December 2011

Lahore Stock Exchange (LSE) (LSE) Continuous Professional Development

Pakistans Capital Markets: Current Challenges

Presentation by : Muhammad Farid Alam, FCA Chief Executive Officer AKD Securities Limited 1

Contents
AKD Securities Limited Economy & Capital Markets Equity Market of Pakistan Debt Market of Pakistan Challenges for Capital Markets The Way Forward

AKD Securities Limited

Value Proposition
The leading stock brokerage in Pakistan, accounting for 6% of average daily volume traded on the Karachi Stock Exchange Ranked among the top 5 brokerage houses Key broker for foreign institutional investors with over US$1,300 million turnover in FY06-07 (25% of the total estimates FII turnover) Member of the Pakistan Mercantile Exchange Limited (PMEX) Over 100 domestic institutional and high net worth clients handled by institutional desk comprising of: Commercial, Investment & Islamic Banks Development Financial Institutions Mutual Funds & Investment Companies Corporate Provident & Pension Funds Public & Private Sector Corporations

Recognition
AKD Securities Limited is a proud recipient of The Best Equity Brokerage House Award for the years 2005-06 and 200607, awarded by the CFA Association of Pakistan.

The globally recognized business journal Asia Money conducted a survey, focused on the quality of brokerage firms, with renowned international portfolio fund managers and ranked AKD Securities Limited as the 2nd Best Local Brokerage, 2nd Best Overall Country Research, and 3rd Best Overall Sales Services.

AKD Trade
First brokerage firm to launch Online Stock Trading Service in 2002, and now a leading franchise in this space Largest customer base with 7,000 registered clients out of a total market size of approximately 19,000 and contribution significantly to overall broking revenues Marketing joint-venture & co-branding with Standard Chartered Bank for their online Priority Banking Clientele which allows immediate funds transfer facility to AKDs broking account while enjoying the banking facilities of SCB Only online trading service provider with fully dedicated customer call-centre support having trained staff Dedicated research portal enabling online customers to be fully informed about market & corporate developments, with access to reports on par with institutional investors

Investment Banking
Successful track record of completing huge capital market transactions Extensive understanding and experience of structuring and executing complex debt & equity transactions Financial strength to commit resources for large underwriting and participation In-depth knowledge of investor demand & appetite Widespread distribution capabilities to a diversified client network through experienced distribution team Close working relationship and credibility with key regulatory agencies Experienced senior resources to ensure swift completion of transactions
We believe that with our in-depth understanding of Pakistans capital markets, qualified management, and prior experience, we are best positioned to provide our clients the level of services required for making every transaction a resounding success.

Investment Banking
AKDS has assembled a core team of expert professionals with a high level of integrity, financial acumen and industry experience. Driven by young and skilled professionals, the team has initiated and successfully executed transactions unique in structure and size. The team has been involved in numerous Initial Public Offerings, Acquisitions, providing risk capital in underwritings, market-making, various TFC issuances & Asset-back Securitization as well as leading Privatization deals in the country. AKDS was selected as advisor for IPO of UBL by the Government of Pakistan. It was the BUYSIDE advisor for NRL privatization which was acquired by the Attock Oil Group. AKDS was also mandated as sell-side advisor to Continental Biscuits Limited for the strategic sale of stake to The Danone Group, France. The consortium of AKDS, Morgan Stanley and Detusche was mandated as the consultants to the GDR of National Bank of Pakistan (on hold) As Financial Advisors, AKDS has successfully consummated the acquisition of a listed commercial bank by a well known Saudi bank and have acted as Joint Financial Advisors for the 100% Rights Issue of The Bank of Khyber of up to PkR 2,552mn.
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Economy & Capital Markets

Phases of an Economy
Phase Economy Fiscal Policy Short-Term Rates Asset Class

Initial Recovery

Inflation still declining

Stimulatory

Low / Declining

Cyclical shares, commodities and other riskier assets

Early Upswing

Healthy economic growth Inflation remains low

Moving Up

Shares and real estate

Late Upswing

Inflation gradually rises Inflation continues to accelerate Inventory correction begins Inflation peaks Production declines

Restrictive

Rising

Bonds, interest sensitive shares Bonds, interest sensitive shares

rate

Slowdown

Peaking

rate

Recession

Declining

Shares (late in cycle), Commodities (late in cycle)

10

The Economy of Pakistan

Falling Interest Rates

Falling Inflation

Initial Recovery

Expansionary Fiscal Policy

Higher Corporate Earnings

11

The Economy of Pakistan - Snapshot

Actual
FY09A Real GDP growth (%) Agri growth (%) Manufacturing growth (%) Services growth (%) Federal budget deficit % of GDP Tax to GDP (%) Average CPI Inflation Rate (%) Foreign direct investments (US$bn) Exports as % of GDP Imports as % of GDP Current Account as % of GDP Inward Remittances (US$bn) Forex reserves (US$bn) Exchange rate (PkR/US$) External debt % of GDP 1.7 4 -3.6 1.7 5.3 9.5 20.8 3.7 11.8 19.6 -5.7 7.8 12.4 66 29 FY10A 3.8 0.6 5.5 2.9 6.3 10.1 11.7 2.2 11.1 17.6 -1.7 8.9 16.8 84 28 FY11A 2.4 1.2 3.0 4.1 5.7 10 14.1 1.5 12.7 13.6 0.5 11.2 17.5 87 31

Budgeted
FY12B 4.2 3.4 3.7 5.1 4.0 10.3 12.0 2.5 12.7 17.8 -0.6 12.2 18.0 88 32

Forecasted
FY12AKD 3.50-3.75 2.5 3.0 4.5 5.75 10.3 12.1 1.5 12.5 18.0 -1.03 12.5 16.0 91.5 30

Note: FY12B is GoP estimates. FY12AKD is AKD Research Estimates

12

15

Economic Growth
%
6.0%

FY2010 5.4%
Emerging Markets Developed Markets

Growth is expected to come out of the Emerging Markets because all variables i.e. consumption, savings etc. are at the lower side. On the other hand the same variables have reached saturation amongst the Developed Markets.

5.0%

4.0%

3.0%

2.0%

1.7%

1.0%

0.0%

Emerging Markets

Developed Markets

Source: EIU; April 2010 13

21

Debt % of GDP
Debt % of GDP
90

29 DEC 2000 31 DEC 2009

80

70

60

50

40

30

20

'00

'01

'02

'03

'04

'05

'06

'07

'08

'09

- Developed Markets : G7. Emerging Markets : 87 non-OECD Countries - Total domestic, external and IMF government debt, as a % of nominal GDP - Usually but not exclusively central government Source: Factset; EIU; April 2010 14

Capital Market Performance

GDP Growth

Over the past decade total market capitalizations input in GDP increased phenomenally from 8% in FY01 and kept on growing with its peak during the golden years of 2006 and 2007

20.0% 15.0% 10.0% 5.0% 0.0%

FY00 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11F
Dec 10

-5.0%

Manufacturing

Agri

Services

GDP Growth

Market Cap. / GDP

50% 45% 40% 35% 30% 25% 20% 15% 10% 5% 0% FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 8% 10% 16% 17% 18% 18.5% 25% 32% 37% 37% 46%

KSE Performance (2001 2011)

Index 14,000 12,000 10,000 8,000 6,000 4,472 4,000 2,000 Dec 01 Dec 02 Dec 03 Dec 04 Dec 05 Dec 06 Dec 07 Dec 08 Dec 09 01-Dec-11

KSE 100 Index

14,076 CAGR CY01-CY11 = 25% 9,557 12,022 11,557

10,041

9,387

6,218

5,865

1,273 2,701

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FY12F

Role of Capital Markets

Mobilization of long-term resources (capital raising avenue for corporates) & investment avenue of investors including retail

Intermediation Function Distribution of these resources & investments in various viable projects

Mechanism of entry and exit in a quick and transparent manner

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Advantages of Capital Markets

Advantages of capital markets to: Government Sponsors Society Investors Regulators -

17

Equity Market of Pakistan

18

KSE-100 Index at a Glance

Index 14,000 12,000 10,000 8,000 6,000 4,472 4,000 2,000 De c 0 1 De c 0 2 De c 0 3 De c 0 4 De c 0 5 De c 0 6 De c 0 7 De c 0 8 De c 0 9 De c 1 0 0 1 -De c-1 1

KSE 100 Index

14,076 CAGR CY01-CY11 = 25% 9,557 10,041 12,022 11,557

During the 90s market movement was sideways ranging between the levels of 1,000 to 2,000 The Decade That Was: The first decade of 21st century was eventful and saw de-regulation opening up the markets, consolidation, privatization, divestments by GoP worth USD 6.7bn that provided for currency stabilization (MCB GDR) and later by the cursed domestic and international financial crisis

9,387

6,218

5,865

1,273 2,701

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KSE Market Dynamics Volatility is an Opportunity

The KSE-100 Index has posted a 10 year return CAGR of 25% however volatility has remained high historically. We view this as an opportunity to maximize returns. In view of expected spells of volatility following the sell-off in global markets, we believe proactive management can provide for above average market returns.
KSE 100 Index High Low CY01 1,550 1,075 CY02 2,701 1,273 CY03 4,604 2,359 CY04 6,218 4,472 CY05 10,303 6,218 CY06 12,274 8,767 CY07 14,815 10,041 CY08 15,676 5,865 CY09 9,846 4,815 CY10 12,031 9,230 CY11* 12,682 10,842

Difference between KSE-100 High & Low 167% Market melt down 2005 and 2008 95% 66% 44% 39% 40% 48% 30% 17% 104%

112%

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011*

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011*

CY % *CYTD

-16%

112%

66%

39%

54%

5%

40%

-58%

60%

28%

-4%

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Pakistan Market Valuation vs Regional Markets

PER vs. EPS Growth (%)
Malaysia Philippines Singapore
PER (x) 2012

ROE (%) vs. PBVS (x)

P/BV (x) 2012

14.0 13.0 12.0 11.0 10.0 9.0 8.0 7.0

India Regional Avg. Thailand

2.60
Indonesia

Indonesia

2.40 2.20 2.00

Malaysia Philippines Regional Avg.

India Thailand China Pakistan

Hong Kong

China

1.80 1.60 1.40 1.20 Singapore 10 12

Hong Kong ROE (%) 2012 14 16 18 20 22

Pakistan 6.0 6 9 12 15 18

EPS Growth (%) 2012 21 24

1.00

2012 Dividend Yield (%)

10.0 9.0 8.0 7.0 6.0 5.0 4.0 3.0 2.0 1.0 8.59

4.16

4.14

4.03

3.63

3.22

3.12

2.56

2.30

1.85

Philippines

Malaysia

Pakistan

Thailand

Singapore

Regional Avg.

Indonesia

21

China

Hong Kong

India

Features of Equity Markets in Pakistan

Exposure to Corporate Growth Provides opportunity with some of Pakistans best corporate stories Inflation Protection Sale price will increase according to inflation if company will be able to pass through inflation Liquidity Ease of entry & exit with market mechanism ensuring availability of buyers and sellers

Higher Returns The KSE-100 Index has on averaged returned 25% p.a. since Dec01 Ease of Trade Online trading

Companies become SICK but Sponsors get HEALTHIER!!!

22

Is it Bulls or Bears in Pakistans Equity Market?

Flags for 2011-12

Market likely to focus on: Political situation & US relations World economy & stock markets Foreign funding release Central banks monetary policy Macroeconomic Performance

KSE-100 can reach 13,750 points by Jun12 based on target price mapping In absence of any catastrophic event, downside limited by: High dividend yield (2012F: 8.6%) Corporate earnings resilience Largely cash based market

Check Points
Key drivers to include: Corporate results & Earnings outlook Interest rate / liquidity trajectory Release of U.S. / multilateral funding Actual vs. FY12 Budget targets Equity Market regulations

Valuation expansion if political risk reduces, economic growth accelerates while monetary easing continues KSE-100 Index can reach 14,250 points by Jun12 if monetary easing sustains

KEY MACRO RISKS

Major terrorism event Disruptive political change Commodity price shock Fiscal indiscipline Weather related agriculture sector failure

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Is it Bulls or Bears in Pakistans Equity Market?

24

Debt Market of Pakistan

25

Fixed Income Market

Features Largest market size PkR 7trn M2 + NSS (PkR 6.6trn + PkR 1.7trn) compared to PkR 600bln size of equity market free-float which is less than 8% of fixed income Certain and regular cash flows with lower volatility in comparison to equities Two classes of investors: growing segment of investors with Islamic segment & normal fixed income seekers Opportunities in Pakistani Fixed Income Medium to Long term investment: National Saving Certificates Pakistan Investment Bonds Sukuks Term Finance Certificates Short term investment: T- Bills Term Deposits in Banks Investor Portfolio Security Account
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Pakistan Investment Bond Yield

18 16 14 12 10 8 Pakistan Investment 6 Bond Yield 4 2 0 Aug-08 Jan-09 Jun-09 Nov-09 Apr-10 Sep-10 Feb-11 Jul-11

Fixed Income Market

Country Pakistan USA UK ECB Japan Australia China India South Korea Malaysia Indonesia Thailand Policy Rate (%) 12 0-0.25 0.5 1.25 0-0.10 4.50 6.56 8.50 3.25 3.00 6.00 3.50 YoY Inflation (%) 10.90 3.50
Source: SBP
14 12 10 8 6 4 2 0 12.0 10.0 8.0 6.0 4.0 2.0 0.0 -2.0

5.00 3.00 -0.20 3.50 5.50 10.10

Malaysia

Pakistan

Australia

3.40 4.40 4.20

Policy Rate (%) LHS

YoY Inflation (%)

The classical theory of positive RIR is now a myth!

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South Korea

Indonesia

Thailand

China

Japan

India

USA

ECB

UK

3.90

Fixed Income Market

Outlook of Fixed Income Securities
Declining interest rates provide opportunities for higher returns With projection of decreasing interest rate, medium term fixed income instruments look attractive

Risks in Fixed Income Securities

18

Pakistan Investment Bond Yield

16 14 12 10 8 6 4 2 0 8/20/2008 8/20/2009 8/20/2010 8/20/2011 Pakistan Investment Bond Yield

Interest Rate Risk Reinvestment Risk Credit Risk Event Risk Inflation Risk

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Challenges for Capital Markets

29

Challenges for Capital Markets in Pakistan

Capital markets move with overall economy - rather more sensitive
Lack of confidence amongst sponsors and investors most wiped off CGT/documentation and high handedness by tax authorities Poor law & order conditions Circular debt and energy crisis deteriorating company profitability, cash flow and balance sheets Inconsistent policy response and reform implementation Reluctance by sponsors to take viable companies to the stock market with limited response risk and lack of regulatory incentive A required concerted effort by members to revive markets lowering mistrust and rebuilding relationships with regulators and stakeholders
People of accomplishment rarely sat back and let things happen to them. They went out and happened to things. - Leonardo Da Vinci

30

Challenges for Capital Markets in Pakistan

Market participants have been unable to move past the wait and see approach Higher interest rate higher return for pensioners and other fixed income investors with no or lower risk Over/Under-regulation has decoupled the joint mandate of regulation and market development Yet to start-off with Over-The-Counter (OTC) Market Lack of support by Government of Pakistan in providing enabling environment Shortage of financial products in comparison to developed markets Keeping the foreign investor engaged in prevailing tougher economic conditions Political and social instability has massively damaged and overall confidence level in the economy Can Trading and Insider Trading be separated?

Overall Effect = Lowest Ever Volumes

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Need for Re-defining Business Model

Comparison of Products ( South Asia vs UK)

South Asia
Trading 2%

Others 3%
Informatio n Sales 3% Equities Broking 8%

Others 11%

UK
Treasury 25%

Equities Broking 95%

Fixed Income 33%

Interest Rate Derivative 20%

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Pathway to Glory Phases Towards Listing

Year
2007 2008 2009 2010 2011

KSE
14,076 6,037 9,387 12,022 11,762

No. of IPOs
10 9 3 6 4

Amount Raised (USD mn)

85 66 17 62 35

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USD 265mn

Realization and efforts by all stakeholders to give depth to the market

It is vital for local companies to get listed in the equity markets of our country not only for the enhancement and growth of the markets but also to gain access to a more convenient & robust form of capital raising

33

KSE Value & Volume

KSE-100 Index + Volume
600.00 18,000 16,000 500.00 14,000

400.00

12,000

10,000 300.00 8,000

200.00

6,000

4,000 100.00 2,000

Sep-07 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Mar-07 Jun-07 Dec-07 Oct-09 Feb-10 May-10 Aug-10 Nov-10 Feb-11 May-11 Aug-11 Dec-11

Volume (mn LHS)

KSE-100 Index (RHS)

34

If Volumes Dont Improve

35

Corporate Profitability Is it intact?

ACCOUNTING PROFITS REAL PROFITS

Numerous profit generating corporate entities in Pakistan are facing liquidity dry-outs recently, mainly due to the energy crisis and mounting circular debt

Growth in Earnings is essential but Dividends must increase in the same proportion as well
36

Can Capital Markets Perform Independent of the Economy?

13,000
MENA crisis escalates MQM parts US says Pakistan not U S forces kill ways from doing enough to coalition combat militancy Osama Bin Laden in Abbottabad MTS launched Selloff inline with global equities Glo bal rec es s ion co nc ern s + U S pre ss u re on Pa k ist an U S a nno unc e s O per atio n Tw is t on g lob al Pak -I M F re ce s sio n fe ars Art ic le IV ta lks F SV b ene fit en han ce d N AT O a tt ac k s an d me mo s c an dle

12,500

12,000

Punjab Governor as sassinat Raym ond Davis issue A dd itio nal affects PM L -N Pak-US parts wa ys r ev enu e m eas u res ties w ith P PP a nn oun ce d in Pu njab a ft er I M F t alk s S ec urit ies Le nd ing an d B orro wing P rodu c t lau nc he d

11,500

FY 12 B udg et ann oun ce d M ood y s giv es as su ran ce on Pak is ta ns so v ereig n deb t DR r edu ce d b y 5 0bp s D R c ut by 150 bp s to 12% F B R t o ex am ine s o urc e of in v es tm e nt in c a pita l m kt s

11,000

10,500

D e teriora ting la w & o rde r in K hi

C PI t um b les Circ ular de bt ex po su re due t o co nv ert ed t o reba s ing Go P s e cu ritie s

Jan-11

Feb-11

Apr-11

May-11

Jun-11

Aug-11

Sep-11

Nov-11

37

Challenging Political Environment

Friendly Opposition

Political parties lack financial and economic expertise

PTI talks about revolution; Reality or Over-confidence?

I feel that the failure of Common-Wealth Games and success of China Olympics shows that Democracy may not be the solution to all the ills!
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Lessons Learned
Imposition of floor was a disastrous decision Failure of regulator to save the Non-Banking Financial Institutions (NBFIs) Monopolistic scenario in the banking sector
Capital hoarding Big 5 only protecting their RoE Enjoying highest banking spreads

A few industries were over-leveraged due to which they had to face the music Success stories like Engro and Nishat need to be respected rather than envied Over-regulated equity market creates no value

Interfering with market mechanism BACKFIRES!!!

The brokerage community in Pakistan was content with plain-vanilla trading services dealing primarily in the Ready Market which led to overdependence on market volumes and vulnerability in the earnings stream.
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The Way Forward???

40

The Way Forward!!!

It has been a tough period for all financial markets since the economic meltdown began in 2008, but there is always a new beginning Integration Demutualization IPOs to keep the primary markets alive

De-regulation New products Tax structure Investor awareness

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Brokerage House (Member of LSE) Yearly Profit & Loss A/c

NEW No. of Employees 4 to 5 PKR Brokerage revenue Operating Expenses: Payroll Depreciation Electricity Rent Other Expenses Audit & Certification Fee 1,320,000 OLD 10 to 13 PKR 4,000,000

1,800,000 49,500 48,000 120,000 240,000 50,000 2,307,500 (987,500)

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4,500,000 148,500 150,000 240,000 480,000 150,000 5,668,500 (1,668,500)

Net Loss Per Annum*

*Excluding certain possible expenses

Thank You!!!

43