Did you know Pakistan was one of the 5 markets that saw a healthy CAGR in the average profit of its large companies for the 5-years till 2016, from amongst a sample of 27 prominent emerging/frontier markets? Did you know Pakistan was one of the 6 from these 27 that saw more than 50% of its large companies deliver a positive CAGR in profits over this 5-year period? Or did you know it ranked amongst the highest in terms of the number of companies that delivered a 10%+ Return on Equity (ROE) in each of the 5 years from 2012 to 2016? Last, did you know it was one of the 5 that saw the highest ROE in 2016? Large companies here refer to the Top-200 listed companies by 2016 Bloomberg market cap. They have better access to resources, so are better proxies for market performers. All these data show the improvement, buoyancy, breadth and consistency in market performance. But despite this, only a dozen portfolio funds had over 90% allocation of their corpus to Pakistan as of early-2017, while Indonesia and South Africa had 50 each and Thailand and Turkey had close to 200 each.
But this also highlights some challenges that may be constraining the scale of investor interest it deserves. Pakistan saw decent economic growth in recent years (GDP grew at 5% CAGR from 2012-2016, as per IMF), and IMF expects a similar CAGR for the next few years till 2021. If Pakistan wants this economic story to evince the scale of sustained investor interest a high-potential like it deserves, it has to reverse these three challenges.
Are profits too concentrated?
The contribution of the largest 3 sectors to the profit-pool of its Top-200 companies was as high as 76% in 2016. These were finance, energy and materials. Most Asian peers were less concentrated; it was sub-70% in Indonesia and Bangladesh and sub-60% in Thailand and India. Developed markets had a concentration between 60-70%, if that serves as a benchmark. A high concentration indicates the impact on the profit-pie due to increased focus on a few sectors of competitive advantage. Its share of materials and finance shot up from 2012 to 2016. Material is made up mostly of cement companies, and this is Pakistan’s success-story. Cement makers (Lucky, DGKhan, Bestway, Fauji, Maple Leaf, Kohat, Pioneer) and banks (Habib, UBL), apart from Engro, saw the maximum growth in profits in this period. While few consumer and utility firms saw healthy profit growth too, the weight of their sectors remains less.
So there is a need to grow the profits of the other sectors so that any risk to the cement firms does not derail overall market performance. More-rounded profit growth would also push the case for more Pakistan-dedicated funds. The case for cement remains compelling. Pakistan’s gross investment rate averaged only 15% with an 8% CAGR for the 5-years till 2016. This augurs well for domestic demand if its investment has to match peers. Also, the drop in the PKR makes their exports competitive. Boosting the services sector may also be worth exploring. This was only ~56% of its GDP, lower than the average ~60% in the large emerging economies. It already spends a high portion of its GDP on private consumption, far higher than the sample-average. An average Pakistani spent ~$4100 out of a per-capita of ~$5000. Pushing the consumption habit further may prove detrimental for savings in the long-term.
Is it investing in size?
Pakistan was one of the smaller markets in our sample of 27, if one looks at the average profit-per-company of its Top-200 companies. The average Chinese company was 54X larger, India 9X, Thailand 4X and Indonesia 3X. Pakistan’s average profit was similar to Morocco, Kuwait and Kenya though it had a larger GDP. So are its companies investing to scale up? While their combined equity rose 8% CAGR from 2012-2016, the leverage dipped marginally implying proportionately less debt infusion. This growth in equity equalled the growth in profits, implying no fresh equity infusion. Its topline growth was flat in this 5-year period while profit growth was 9%, indicating cost-control.
Ideally an investing company in a market in the initial stage of its growth-journey should see capital addition eroding near-term profitability. The long-term gains from capacity would justify the short-term pain of capex. But even if companies need more capital, where would it come from? Pakistanis spends more and save less on an average. Hence, it has a low savings rate of 14% and a resultant over-dependence of external borrowing to fund investment. It needs to deepen its financial savings industry so that they mobilize more savings and channelize it to meet the growth capital. Last, size also implies the gap between the real and listed economy. Pakistan’s ratio of large companies’ revenue to GDP is relatively low, and tit needs to list the good performers across sectors that are currently unlisted.
Do conglomerates deliver in the long-run?
Typically, as a company starts making disproportionately higher profits than what it can reinvest in its business, it starts expanding into other sectors, often inorganically. While we have spoken of size, most of the companies who made recent news due to expansion plans are conglomerates. One is even called Mega Conglomerate. But do such monoliths contribute to profit-share in the long-term? Or do the new sectors only bleed as it is not their area of core competence? In India, the highest profit-growth companies from 2012 to 2016 either focused on a single business or expanded only within their sector.
Given many sunrise sectors in Pakistan are still under-penetrated in the organized economy, its cash-rich firms might focus on reinvesting in their business/sector to go deeper and not wider. They should also enhance their productivity in those businesses, since Pakistan’s asset turnover ratio was low in this sample of 27. That itself would unlock more value in its ROE.
On the back of Pakistan’s recent market performance, reversing these three aspects would help evince the scale of investor interest a high-potential market like Pakistan deserves!