1,076 9,855 87,860 3,276 4.75 2.38% 1.40% 192 Dec 15,070 698 1,620 2,717 1,097 355 16,503 122,503 3,378 4.49 2.19% -0.50% 204 Jan 14,516 668 1,626 2,525 899 1,289 18,902 112,489 3,363 4.60 -0.58% 2.40% 217 Feb 14,786 589 1,527 2,330 803 1,413 14,842 96,743 3,387 4.62 0.56% 0.40% 219 Mar 14,951 764 1,869 2,504 635 9,192 20,777 118,189 3,388 4.47 0.43% 1.30% 223 Apr 15,049 756 1,835 2,804 969 6,744 16,655 4.19 1.70% 2,049 May 16,149 -

Source: SBP, FBR, FBS, NCCPL and JSK Research

Money Markets
KIBOR Tenor 1 Week 2 Week 1 Month 3 Month 6 Month 9 Month 1 Year 2 Year 3 Year 03 - May 31 - May Change 11.50% 11.81% 12.03% 12.18% 12.27% 12.60% 12.68% 12.80% 12.88% 12.37% 12.31% 12.31% 12.27% 0.87% 0.50% 0.28% 0.00%

Events Calendar
Economic Calendar Event/Announcement Economic Survey National Budget (PKR tn) Money Supply Growth Export Figures (US$ bn) Import Figures (US$ bn) Consumer Price Index - YoY
Corporate Calendar Company TRG Pakistan Lotte Pakistan PTA Ltd Arif Habib Securities Ltd Bank of Punjab Pakistan WorldCall Telecom Ltd Pakistan Oilfields Ltd
Source: SBP & JSK Research

Period FY10 FY11 April May May May

Expected Date Prior Results 04 - Jun 05 - Jun 02-10 Jun 08-12 Jun 08-12 Jun 09-13 Jun 1.30 0.43% 1,835 2,804 1.70%

12.16% -0.02% 12.58% -0.02% 12.66% -0.02% 12.77% -0.03% 12.86% -0.02%

Ticker TRG

Period 3QFY10

Expected Date 03 - Jun 04 - Jun 04 - Jun 04 - Jun 04 - Jun 04 - Jun

Prior Results (EPS) N/A PKR0.89 - 4QCY09 PKR1.51 - 2QFY10 PKR(19.07) - CY2008 PKR(0.57) - FY2009 PKR23.59 - FY2009

LOTPTA 1QCY10 AHSL 3QFY10 BOP WTL POL CY2009 3QFY10 3QFY10

FOREX Currency USD EUR GBP JPY 03 - May 84.1050 31 - May 85.2393 Change -1.35% 5.36% 3.21% -5.12%

110.7729 104.8373 127.9965 123.8894 0.8880 0.9335

PAKISTAN INVESTMENT BONDS Tenor 3 Year 5 Year 7 Year 10 Year
Source: SBP & JSK Research

WTD Avg Yield 12.4207% 12.4993% 12.5941% 12.6552%

17

Economics & Strategy

THE JSK STRATEGIST
June 2010

JSK Contact Information
JSK Research
Bilal Subhani Head Of Research Tel: +92 213 537 0681 (Direct) Mobile: +92 300 856 9680 Email: bilal@jsksecurities.com Osman Kafray Research Analyst Tel: +92 213 582 1238 (Ext: 107) Mobile: +92 300 2591091 Email: usman@jsksecurities.com Sundus Naz Junior Analyst Tel: +92 213 582 1239 (Ext: 108) Karachi Office The Plaza, Block 9, Clifton, Karachi, Pakistan Tel: +92 213 582 1238 Fax: +92 51 289 5115 Email: research@jsksecurities.com
AC

JSK Brokerage
Ibrar Bashir Senior Manager Operations Tel: +92 51 289 5118 (Direct) Mobile: +92 300 856 7669 Email: ibrar@jsksecurities.com Trading Desk Tel: +92 51 289 5111-12, Ext:105 Risk Management Desk Tel: +92 51 289 5113-14, Ext:108 Account Management Desk Tel: +92 51 289 5113-14, Ext:103

Islamabad Office 1111, Islamabad Stock Exchange Towers, Jinnah Avenue, Islamabad, Pakistan Tel: +92 51 289 5111 Fax: +92 51 289 5115

JSK Research is also available at Bloomberg

18

Economics & Strategy

THE JSK STRATEGIST
June 2010

Analyst’s Certification
I, Bilal Subhani, hereby certify that all of the views expressed in this report accurately reflect my personal views about the markets, sectors, securities and companies that are the main subject of this report. I also certify that no part of my compensation was, is or will be , directly or indirectly, related to the specific recommendations or views expressed in this report.

Disclosure
This report has been prepared by JSK Securities Limited and is for distribution only under such circumstances as may be permitted by applicable law. It has no regard to the specific investment objectives, financial situation or particular needs of any specific recipient. It is published solely for informational purposes and is not to be construed as a solicitation or an offer to buy or sell any securities or related financial instruments or the solicitation of an offer to buy any security in any jurisdiction where such an offer or solicitation would be illegal. No representation or warranty, express or implied, is provided in relation to the accuracy, completeness or reliability of the information contained herein nor is it intended to be a complete statement or summary of the securities, markets or developments referred to in the report. The report should not be regarded by recipients as a substitute for the exercise of their own judgment. Before acting on any advice or recommendation in this material, clients should consider whether it is suitable for their particular circumstances and, if necessary, seek professional advice. The price and value of the investments referred to in this material and the income from them may go down as well as up, and investors may realize losses on any investments. Past performance is not necessarily indicative of future results. Future returns are not guaranteed, and a loss of original capital may occur. Any opinions expressed in this report are subject to change without notice and may differ or be contrary to opinions expressed by other analysts as a result of using different assumptions and criteria. The analysis contained herein is based on numerous assumptions. Different assumptions could result in materially different results. The analyst(s) responsible for the preparation of this report may interact with trading desk personnel, sales personnel and other constituencies for the purpose of gathering, synthesizing and interpreting market information. JSK Securities Limited is under no obligation to update or keep current the information contained herein. The securities described herein may not be eligible for sale in all jurisdictions or to certain categories of investors. Foreign currency rates of exchange may adversely affect the value, price or income of any security or related instrument mentioned in this report. For investment advice, trade execution or other enquiries, clients should contact regional sales representative. Neither JSK Securities Limited nor any of its affiliates, directors, employees or agents accepts any liability for any loss or damage arising out of the use of all or any part of this report. The material is based on information that we consider reliable, but we do not represent that it is accurate or complete, and it should not be relied on as such. Additional information will be made available upon request.

JSK Research is also available at Bloomberg

19

Economics & Strategy

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...education for sustainable development is to help people develop the attitudes, skills, and knowledge to make informed decisions for the benefits of themselves and others, now and for the future, and to act upon those decisions” (Canada Council for the Arts). Education for sustainable development is an approach to teaching and learning based on the ideals and principles that underlie sustainability of human rights, poverty reduction, sustainable livelihoods, peace, environmental protection, democracy, health, biological and landscape diversity, climate change and so on. Education is a human right and the primary agent of transformation towards sustainable development by increasing people’s capacities to transform their visions for society into reality (Margaret & John, 2009, p.77). To implement education for sustainable development, in many communities or institutions seek to promotes and improve basic education, education programs at all levels to address sustainable development, develop public awareness and understanding of sustainability, and provide training for jobs. Through education for sustainability for living, students gain knowledge, skills and values to address the environmental and social challenges of the coming decades. There are many aims have been proposed by philosophers and other education theorists; they include the cultivation of curiosity and the fostering of creativity, the production of knowledge and of knowledgeable students to enhance of......

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