Pakistan's Capital Markets - Lahore Stock Exchange

Lahore Stock Exchange (LSE)“Continuous Professional Development”December 2011Pakistan’s Capital Markets:Current ChallengesPresentation by : Muhammad Farid Alam, FCAChief Executive OfficerAKD Securities Limited1

ContentsAKD Securities LimitedEconomy & Capital MarketsEquity Market of PakistanDebt Market of PakistanChallenges for Capital MarketsThe Way Forward2

AKD Securities Limited3

Value Proposition‣ The leading stock brokerage in Pakistan, accounting for 6% of average daily volumetraded 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 inFY06-07 (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 deskcomprising of: Commercial, Investment & Islamic Banks Development Financial Institutions Mutual Funds & Investment Companies Corporate Provident & Pension Funds Public & Private Sector Corporations4

RecognitionAKD Securities Limited is a proud recipient of “The Best Equity Brokerage House” Awardfor the years 2005-06 and 2006–07, awarded by the ‘CFA Association of Pakistan’.The globally recognized business journal ‘Asia Money’ conducted a survey, focused on thequality of brokerage firms, with renowned international portfolio fund managers and rankedAKD Securities Limited as the 2 nd Best Local Brokerage, 2 nd Best Overall CountryResearch, and 3 rd Best Overall Sales Services.5

AKD Trade‣ First brokerage firm to launch Online Stock Trading Service in 2002, and now a leadingfranchise in this space‣ Largest customer base with 7,000 registered clients out of a total market size ofapproximately 19,000 and contribution significantly to overall broking revenues‣ Marketing joint-venture & co-branding with Standard Chartered Bank for their online PriorityBanking Clientele which allows immediate funds transfer facility to AKD’s broking accountwhile enjoying the banking facilities of SCB‣ Only online trading service provider with fully dedicated customer call-centre support havingtrained staff‣ Dedicated research portal enabling online customers to be fully informed about market &corporate developments, with access to reports on par with institutional investors6

Investment Banking‣ AKDS has assembled a core team of expert professionals with a high level of integrity, financialacumen and industry experience. Driven by young and skilled professionals, the team has initiatedand successfully executed transactions unique in structure and size.‣ The team has been involved in numerous Initial Public Offerings, Acquisitions, providing riskcapital in underwritings, market-making, various TFC issuances & Asset-back Securitization aswell as leading Privatization deals in the country.‣ AKDS was selected as advisor for IPO of UBL by the Government of Pakistan. It was the BUYSIDEadvisor 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 saleof stake to The Danone Group, France.‣ The consortium of AKDS, Morgan Stanley and Detusche was mandated as the consultants to theGDR of National Bank of Pakistan (on hold)‣ As Financial Advisors, AKDS has successfully consummated the acquisition of a listed commercialbank by a well known Saudi bank and have acted as Joint Financial Advisors for the 100% RightsIssue of The Bank of Khyber of up to PkR 2,552mn.8

Economy & CapitalMarkets9

Phases of an EconomyPhase Economy Fiscal PolicyShort-TermRatesAsset ClassInitial Recovery • Inflation still declining Stimulatory Low / DecliningCyclical shares,commodities and otherriskier assetsEarly Upswing• Healthy economic growth• Inflation remains lowMoving UpShares and real estateLate Upswing • Inflation gradually rises Restrictive RisingBonds, interest ratesensitive sharesSlowdown• Inflation continues toacceleratePeakingBonds, interest ratesensitive sharesRecession• Inventory correctionbegins• Inflation peaks• Production declinesDecliningShares (late in cycle),Commodities (late incycle)10

The Economy of PakistanFalling Interest RatesFalling InflationInitial RecoveryExpansionary Fiscal PolicyHigher Corporate Earnings11

The Economy of Pakistan - SnapshotActual Budgeted ForecastedFY09A FY10A FY11A FY12B FY12AKDReal GDP growth (%) 1.7 3.8 2.4 4.2 3.50-3.75Agri growth (%) 4 0.6 1.2 3.4 2.5Manufacturing growth (%) -3.6 5.5 3.0 3.7 3.0Services growth (%) 1.7 2.9 4.1 5.1 4.5Federal budget deficit % of GDP 5.3 6.3 5.7 4.0 5.75Tax to GDP (%) 9.5 10.1 10 10.3 10.3Average CPI Inflation Rate (%) 20.8 11.7 14.1 12.0 12.1Foreign direct investments (US$bn) 3.7 2.2 1.5 2.5 1.5Exports as % of GDP 11.8 11.1 12.7 12.7 12.5Imports as % of GDP 19.6 17.6 13.6 17.8 18.0Current Account as % of GDP -5.7 -1.7 0.5 -0.6 -1.03Inward Remittances (US$bn) 7.8 8.9 11.2 12.2 12.5Forex reserves (US$bn) 12.4 16.8 17.5 18.0 16.0Exchange rate (PkR/US$) 66Note: FY12B is GoP estimates. FY12AKD is AKD Research Estimates84 87 88 91.5External debt % of GDP 29 28 31 32 3012

Economic Growth15%6.0%5.0%FY20105.4% Emerging MarketsDeveloped MarketsGrowth is expected to come out of the EmergingMarkets because all variables i.e. – consumption,savings etc. are at the lower side.On the other hand the same variables havereached saturation amongst the DevelopedMarkets.4.0%3.0%2.0%1.7%1.0%0.0%Emerging MarketsDeveloped MarketsSource: EIU; April 201013

Debt % of GDP21Debt % of GDP29 DEC 2000 – 31 DEC 20099080706050403020'00 '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 governmentSource: Factset; EIU; April 201014

Capital Market PerformanceOver the past decade total marketcapitalization’s input in GDP increasedphenomenally from 8% in FY01 and kepton growing with its peak during thegolden years of 2006 and 200720.0%15.0%10.0%5.0%0.0%GDP Growth-5.0%FY00FY01FY02FY03FY04FY05FY06FY07FY08FY09FY10FY11FFY12FManufacturing Agri Services GDP GrowthMarket Cap. / GDPKSE Performance (2001 – 2011)50%46%IndexKSE 100 Index45%40%35%30%25%20%15%10%5%0%16%37%37%32%25%17%18% 18.5%8% 10%FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY1114,00012,00010,0008,0006,0004,0002,000-14,076CAGR CY01-CY11 = 25%9,55710,0414,472 6,218 5,8651,273 2,701Dec 01Dec 02Dec 03Dec 04Dec 05Dec 06Dec 07Dec 0812,0229,387Dec 09Dec 1011,55701-Dec-1115

Role of Capital Markets‣ Mobilization of long-term resources (capital raising avenue forcorporates) & 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 manner16

Advantages of Capital MarketsAdvantages of capital markets to:‣ Government -‣ Sponsors –‣ Society -‣ Investors -‣ Regulators -17

Equity Market ofPakistan18

KSE-100 Index at a GlanceIndex14,00012,00010,0008,0006,0004,0002,000-KSE 100 Index14,076CAGR CY01-CY11 = 25%9,55710,0414,472 6,218 5,8651,273 2,701De c 0 1De c 0 2De c 0 3De c 0 4De c 0 5De c 0 6De c 0 7De c 0 812,0229,387De c 0 9De c 1 011,5570 1 -De c-1 1During the 90s marketmovement was sidewaysranging between the levelsof 1,000 to 2,000The Decade That Was:The first decade of 21stcentury was eventful andsaw de-regulation openingup the markets,consolidation, privatization,divestments by GoP worthUSD 6.7bn that provided forcurrency stabilization (MCB –GDR) and later by the curseddomestic and internationalfinancial crisis19

KSE Market Dynamics – Volatility is an OpportunityThe KSE-100 Index has posted a 10 year return CAGR of 25% however volatility has remained highhistorically. We view this as an opportunity to maximize returns. In view of expected spells ofvolatility following the sell-off in global markets, we believe proactive management can provide forabove average market returns.KSE 100 Index CY01 CY02 CY03 CY04 CY05 CY06 CY07 CY08 CY09 CY10 CY11*High 1,550 2,701 4,604 6,218 10,303 12,274 14,815 15,676 9,846 12,031 12,682Low 1,075 1,273 2,359 4,472 6,218 8,767 10,041 5,865 4,815 9,230 10,842Difference between KSE-100 High & Low167%112%95%Market melt down 2005and 2008104%66%44%39%40%48%30%17%2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011*2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011*CY % -16% 112% 66% 39% 54% 5% 40% -58% 60% 28% -4%*CYTD20

Pakistan Market Valuation vs Regional MarketsPER vs. EPS Growth (%)ROE (%) vs. PBVS (x)14.013.012.011.010.09.08.07.06.0Malaysia2.60PhilippinesIndiaIndonesia2.40Regional Avg.2.202.00ThailandChina1.801.60PER (x) 2012 SingaporeHong Kong1.401.20Pakistan EPS Growth (%) 20121.006 9 12 15 18 21 24P/BV (x) 2012IndonesiaMalaysiaIndiaPhilippinesThailandRegional Avg.ChinaPakistanSingapore Hong KongROE (%) 201210 12 14 16 18 20 222012 Dividend Yield (%)10.09.08.07.06.05.04.03.02.01.0-8.594.16 4.14 4.033.633.22 3.122.56 2.301.85PakistanThailandHongKongMalaysiaSingaporeRegionalAvg.PhilippinesIndonesiaChinaIndia21

Features of Equity Markets in PakistanExposure to Corporate GrowthProvides opportunity with some of Pakistan’s best corporate storiesInflation ProtectionSale price will increase according to inflation if company will be able to pass through inflationLiquidityEase of entry & exit with market mechanism ensuring availability of buyers and sellersHigher ReturnsThe KSE-100 Index has on averaged returned 25% p.a. since Dec’01Ease of TradeOnline tradingCompanies become SICK but Sponsors get HEALTHIER!!!22

Is it Bulls or Bears in Pakistan’s Equity Market?Flags for 2011-12Market likely to focus on:• Political situation & US relations• World economy & stock markets• Foreign funding release• Central bank’s monetary policy• Macroeconomic PerformanceCheck PointsKey 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• KSE-100 can reach 13,750points by Jun’12 based ontarget price mapping• In absence of any catastrophicevent, downside limited by:‣ High dividend yield(2012F: 8.6%)‣ Corporate earningsresilience‣ Largely cash based market• Valuation expansion if politicalrisk reduces, economic growthaccelerates while monetaryeasing continues• KSE-100 Index can reach14,250 points by Jun’12 ifmonetary easing sustainsKEY MACRO RISKS‣ Major terrorism event‣ Disruptive political change‣ Commodity price shock‣ Fiscal indiscipline‣ Weather related agriculture sector failure23

Is it Bulls or Bears in Pakistan’s Equity Market?24

Debt Market of Pakistan25

Fixed Income MarketFeatures‣ Largest market size‣ PkR 7trn M2 + NSS (PkR 6.6trn + PkR 1.7trn)compared to PkR 600bln size of equity marketfree-float which is less than 8% of fixed income‣ Certain and regular cash flows with lowervolatility in comparison to equities‣ Two classes of investors: growing segment ofinvestors with Islamic segment & normal fixedincome seekersOpportunities 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 Account181614121086420Pakistan Investment Bond YieldPakistan InvestmentBond YieldAug-08 Jan-09 Jun-09 Nov-09 Apr-10 Sep-10 Feb-11 Jul-1126

Fixed Income MarketCountry Policy Rate (%) YoY Inflation (%)1412.0Pakistan 12 10.90USA 0-0.25 3.50UK 0.5 5.00ECB 1.25 3.00Japan 0-0.10 -0.20Source: SBP12108610.08.06.04.0Australia 4.50 3.50China 6.56 5.50India 8.50 10.10South Korea 3.25 3.90Malaysia 3.00 3.40Indonesia 6.00 4.40Thailand 3.50 4.20420PakistanUSAUKECBJapanAustraliaChinaIndiaSouth KoreaMalaysiaIndonesiaThailandPolicy Rate (%) LHS YoY Inflation (%)2.00.0-2.0The classical theory of positive RIR is now a myth!27

Outlook of Fixed Income SecuritiesFixed Income Market‣ Declining interest rates provide opportunities for higher returns‣ With projection of decreasing interest rate, medium term fixedincome instruments look attractiveRisks in Fixed Income Securities‣ Interest Rate Risk‣ Reinvestment Risk‣ Credit Risk‣ Event Risk‣ Inflation RiskPakistan Investment Bond Yield181614121086Pakistan Investment Bond Yield4208/20/2008 8/20/2009 8/20/2010 8/20/201128

Challenges for CapitalMarkets29

Challenges for Capital Markets in PakistanCapital 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 balancesheets‣ Inconsistent policy response and reform implementation‣ Reluctance by sponsors to take viable companies to the stock market with limited response riskand lack of regulatory incentive‣ A required concerted effort by members to revive markets lowering mistrust and rebuildingrelationships 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 Vinci30

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 noor lower risk‣ Over/Under-regulation has decoupled the joint mandate of regulation and marketdevelopment‣ 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 theeconomy‣ Can Trading and Insider Trading be separated?Overall Effect = Lowest Ever Volumes31

Need for Re-defining Business ModelComparison of Products ( South Asia vs UK)Trading2%South AsiaOthers3%Others11%Information Sales3%UKTreasury25%EquitiesBroking8%EquitiesBroking95%FixedIncome33%InterestRateDerivative20%32

Pathway to Glory – Phases Towards ListingYear KSE No. of IPOsAmount Raised(USD mn)2007 14,076 10 852008 6,037 9 662009 9,387 3 172010 12,022 6 622011 11,762 4 35Realization andefforts by allstakeholders to givedepth to the market32 USD 265mnIt is vital for local companies to get listed in the equitymarkets of our country not only for the enhancementand growth of the markets but also to gain access to amore convenient & robust form of capital raising33

KSE – Value & VolumeKSE-100 Index + Volume600.0018,00016,000500.0014,000400.0012,00010,000300.008,000200.006,0004,000100.002,000--Mar-07Jun-07Sep-07Dec-07Apr-08Jul-08Oct-08Jan-09Apr-09Jul-09Oct-09Feb-10May-10Aug-10Nov-10Feb-11May-11Aug-11Dec-11Volume (mn LHS)KSE-100 Index (RHS)34

If Volumes Don’t Improve…35

Corporate Profitability – Is it intact?ACCOUNTING PROFITSREAL PROFITSNumerous profit generating corporateentities in Pakistan are facing liquiditydry-outs recently, mainly due to theenergy crisis and mounting circular debtGrowth in Earnings is essential but Dividendsmust increase in the same proportion as well36

Can Capital Markets Perform Independent of the Economy?13,00012,50012,00011,50011,00010,500MENA crisisescalatesPunjabGovernoras sassinatR aym ondD avisissueaffectsPM L -NPak-US parts wa ystiesw ith P PPin Pu njabUS says Pakistan notdoing enough to U S forces killcombat militancy Osama BinLaden inMTSAbbottabadlaunchedA dd itio nalr ev enu em eas u resa nn oun ce da ft er I M Ft alk sS ec urit iesLe nd ingan dB orro w ingP rodu c tlau nc he dFY 12 B udg etann oun ce dM ood y ’sgiv esas su ran ceonPak is ta n’sso v ereig ndeb tMQM partsways fromcoalitionSelloff inlinewith globalequitiesD Rr edu ce db y 5 0bp sD e teriora tingla w & o rde rin K hiGlo balrec es s ionco nc ern s +U S pre ss u reon Pa k ist anU S a nno unc e sO per atio n Tw is ton g lob alre ce s sio n fe arsC PI t um b lesdue t oreba s ingF SV b ene fiten han ce dD R c ut by150 bp s to12%Pak -I M FArt ic le IVta lksC irc ular de btex po su reco nv ert ed t oGo P s e cu ritie sN AT Oa tt ac k s an dm e m os c an dleF B R t o ex am ines o urc e ofin v es tm e nt inc a pita l m kt sJan-11 Feb-11 Apr-11 M ay-11 Jun-11 Aug-11 Sep-11 Nov-1137

Challenging Political EnvironmentFriendly OppositionPolitical parties lackfinancial and economicexpertisePTI talks about revolution;Reality or Over-confidence?I feel that the failure of Common-Wealth Games and success of ChinaOlympics shows that Democracy may not be the solution to all the ills!38

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 withplain-vanilla trading services dealing primarily in theReady Market which led to overdependence on marketvolumes and vulnerability in the earnings stream.39

The Way Forward???40

The Way Forward!!!‣ It has been a tough period for all financial markets since the economic meltdownbegan 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 awareness41

Brokerage House (Member of LSE) – Yearly Profit & Loss A/cNEWOLDNo. of Employees 4 to 5 10 to 13PKRPKRBrokerage revenue 1,320,000 4,000,000Operating Expenses:Payroll 1,800,000 4,500,000Depreciation 49,500 148,500Electricity 48,000 150,000Rent 120,000 240,000Other Expenses 240,000 480,000Audit & Certification Fee 50,000 150,0002,307,500 5,668,500Net Loss Per Annum* (987,500) (1,668,500)*Excluding certain possible expenses42

Thank You!!!43