Research Federal Budget 2013 www.akdsecurities.

net
Fiscal Policy at a Cross Road!
Priced on June 01, 2012 KSE-100 Index 13,876.97 FYTD Chg. 11.1% KSE Market Cap PkR3,552bn (US$37,787mn) FYTD KSE-100 High/Low 14,617.97 / 10,842.26 FYTD Avg. Daily Traded Value PkR4,054.91mn (US$45.323mn) KSE-30 Index / KMI-30 Index 12,056.44 / 24,202.81 FYTD Chg. 4.1% / 15.6% As % of Total Cap. 18% / 13% AKD Universe 75% of KSE-100 Market Cap.

June 2012

A landmark 5th Federal Budget by the incumbent Government is thematically designed for election year politics focusing on providing broader relief while leaving structural issues unanswered. This could potentially pose risk 6-12 months down where mitigation includes Pakistan's return to the fold of the IMF and sharp pull back in international hard and soft commodity prices. While budgeted measures include further streamlining within the current collection ambit, additional steps need to be taken in terms of revenue enhancing measures. For projections to be realistic, power sector reforms remain critical and require refocusing on rationalizing power sector tariffs and leakages from public sector enterprises at a brisk clip representing the core of fiscal imbalances. From the market's vantage, inclusion of Capital Gain Tax reforms in the Finance Bill 2012 and broader sector wide neutral to benign impacts should provide for post budget upside. We retain our Dec'12 end Index target of 16,000 but sustainable gains would require balancing of inflationary pressures (continued . recourse to SBP financing) and risk mitigation on Pakistan's external account. Economy Outlook: While the fiscal deficit in FY12 remained high at 7.4% of GDP (inclusive of 1.9% of GDP debt consolidation) and real GDP growth logged in at 3.7%YoY vs. the target of 4.2%YoY, positives included below target inflation of 11%, tax revenue collection (up 22%YoY) and buoyance in remittances. In our view Pakistan has and still needs structural and fiscal reforms that address external and chronic fiscal imbalances. With election year politics striking, a balance between growth objectives and fiscal consolidation appears challenging. We expect fiscal deficit to exceed 6% of GDP in FY13 vs. FY13B estimate of 4.7% of GDP with risks of continuing monetization of subsidies and uncertain outlook for external financing. On the revenue side the GoP's main focus for tax revenue enhancement is through improved tax administration and compliance while current expenditures remain entrenched. Market Implications: Inclusion of CGT reforms introduced via Presidential Ordinance and included in the Finance Bill 2012 will likely provide for renewed upside ahead of vetting by the Parliament. Sector impacts are largely neutral to benign in our view. Market implications include imposition of 0.01% CVT on purchase value of shares introduced through the Finance (Amendment) Ordinance 2012 and entrusting NCCPL to collect advance tax from members in respect of margin financing. Imposition of CGT on immovable property and increase in tax rate for banks investments in money market and income funds can potentially provide for increasing stock market investments. Sector Impacts: Budget contains positives for cements in the shape of lower FED and incentivizes the use of alternative lower cost energy while for autos reduction in custom duties is a positive. Upstream exploration receives the benefit of one-time tax charge @40% against inconsistency between PCA's and Statute. For Banks, a minor negative in terms of higher taxation on dividends from income and money market funds but considering expectations of harsher treatment, we believe the sector could post a relief rally. Insurance receives benefit of revision in CGT rates while life insurance premiums for tax credit have been enhanced. Chemicals face negative implications on enhancement of Gas Infrastructure Development Cess ahead of temporary weakening in pricing . power.

AKD Universe Valuation Summary

2011A PER (x) P/BVS (x) DY (%) ROE (%) ROA (%) 7.8 1.7 6.7 22.1 4.0 2012F 2013F 6.9 1.5 7.6 21.7 4.1 6.1 1.3 9.3 22.2 4.3

KSE-100 Index vs. Volume

(mn) 700 600 500 400 300 200 100 (Index) 15,000 14,500 14,000 13,500 13,000 12,500 12,000 11,500 11,000

0 10,500 Jun-11 Aug-11 Dec-11 Mar-12 May-12 Volume (LHS) KSE-100 Index

Important disclosures, including investment banking relationships and analyst certification at end of this report. AKD Securities does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of the report. Investors should consider this report as only a single factor in making their investment decision. AKD Securities Limited
Member Karachi Stock Exchange
Find AKD research on Bloomberg (AKDS<GO>), firstcall.com and Reuters Knowledge UAN: 111-253-111
Copyright2012 AKD Securities Limited. All rights reserved. The information provided on this document is not intended for distribution to, or use by, any person or entity in any jurisdiction or country where such distribution or use would be contrary to law or regulation or which would subject AKD Securities or its affiliates to any registration requirement within such jurisdiction or country. Neither the information, nor any opinion contained in this document constitutes a solicitation or offer by AKD Securities or its affiliates to buy or sell any securities or provide any investment advice or service. AKD Securities does not warrant the accuracy of the information provided herein.

June 2012

AKD Securities Limited

Budget Review 2012-13

Contents
The KSE outperforms in lower Global Risk Tolerance! ........................................................................04 Self-centered Pakistan .........................................................................................................................06 Corporate Earnings are topping estimates...........................................................................................06 Budgetary Implications .........................................................................................................................07 Budget Implications on Sectors ......................................................................................................08-09

Economy Election Year Budget............................................................................................................................10 RISKS...................................................................................................................................................10 Budget Snapshot ..................................................................................................................................11 EXPENDITURE....................................................................................................................................12 REVENUE: FBR trying to achieve double digit Tax to GDP.................................................................13 Non Tax Revenue Measures ................................................................................................................14 Deficit & Financing: Elusive fiscal deficit target of 4.7% of GDP.........................................................14 Total external financing ........................................................................................................................16 Medium Term budgetary Targets..........................................................................................................16

Sector Implications Cements ...............................................................................................................................................17 Banks ...................................................................................................................................................17 Oil & Gas ..............................................................................................................................................18 Autos ....................................................................................................................................................18 Insurance..............................................................................................................................................19 Fixed Line Telecom ..............................................................................................................................19 Fertilizer................................................................................................................................................20 Textiles .................................................................................................................................................20 Chemicals.............................................................................................................................................20 Annexure - Salient features of the FY13 Budget ............................................................................21-22

AKD Research Team

Analyst Naveed Vakil Raza Jafri, CFA Usman Zahid Ayub Ansari Anum Dhedhi M. Naeem Javid Qasim Anwar Hassan Quadri Azher Ali Quli Nasir Khan Tariq Mehmood Tel no. +92 111 253 111 (692) +92 111 253 111 (637) +92 111 253 111 (693) +92 111 253 111 (693) +92 111 253 111 (637) +92 111 253 111 (693) +92 111 253 111 (680) +92 111 253 111 (639) +92 111 253 111 (639) +92 111 253 111 (639) +92 111 253 111 (643) E-mail naveed.vakil@akdsecurities.net raza.jafri@akdsecurities.net usman.zahid@akdsecurities.net ayub.ansari@akdsecurities.net anum.dhedhi@akdsecurities.net naeem.javid@akdsecurities.net qasim.anwar@akdsecurities.net hassan.quadri@akdsecurities.net azher.quli@akdsecurities.net nasir.khan@akdsecurities.net tariq.mehmood@akdsecurities.net Coverage E&P, Oil Marketing Pakistan Economy & Commercial Banks Cement & Power Fertilizer, Chemical & Telecom Pakistan Economy & Commercial Banks Textiles, Fertilizer Technical Analysis Research Production Research Production Research Production Library Operations

02

AKD Securities Limited

June 2012

Budget Review 2012-13

15,000 14,500 14,000 13,500 13,000 12,500 12,000 11,500 11,000 10,500
Additional revenue measures PML-N parts announced after IMF ways with PPP in Punjab talks Raymond Davis issue affects PakUS ties Securities Lending and Borrowing Product launched

KSE-100 Index - Timeline

President Zardari signs the Stock Exchange Demutualization Act, 2012 Presidential Ordinance on CGT released

US says Pakistan MQM parts not doing ways from enough to coalition MENA combat crisis militancy escalates US forces kill Osama Bin Laden in Abbottabad MTS launched Punjab Governor assassinated

Global recession concerns + US pressure on Pakistan Selloff inline with global equities

Pak-IMF Article IV talks

FBR to examine source of investment in capital mkts

S&P maintains Pakistan's credit rating at B- with stable outlook.

US announces Operation Twist on global recession fears FSV benefit enhanced

Gop agrees to SECP demands for relaxation in CGT Regime NATO attacks and memo scandle US freezes US$700mn aid to Pakistan

The US Congress proposes stopping preferential trade with Pakistan and reducing aid to just 10% of available funds

SECP Chairman announces the delay in implementation of new CGT regime due to legal formalities.

FY12 Budget announced Moodys gives assurance on Pakistans sovereign debt DR reduced by 50bps

CPI Deteriora tumbles ting law & due to order in rebasing Khi

DR cut by 150bps to 12%

US freezes CSF Consensus made on which rule should be amended to dilute the impact of CGT on share transaction

Pakistan makes US$417mn repayment to IMF. Newsflow indicates the Privatization Commission will shortly table the secondary offering details for PPL.

Circular debt exposure converted to GoP securities

10,000 Jan-11

Mar-11

May-11

Aug-11

Oct-11

Dec-11

Mar-12

May-12
03

AKD Securities Limited

June 2012

Budget Review 2012-13

The KSE outperforms in lower Global Risk Tolerance!

In our report titled "U.S. Monetary Policy and Implications at Home" (dated 28th January, 2012), we highlighted improving levels of global risk tolerance underpinning the best 1Q rally in global equities since 1998 where the KSE-100's 21% return was the highest since 1QCY06. Post 1QCY12, increasing risk aversion (see graph below), with sentiment undermined by the European debt crisis and slowing Asian growth, has led CYTD MSCI World and MSCI EM returns negative. The KSE-100 has declined by 5% from its CYTD peak but remains up 22%CYTD buttressed by 1) above-line corporate earnings, 2) return of individual and market maker classes post CGT reforms with liquidity re-rating valuations and 3) continuing FII flows - the first set of inflows even as U.S. Treasury yields are at record lows. Our proxy for risk tolerance since 2009 (from where asset class discrimination has had little meaning) shows Pakistan outperforming regional equities in times of broader risk-off investment. In periods of sharp contraction between U.S. Treasury yields and the Federal Funds Rate, Pakistan has on average outperformed the MSCI EM and MSCI World by 7%, underscoring Pakistan's weak correlation in broader sell-offs as well as undemanding valuations.

Pakistan outperforms in times of broader risk-off investment

Proxy for Risk Tolerance

60.0 50.0
U.S. 10yr Treasury Yield - Federal Funds Rate vs. VIX

Relative Performance
4.25 3.75 3.25 180% 160% 140% 120% 100% 80% 60% 40% 20% 0% -20% -40% Dec-09 Mar-10 Jul-10 May-12 Jan-09 Aug-09 Nov-10 Feb-11 Jan-12 Apr-09 Jun-11 Oct-11 MXEF Index MXWO Index KSE100 Index

Total Assets of U.S. Federal Reserve

USDbn 3,500 3,000 2,500

40.0 30.0 20.0 10.0 VIX Index (LHS) US 10 Yr. Treasury (minus) Fed Rate Sep-09 May-09 May-10 Sep-10 May-12

2.75 2.25 1.75 1.25 0.75 0.25 May-11 Sep-11 Jan-09 Jan-10 Jan-12 Jan-11

2,000 1,500 1,000 500 Dec-09 Mar-08 Jul-10 May-09 Aug-07 Sep-11 Feb-11 Oct-08 Apr-12

Source: Bloomberg & AKD Research

Source: Federal Reserve

Maturity Extension - Operation Twist

USDbn 100 50 (50) (100) (150) (200) (250) (300) (350) Up to 3 Over 6 Over 8 Over 10 Over 20 years years to years to years to years to 8 years 10 years 20 years 30 years

Source: Federal Reserve

During periods of low risk tolerance, VIX (a measure of implied volatility - fear gauge) increases while the spread between benchmark 10yr U.S. Treasury and Federal Funds rate contracts. Two rounds of asset purchases by the U.S. Federal Reserve led to declining levels in VIX and increasing U.S. Treasury yields which underscored a broader rally in risk assets. During 1QCY12, decline in risk aversion was underpinned by the U.S. Economy moving past trough with manufacturing at the heart of the recovery while housing showed signs of stabilizing within the backdrop of the U.S. Federal Reserve extending the maturity profile of its securities portfolio (see chart on the right for US$400bn in maturity extensions) in efforts to lower longer term interest rates. European Governments negotiated a second bailout for Greece while Asian economies moved to unconventional monetary stimulus with balance sheet expansion by the BoJ (Bank of Japan) while the PBOC (Peoples Bank of China) moved to ease lender reserve requirements. However, recent shift in the European political landscape with risks to scale-back in austerity measures and fallout contagion have lowered global risk tolerance - 10yr U.S. Treasury yields have declined to record lows with the Feds maturity extension program coined "Operation Twist" scheduled to expire in Jun'12. Pakistan Market's returns since 2009, in periods of risk-off investment on average
04

AKD Securities Limited

June 2012

Budget Review 2012-13

show 7% outperformance vs. the MSCI EM and MSCI World Indices. In our view, this vindicates Pakistan's low correlation in broader global sell-offs. Markets will likely look to the FOMC meeting scheduled for later this month for cues on the Federal Reserve's response where balance sheet expansion will likely be weighed for political support ahead of U.S. Presidential Elections as well as anchoring inflationary expectations while maturity extension programs will likely be limited with capacity at the shorter end of the yield curve.

KSE Correlation
100% 80% 60% 40% 20% 0% -20% -40% 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 MXEF Index Linear (MXEF Index)

MSCI Correlation with TRJ-CRB/S&P GSCI

MXWO Index Linear (MXWO Index) 1.00 0.80 0.60 0.40 0.20 (0.20) (0.40) 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012
HOLLAND FINLAND S&P 500 DOW JONES IND. AVG. MSCI ASIA PACIFIC MSCI ASIA GREECE

(0.60)

2011 2012

-60%

MSCIEM-SPGS MSCIWO-SPGS

MSCIEM-TRJ MSCIWO-TRJ

Source: Bloomberg & AKD Research

Pakistan's historically volatile yet relatively low correlation underscores corporate earnings drivers in confluence with domestic demand as well as oft volatile political landscape and external account stress

Taking monthly returns since 1991 over an annual time series, Pakistan's correlation to MSCI EM and MSCI World has gradually increased off a low base but at 0.4 (linear trend) it remains weak enough, in our view, to retain outperformance potential even within the backdrop of a global sell-off in risk assets. Pakistan has posted volatile correlation over our time series, in contrast to a sustained correlation between MSCI World and MSCI EM at 0.78 on monthly returns since 1991. Pakistan's historically volatile yet relatively low correlation underscores corporate earnings drivers in confluence with domestic demand as well as oft volatile political landscape and external account stress. Despite these negatives, Pakistan has posted the 7th best US$ adjusted return over the last decade!

10Yrs US Dollar adjusted return CAGR

30% 25% 20% 15% 10% 5% 0% PHILIPPINES POLAND Pakistan LUXEMBOURG AUSTRIA S.KOREA HONG KONG MEXICO MALAYSIA INDONESIA CANADA AUSTRALIA NORWAY INDIA CHINA THAILAND MSCI EM BRAZIL DENMARK -5% -10% -15% JAPAN - TOKYO JAPAN - NIKKEI 225 FRANCE UNITED KINGDOM SPAIN NEW ZEALAND TAIWAN BELGIUM IRELAND SWEDEN NASDAQ MSCI WORLD SWITZERLAND HUNGARY GERMANY MSCI EUROPE

Source: Bloomberg & AKD Research

While we have highlighted Pakistan's low correlation, we remain cognizant of Pakistan's exposure to global commodity prices where 55% of KSE-100 market capitalization is commodity based. Taking monthly returns over an annual time series between MSCI World
05

AKD Securities Limited

June 2012

Budget Review 2012-13

We flag Commercial Banks as potential outperformers over FY13

and MSCI EM, correlations to commodity indices (S&P GSCI and TRJ-CRB) show returns in increasing lockstep with correlation on average logging in at 0.8 since 2009, undermining traditional asset class discrimination in our view. Downside risks to commodity prices will likely have implications for the commodity-based market cap at the KSE. A sharp pull back in commodities poses downside risks for Oils, Fertilizers and Textiles - cotton is already at multi-year lows (barring composites). Within this backdrop, while we retain selective conviction within the commodity-backed market cap, we flag Commercial Banks as potential outperformers over FY13 (see our section on commercial banks). Self-centered Pakistan: Recent Capital Gain Tax Reforms announced via Presidential Order and now included in the Finance Bill 2012 will likely serve to extend the Pakistan market disconnect. Tracing back to the Finance Minister's announcement of the same in Jan12, daily market volumes have risen to an average of 245mn shares while traded value has improved to US$66mn - levels last seen in CY09. FII participation has held up with an inflow of US$90.7mn within the same time frame (since Jan 2112) while individual and market maker asset classes have returned (inflow of US$53.6mn) improving liquidity, and consequently the KSE has seen a re-rating of valuations and a compression in the discount to regional peer group.

KSE PE Discount to Region

80% 60% 40% 20% 0% -20% -40% Sep-08 Aug-07 Sep-09 Feb-08 Mar-09 Jan-06 Jan-07 May-11 Nov-11 Jun-12 Jul-06 Apr-10 Oct-10

KSE - Volume and Value Traded

400.0 350.0 300.0 250.0 300 200.0 150.0 100.0 CY05 CY06 CY07 CY08 CY09 CY10 CY11 CY12TD 50.0 200 100 Avg. Traded Value (US$mn) Avg. Daily Volume (mn, LHS) 600 500 400

Source: Bloomberg & AKD Research

Discount/Premium to Floor Valuations

150% 100% 50% 0% -50% -30% -100% -150% -21% -57% -94% Autos Banks Electricity Oil and Gas FMCGs Cement Fertilizer Telecom Engineering Multiutilities Chemicals Textiles 53% 15% 2% 8% -18% -51% 134% 101%

Source: AKD Research

Corporate Earnings are topping estimates: With the recent Capital Gain Tax Reform shoring up market liquidity, price discovery has tracked a stellar trend in corporate earnings, which are consistently topping consensus estimates. Over the last 4 sequential quarters, earnings have topped ours as well as consensus estimates by 1%-6%. Following a 7% bottomline expansion in 2QFY12, earnings growth for 3QFY12 clocked in flat (dragged lower by Fertilizer Sector earnings) but beat ours as well as consensus expectations by 5%. Oil and Gas and autos topped forecast by 33% and 10%, respectively, while banks remained in-line with a marginal 3% deviation. Going forward for 4QFY12, we expect coverage cluster earnings to decline by 4% led by oil and gas (lower oil prices) and commercial banks (impact of revision in floor rate of savings deposits) whereas cements and fertilizers will likely outperform on improving fundamentals and a lower base effect. That said, over the next 12 months, we retain conviction with commercial banks and flag the sector an outperformer where the sector trades at below floor level valuations despite marked improvement in asset quality metrics, expected uptick in lending yields and continuing focus on risk free investments.
06

AKD Securities Limited

June 2012

Budget Review 2012-13

QoQ Profitability Growth

50% 40%

QoQ Sectoral Profitability 2QCY12

120% 100% 80% 60% 12% 40% 0% 9% 20% 0% 67% -6% -2% -10% Chemicals -15% Oil & Gas Banks Telecom FMCG* -11% Cements Fertilizers Power Autos Textile Aug-08 Nov-03 Mar-10 Jun-05 Jan-07 Apr-02 Oct-11 Source: AKD Research 16,000 14,000 12,000 10,000 8,000 6,000 4,000 2,000 Source: AKD Research Total -4% 112%

Over the last 4 sequential quarters, earnings have topped ours as well as consensus estimates by 1%-6%

30% 20% 10% 0% -10% -20% -30% 1QCY10 YoY Growth 2QCY10 3QCY10 4QCY10 1QCY11 Deviation from AKD Est. QoQ Growth 1QCY12 2QCY11 3QCY11 4QCY11

-20% -40%

Sustainable gains will require balancing of inflationary pressures and risk mitigation on Pakistan's external account (increase in NFA)

Budgetary Implications: Recent budgetary measures in line with election year politics should provide the market reason to rejoice where sector related developments have panned out Neutral to benign in our view, contrary to negative expectations. Expansionary/populist nature of the Federal Budget 2012-13 and resultant growth in reserve money led by NDA expansion should provide for market upside to our end-Dec'12 Index target of 16,000 but sustainable gains will require balancing of inflationary pressures and risk mitigation on Pakistan's external account (increase in NFA) which includes an inevitable return to an IMF program. Budgetary measures include a repeat of prior year targeted foreign flows and remain ambitious where our Economist Anum Dhedhi estimates a 28%YoY rise in NDA in the event of non-materialization of foreign inflows which could provide upside risks to inflation.

KSE Tracks Reserve Money

8,121 7,121 6,121 5,121 4,121 3,121 2,121 1,121 May-94 Sep-00 Dec-95 121 Oct-92 Feb-99 Jul-97 Reserve Money (PKRbn) Money Supply (PkRbn) KSE-100 Index (RHS)

07

AKD Securities Limited

June 2012

Budget Review 2012-13

Budget Implications on Sectors

Sector
Budget Stance

Budget Implications
CGT reforms introduced through Presidential Ordinance has been made part of Finance Bill 2012. CVT imposed at 0.01% of purchases value is a slight negative in overall positives. NCCPL to collect 10%WHT on margin financing

AKD Research Comment

Overall impact should be positive for the market as sector wide impacts are neutral to benign in our view. Inclusion of CGT reforms should provide comfort before ratification from Parliament. CGT on immovable property and higher tax rate for banks investments can provide for funds flow to equities

Market

Positive

Positive

The overall theme for cements in Budget FY13 remains positive with i) a PkR100 per ton cut in FED, ii) reduction of duty on rubber scrap / shredded tyres to 10% (previous: 20%) and iii) increased PSDP allocation at PkR873bn. A move to normal tax regime (NTR) from current final tax regime (FTR) for exports is also provided for, should companies decide to avail it. Custom Duty on imported CKD kits is reduced to 30% from 35%. Advance tax on 1300cc to 1600cc cars is increased to PkR25,000 from previously PkR16,875, no change for below 1300cc cars. The prevailing fear of reducing duties on CBUs is no longer present which is positve for the local auto sector Exploration and Production companies have been given a one-time option to pay tax @40% against profits and gas net of royalty for tax year 2012 onwards subject to withdrawal of pending appeals etc and outstanding tax liability up to tax year 2012. Royalty targets remain flat relative to revised estimates at PkR58bn while dividends from oil and gas are expected to increase by 10% with notable change from PPL

Positives aplenty for the Construction & Materials sector, however, FED reduction has been a tad bit on the lower side than initial market expectations. The move to NTR from FTR is unlikely given that exporters will likely lose out through incurring higher taxes should they avail it

Cements

Neutral to Positive

Budget impact on the Auto sector is Neutral to Positive as there is no reduction on the duties of CBUs. The advance tax change will not impact the local auto industry where custom duty reduction will likely pressurize to decrease the prices of locally assembled cars

Autos

Positive

We view budget implications as positive for oil and gas companies. One-off change in tax regime to clear pending disputes in relation to inconsistency between Mining Act 1948 and respective PCAs @40% tax bodes well for pending litigation and outstanding tax liabilities. Increase in expected dividends from PPL is a positive while flat royalty collection targets indicate production additions to offset declining assets

Oil & Gas

FMCGs

Positive

100% tax credit for fully equity financed dairy farming projects. Sharp reduction in GST on tea from 16% to 5%

GoP trying to incentivize the high potential dairy segment and this may lead towards new corporate players in the field. Lower GST on tea to help combat smuggling

Neutral to Negative

Budget remains mixed for textiles. Option to opt out from FTR may provide relief to some textile manufacturers. Modest increase of PkR50mn in EDF is unlikely to support textile exports to a material extent. Increase in GIDC will hamper the profitability of those textile manufacturers who have natural gas fired captive power facility

Textiles

While FY13 budget is neutral to negative for textiles, intl cotton prices and fundamentals of the companies will drive price performance

08

AKD Securities Limited

June 2012

Budget Review 2012-13

Budget Implications on Sectors

Sector
Budget Stance

Budget Implications

AKD Research Comment

Subsidies are budgeted to decline indicating a probable increase in consumer tariffs. That said, with governments focus on the upcoming elections, we remain skeptic with regards to tariff increases and expect subsidy targets to be revised upwards. No steps have been announced for controlling circular debt which had already earlier caused 9 IPPs to temporarily halt operations and threaten invoking sovereign guarantees More affected banks, in our view, are ABL, MEBL and HMB. From a macro perspective, this may lead to shift towards alternative investment avenues including the stock market. We believe Banks are in for a sustained bull run across 2HCY12

Electricity

Neutral

Budget is largely a non-event for the Electricity (Power) sector. No concrete measure has been announced for resolving circular debt but power sector subsidies are envisaged to be slashed by about 60%, indicating a continuing resolve to rationalize tariffs

Banks

Neutral to Negative

Dividend income arising from money market/income funds to be taxed at 25% in FY13 and at 35% in FY14, up from 10% at present. Much feared increase in corporate tax rate/tax on T-bills did not materialize For tax credit purposes, limit of investment in securities and insurance as proportion of taxable income increased from 15% to 20% and from PkR500k to PkR1mn, whichever is lower. Required retention period of shares is also being reduced to 2yrs from 3yrs. At the same time, FED on livestock insurance has been eliminated which should prove to be uplifting at the margin GoP has announced a 20% hike in salaries for government employees which will lead to escalation in costs for PTC. GST on telecom services has been maintained at 19.5%. 3G auction target has been slightly upward revised to PkR79bn, while the GoP has maintained its FY12 dividend target of PkR6.5bn for PTC

Neutral to Slightly Positive

Insurance

We see FY13 Budgetary proposals as Neutral to slightly Positive for the Insurance sector. Potential increase in funds flow to the equity market should bode well for listed Insurance companies given their hefty reliance on investment income We view budgetary measures for FY13 as Neutral to Negative for the Telecom sector with the significant hike in government employee salaries being the biggest negative for PTC. However, given the GoP fiscal constraints, PTC is likely to announce its first interim dividend for FY12 this month, which based on GoP estimates of PkR6.5bn translate into a expected DPS announcement of PkR2.05 With pricing power curtailed due to excess urea supply, urea manufacturers are unlikely to fully pass on the impact of GIDC. Furthermore, given the total urea subsidy of PkR26bn and current landed cost of US$525/ton, GoP can import a further 1.2mn tons in FY13 and keep the market well supplied.

Telecom

Neutral

Negative

GIDC on fertilizers has been further increased with feed stock and fuel stock prices raised by PkR103/mmbtu and PkR87/mmbtu, respectively. Urea subsidy target has been revised down to PkR26bn from last year's level of PkR45bn

Chemicals

Fertilizer

Negative

Status quo as far as import duty on PTA is concerned. Higher gas prices (GIDC on fuel stock) to pare margins

The budget FY13 was largely a non-event for the chemical sector as there was no change in PTA import duty. Higher fuel charges to hit EPCL and LOTPTA's margins

09

AKD Securities Limited

June 2012

Budget Review 2012-13

Election Year Budget

Budget Estimates
Real GDP Growth (%) Agri Growth (%) Manufacturing Growth (%) Services Growth (%) Average CPI Inflation (%) Total Tax Revenue as (%) of GDP Total Expenditure as (%) of GDP Current Expenditure as (%) of GDP Development Expenditure as (%) of GDP Fiscal Balance as (%) of GDP Revenue Balance as (%) of GDP Total Public Debt as (%) of GDP Total Investment as (%) of GDP National Savings as (%) of GDP Total Exports (US$bn) Total Imports (US$bn) CA Balance (US$bn) Remittances (US$bn) Major Export Targets Food Group (US$bn) Textiles (US$bn) Manufacturings (US$bn) Major Import Targets Food Group (US$bn) Petroleum (US$bn) Fertilizer Agriculture & Chemical Machinery 4.30 4.10 4.00 4.60 9.50 11.10 19.00 14.50 4.40 -4.70 -0.30 56.50 13.1 11.2 25.26 45.69 4.77 14.09

Fiscal rules operate at the crossroads of politics and economics. Slippages in implementing IMF prescribed fiscal reforms, particularly implementation of RGST, elimination of electricity subsidies and resolution of circular debt, in our view inter alia are the key reasons for a sustained high deficit. While the government in FY12 managed to achieve below targeted inflation of 11% and on track tax revenue collection, up 22%YoY in FY12, fiscal deficit remained at 7.8% of GDP (inclusive of 1.9% of GDP debt consolidation). A confluence of unfavorable factors included a global environment with non-materialization of expected foreign flows (3G license/Etisalat payment/CSF and lower logistical support receipts from the US). Going forward, total budgetary outlay has been set at PkR3.2trn for FY13 (up 15.8%YoY) with current expenditure at a rigid 82% of total outlay. Gross revenue target is set at PkR2.5trn, up 24%YoY, resulting in a budgetary gap of PkR1.2trn (4.7% of GDP - inclusive of provincial surplus of PkR80bn). Heading upto election year, budget expenditure risks overshooting with fiscal deficit likely to exceed 6% of GDP. Budgetary measures include broader relief while heightened tax collection targets will likely fall on the shoulders of improved administrative and collection measures.
Key Points 1.) Fiscal deficit 2.) PSDP outlay 3.) Tax collection Target 4.7% of GDP or PkR1.2tr inclusive of provincial surplus Target of PkR873bn with federal component at PkR360bn Tax collection target up 24%YoY to PkR2.5tr. Comment Fiscal deficit target is conservative given the continuing subsidy burden We expect utilization inline till general elections Target dependent upon continued streamlining of administration and collections Source: AKD Research

5.2 13.2 5.2

3.6 15.3 3.6 4.3

Fiscal Deficit and GDP Growth(%)

10 9 8 7 6 5 4 3 2 1 0 FY93 FY95 FY97 FY99 FY01 FY03 FY05 FY07 FY09 FY13 FY11 30 25 20 15 10 5 0

Revenue and Expenditure

Source: Annual Plan & Budget Brief

Fiscal Deficit

FY92

FY94

FY96

FY98

FY00

FY02

FY04

FY06

FY08

FY10

Fiscal deficit as a % of GDP

Real GDP grwoth

Total Expenditure

Total Revenue

Source: MoF & AKD Research

RISKS: As with prior years, expenditure overshooting is a key risk with increasing subsidies and realization of development expenditure with election year politics. Acknowledged risks to the Budget remain on the back of 1) weak external financing, which can lead to a spiraling twin deficit, 2) matching upside and downside risk to oil prices and impact on oil import bill, 3) spillover effect from global slowdown (particularly the Eurozone) and 4) increasing share of budgetary borrowing from domestic sources leading to crowding out of private sector credit growth and inflationary central bank borrowing.
10

FY12

AKD Securities Limited

June 2012

Budget Review 2012-13

Expenditures
Expenditures (PkRbn) Defence Subsidies Debt Service (Foreign) Debt Repayment (Foreign) Debt Service (Domestic) Total Debt Servicing Public Order & Safety Economic Affairs Education Affairs Health Affairs Others Total Current Expenditure Development Exp (PSDP & Others) TOTAL EXPENDITURE As percentage of Total Expenditure Defence Subsidies Total Debt Servicing Public Order & Safety Economic Affairs Education Affairs Health Affairs Others Total Current Expenditure Development Exp (PSDP & Others) 18% 11% 39% 2% 4% 2% 0% 21% 63% 19% 21% 19% 41% 3% 4% 2% 0% 20% 72% 18% 24% 25% 47% 3% 2% 2% 0% 21% 82% 23% FY10R 378 229 71 148 596 815 37 81 32 7 439 2,017 405 2,422 FY11R 445 396 74 127 654 855 59 80 40 7 414 2,296 382 2,678 FY12R 510 512 72 137 772 981 62 72 45 7 443 2,632 478 3,110

Budget Snapshot
Revenues
Indirect Taxes Direct Taxes Total Tax Revenue Income from Property & Enterprise Civil Admin & Other Receipts Misc. Revenue Sources Total Non-Tax Revenue 70 54 48 8 537 2,612 591 3,203 70 65 50 8 550.00 2,744 600 3,344 Gross Revenue Receipts (Less: Provincial Share) Net Revenue Receipts Net Capital Receipts External Receipts Estimated provincial surplus Privatization Proceeds Bank Borrowing TOTAL RESOURCES As percentage of Total Revenues Indirect Taxes 26% 10% 55% 3% 3% 2% 0% 26% 81.5% 28% 26% 11% 59% 3% 3% 2% 0% 26% 86% 29% Direct Taxes Total Tax Revenue Income from Property & Enterprise Civil Admin & Other Receipts Misc. Revenue Sources Total Non-Tax Revenue Gross Revenue Receipts (Less: Provincial Share) Net Revenue Receipts Net Capital Receipts External Receipts
Source: AKD Research & MoF

FY13B 545 209 80 216 846 1,142

FY13AKD 545 220 85 281 870 1,236

Revenues (PkRbn)

FY10R 943 540 1,483 116 338 115 569 2,052 655 1,397 260 578 262 89 2,586 36% 21% 57% 4% 13% 4% 22% 79% 25% 54% 10% 22% 10% 0% 3% 100%

FY11R 1,052 627 1,679 104 303 150 557 2,236 998 1,238 459 290 120 452 2,559 41% 24% 66% 4% 12% 6% 22% 87% 39% 48% 18% 11% 5% 0% 18% 100%

FY12R 1,279.6 745.0 2,025 93.719 249 169 512.2 2,537 1,208.62 1,328 525 226 91 939 3,110 46% 27% 73% 3% 9% 6% 19% 92% 44% 48% 19% 8% 3% 0% 37% 100%

FY13B 1,572 932 2,504 179 354 197 730.3 3,234 1,459 1,775 478 387 80 484 3,203 57% 34% 90% 6% 13% 7% 26% 117% 53% 64% 17% 14% 3% 0% 19% 100%

FY13 AKD 1,356 904 2,260 209.00 313 143 665 2,925 1,287 1,638 490 350 100 696 3,344 49% 33% 82% 8% 11% 5% 24% 106% 47% 59% 18% 13% 4% 3% 27% 100%

Estimated provincial surplus Privatization Proceeds Bank Borrowing TOTAL RESOURCES

Source: AKD Research & MoF

11

AKD Securities Limited

June 2012

Budget Review 2012-13

EXPENDITURE
Expenditures on face value show marginal YoY growth; however in view of election year politics, there are concrete risks to overshooting. Total Federal outlay has been earmarked at PkR3.2tn versus a revised PkR3.11tn last year, up a marginal 3%YoY. Last year, budgeted expenditures were overshot by 16% or PkR343bn underpinned by Power Sector and Fertilizer subsidies. Current expenditures are projected at PkR2.61tn down a tepid 1%YoY. However, this includes a sharp reduction in subsidies at 59%YoY to PkR209bn which we believe is extremely optimistic. Debt servicing inclusive of repayments, are projected to increase by 16%YoY and account for 36% of total expenditures. Defense expenditures logged in line with previous year trends up 7%YoY and at 26% of total expenditures. Considering election year, we believe the tradition of balancing expenditure subsidies with PSDP is unlikely. For FY13, the Federal Budget targets Federal development expenditure at PkR591bn (PSDP PkR360bn) up 24%YoY from a revised PkR478bn last year where we expect targets to be inline till the run up in general elections. Inclusive of provincial allocations, PSDP is targeted at PkR873bn (3.7% of GDP) up 19%YoY versus a revised PkR743bn last year.

FY13F Current Expenditures

Public Order & Economic Education Affairs Affairs Safety 2% 2% 3% Subsidies 8% Health Affairs 0% Debt Servicing 43%

Others 21% Defence 21%

Source: Economic Survey

Current Expenditure Budget versus Actual/PSDP Utilization

5% 0% -5% -10% -15% -20% -25% -30% -35% FY10 -21.1% 0.5%

Entrenched Current Expenditures

25 20 15 10 5 0 FY92 FY93 FY94 FY95 FY96 FY97 FY98 FY99 FY00 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY12

-30.3% FY11 FY12

Current Exp as % of GDP

Dev Exp as % of GDP Source: MoF, PES & AKD Research

Source: Economic Survey

We view targets as conservative particularly in relation to containing subsidies particularly as PSDP cuts may prove difficult specifically till the run up in general elections. This will include allocations to complete ongoing projects and schemes (96% allocation) with the power sector allocation earmarked at PkR185bn. Expenditure side slippages have become recurring with sharp deviations in subsidies led by power where revised estimates for FY12 place the subsidy bill at PkR512bn against PkR166bn budgeted with tariff differential subsidies exceeding the target by PkR383bn (inclusive of KESC). We expect this is where chronic challenges will likely remain where based on our estimates taking only fuel oil generation; we expect power sector tariff under-recovery in excess of 34% (including the recent 16% hike) against consumer tariffs for 700-1000 units (as a proxy). . Even with downside risks to oil prices we believe the GoP will be required to rationalize power sector tariffs at a brisk pace. Our sensitivity shows for international crude oil prices at US$90/bbl fuel oil generation costs over an annual basis would exceed consumer tariffs by PkR165bn. This compares to a total tariff differential allocation of PkR170bn inclusive
12

FY13

FY11

AKD Securities Limited

June 2012

Budget Review 2012-13

Fuel Oil Generation cost

23.00 21.00 19.00 17.00 15.00 13.00 11.00 9.00 7.00 5.00 40% 35% 30% 25% 20% 15% FY08 FY09 FY10 FY11 FY12 10%

Power Sector Subsidy Sensitivity

70% 60% 50% 40% 30% 20% 10% 0% 80 90 95 350 300 250 200 150 100 50 100 110 Subsidy Burden PkRbn Power Sector Under Recovery Source: PES, Energy Year Book & AKD Research

Fuel Oil Generation Cost Consumer Rates 700 - 1000 Units Under Recovery (RHS)

of KESC allocations and life line consumer subsidies. The overall subsidy package of PkR209bn includes increasing allocations for FFBL at PkR3.4bn and USC for the sale of sugar at PkR6bn.

REVENUE: FBR trying to achieve double digit Tax to GDP

Total and Tax Revenue as % of GDP
19 17 15 13 11 9 7 FY92 FY95 FY98 FY01 FY04 FY07 FY10 FY13 5

Rev as % of GDP

Tax to GDP

Source: AKD Research

Pakistan's tax to GDP (FBR) at 9.3% is one of the lowest in the region. The GoP is targeting domestic internal revenue generation in FY13 of nearly Pk2.5trn, up 24% YoY to bring tax to GDP to double digits at 11.1%. While no new tax is imposed, achieving a 25%YoY increase in Direct tax and 23%YoY increase in Indirect tax is ambitious with our projected nominal GDP growth target of 15.2%. While this is achievable, it will require continued focus on improving administrative and collection measures. Of particular note is the imposition of 1% withholding tax on disributors/dealers, which would help in enhancing documentation in the economy and curb hoarding practices going forward. In our view, going by the recent track record of the government, growth in tax collection will gather pace on the back of 1) efforts to increase tax payer documentation and strengthening electronic payment, 2) improved tax administration and risk based audit, 3) simplifying the taxation system by focusing on Income tax and Sales Tax, 4) close watch on Afghan transit trade and recovering arrears and 5) natural course of PkR/US$ depreciation. .

Tax Collections
(PkRbn) 200.0 160.0

Breakup of FED
POL Products Others

Breakup of Customs Duty

Beverage Concentrate Imported Goods

Cigarettes & Tobacco

Others

Vehicles Edible Oil

120.0 80.0

40.0 Jul-11 Feb-12 Aug-11 Nov-11 Mar-12 Sep-11 Dec-11 Jan-12 Oct-11

Other Services Cement Natural Gas Iron & steel

POL Products Machinery & Mechanical Electric machinery appliance

Source: SBP

Source: Budget Doucments & AKD Research

13

AKD Securities Limited

June 2012

Budget Review 2012-13

We expect FY13 target of Income tax collection (96% of Direct tax) at PkR914bn to be an uphill task

Out of the total tax collection, 57% is through indirect taxation (PkR1,572bn) where sales tax growth is targeted in line with FY12 and is estimated to increase 26%YoY to PkR1.07trn in FY13. Total indirect collection against FED and Customs/Regulatory Duty is projected at PkR372bn, up a marginal 5%YoY. This is despite the abolishment of FED on 12 items, reduction in FED on Cement by PkR100/ton and custom duties on stationery items being abolished and reduced on pharmaceutical raw material. Petroleum levy is targeted at PKR120bn, up 74%YoY against the revised FY12 estimate, which in our view is realistic provided oil prices do not rebound sharply. That said, we expect FY13 target of Income tax collection (96% of Direct tax) at PkR914bn to be an uphill task.

Non Tax Revenue Measures

The government has budgeted non tax revenue target of PkR730.3bn during FY13 up 43%YoY from a revised estimate of PkR561bn in FY12. On the Non Tax revenue front, receipts from civil administration and other functions (being 48% of total Non Tax Revenue) are earmarked at PkR354.2bn in FY13, up 42%YoY. The primary contributor towards the national kitty remain profits from SBP which are estimated at PkR200bn. SBP profitability has historically been directly linked with the overall interest rate level in the economy and Central Bank lending to the private and public sector. We expect this to be a realistic target where further upside can come from any increase in interest rates. In addition revenue of PkR150bn is expected under the Defense head which include the logistical support receipts provided from coalition forces. However this carries risk with the recent uneasy relationship between the U.S and Pakistan. Partial financing will be done through income from property and enterprise of PkR179bn, up 91%YoY. This growth will largely be underpinned by auction of 3G licenses expected to generate PkR79bn which failed to materialize over the past two years. The miscellaneous receipts target of PkR197bn remains inline with our projected growth of 16%YoY. Notable drivers include a 28%YoY increase in Gas Development Surcharge while PkR30bn from Gas Infrastructure Development Cess is conservative (AKD Research Estimates GIDC at PkR60bn. Royalty collections are forecasted to remain flat at PkR58bn. Dividend income is forecasted to increased by 10%YoY to PkR64.6bn led by higher dividend expectations from Pakistan Petroleum Limited (PPL). .

This growth will largely be underpinned by auction of 3G licenses expected to generate PkR79bn which failed to materialize over the past two years

Dividend Estimates
2011-12 2012-13 (PkRmn) Revised Budget Est. FINANCIAL INSTITUTIONS 405.9 408.7 National Investment Trust 27 27 National Bank of Pakistan 33 33 Allied Bank of Pakistan 48 48 United Bank Limited 25 28 Habib Bank Limited 65 65 PaK Oman Investment Co, 108 108 Pak Brunei Investment Co, 50 50 Pak China Investment Co, 25 25 Pak Iran Joint Investment Co. 25 25 NON-FINANCIAL INST. PPL MARI PSO PARCO SNGPL SSGCL GHPL OGDCL PTCL Others Total 61,543.96 67,842.76 6,358 9,339 60 65 385 450 2,400 3,000 174 500 1,115 1,200 13,000 13,500 25,000 26,000 6,500 6,500 3,276 3,644 58,674 64,607 Source: Budget Brief

SBP profits
15% 14% 13% 12% 11% 10% 9% 8% FY05 FY06 FY07 FY08 FY09 FY10 FY12 FY13 FY11 250 200 150 100 50 0
Gas Dev. Surcharge Interest Oil/Gas Royalty

Non Tax Revenue

PTA profits (3G auction) Dividends

Others

Defense Receipts

SBP Profit

SBP Profits (RHS)

Discount Rate (LHS) Source: SBP & Budget Documents

Deficit & Financing: Elusive fiscal deficit target of 4.7% of GDP

With Expenditure to GDP aimed at 18.9% and tax to GDP of 10.1% in FY13, the onus of financing falls on domestic and external financing. The GoP has historically used development
14

AKD Securities Limited

June 2012

Budget Review 2012-13

expenditure as a counter balance; however, considering election year, outlays are likely to remain in line with projections particularly in the run up to general elections. We expect total expenditure outlays to overshoot by approximately PkR200bn. The GoP estimate for FY13 fiscal deficit of PkR1.1trn (4.7% of GDP), in our view, is optimistic and will likely exceed 6% of GDP. The budget plans to finance this shortfall by PkR135bn from Net External Financing and PkR971bn from Domestic Sources (Bank and Non Bank borrowing). In our view, FY13 budget has unrealistically estimated external financing to the tune of PkR386.9bn, up 71%YoY from the revised FY12 estimate of PkR226.1bn. While only 54% of budgeted foreign flows materialized during the current fiscal year, we conservatively expect PkR265bn to materialize in FY13. Out of the total Capital Receipts long term debt (Floating and Permanent) and NSS have been highlighted as the two main funding sources with an aggregate target of PkR477bn in FY13. Coupled with expected recourse to central bank borrowing we believe this could provide for upside pressure on money market yields.

While Pakistan has positive real interest rates, increasing government borrowing for budgetary support and uncertain materialization of foreign inflows (leading to a weak PkR/US$) remain the key risks to interest rate outlook

While Pakistan has positive real interest rates, increasing government borrowing for budgetary support and uncertain materialization of foreign inflows (leading to a weak PkR/US$) remain the key risks to interest rate outlook. Should external financing fall below target and expenditure overshoot by by our estimates in FY13, we estimate deficit monetization will increase average CPI inflation to 12.5%YoY from budgeted 9.5%YoY and above our base case estimate of 11%. That said, pressure on fiscal deficit may be contained with vigilance on inflation and focus on curbing the leakage from PSEs and refocus on power sector tariff rationalization.

Insufficient external flows shift reliance on Domestic Sources

100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0%

FY08

FY09 External as % of financing

FY10

FY11 Domestic as % of financing

FY12 JUL-MAR Source: SBP & AKD Research

Domestic Financing
90% 80% 70% 60% 50% 40% 30% 20% 10% 0% FY08 FY09 Non Banks FY10 FY11 Banks FY12 JULMAR 6.0 5.0 4.0 3.0 2.0 1.0

NDA/NFA vs. CPI

18% 16% 14% 12% 10% 8% 6% 4% 2% Jan-10 Jan-12 Jul-09 Oct-09 Apr-10 Jul-10 Oct-10 Apr-12 Jan-11 Apr-11 Jul-11 Oct-11 0%

0.0

NDA/NFA

CPI YoY Source: SBP & AKD Research

15

AKD Securities Limited

June 2012

Budget Review 2012-13

Total External Financing

External Financing
External grants 29% Project Loans 36%

The government has estimated external loans of PkR274.8bn, up 34%YoY against the revised FY12 estimate. These include project loans of PkR140.3bn, down 15.3%YoY and program loans (budgetary support) of PkR41.4bn, up 9.2x. At the same time, GoP expects a challenging PkR46.5bn from Euro Bonds which we view as unlikely considering increasing strains in global financial markets. The budget estimates External Grants of PkR112bn for FY13, up 11.6%YoY from a revised FY12 target of PkR45bn. Out of this, PkR74.4bn is estimated from Privatization Proceeds including the SPO of PPL, OGDCL exchangeable bond offering and small ticket items including Heavy Electrical Complex and NPCC.

Euro Bonds and others 24%

Programme Loans 11% Source: Economic Survey

Medium Term Budgetary Targets

Real GDP growth has been targeted at 4.3% higher than the 3% average from FY08-FY12. However in view of continuing infrastructure bottlenecks and chronic energy shortages we expect real GDP growth to contain at 4.3% only. The 10MFY12 current account deficit has surged to 1.7% of GDP, due to expanding trade imbalance and decline in foreign official and private capital inflows. Despite non-materialization of foreign inflows and US$1.2bn repayment to the IMF, the external sector has been sustained by surging remittances. This has been possible due to introduction of innovative schemes like the Pakistan Remittance Initiative (PRI) to enhance the flow of remittances with the SBP as the processing agent. The initiative envisions Pakistan as a remittance hub to process all transactions backed by incentive to maximise remittances. The GoP expect remmittance growth to clock in at 13%YoY for FY13.

GDP Growth (%)

5.0 4.5 4.0 3.5 3.0 2.5 2.0 1.5 1.0 FY09 FY10 FY11 FY12 FY13 FY14

Source: Economic Survey

Sectoral GDP Growth Trend (%)

9.0 8.0 7.0 6.0 5.0 4.0 3.0 2.0 1.0 0.0 -1.0 FY09 Agri FY10 FY11 FY12 FY13 FY14 Services

For FY13, Pakistan continues to face challenges on the external front with IMF repayments of US$2.78bn at the forefront. That said, the sell-off in global commodities will dissuade risks and provide some respite. As for oil, the main import driver, we expect the import bill to contract by ~US$1.2bn for every US$10/bbl fall in crude price. Furthermore, external account risk mitigates also include a return to the fold of an IMF program. . We have provided our sensitivity analysis of Oil (Arab light) price and Oil import bill.

Pakistan oil import bill sensitivity to International Oil

Arab light (US$/bbl) Import bill (US$ bn) 75 10.18 100 13.20 125 16.23 Source: AKD Research

Manufacturing

Source: AKD Research

Investment is targeted to improve from the current level of 12.5% of GDP to 13.1% in FY13, while addressing energy shortages the GoP has committed to utilize the increase in Gas Infrastructure Development Cess for the construction of Iran-Pakistan (IP) and TurkmenistanAfghanistan-Pakistan-India (TAPI) pipelines to overcome the energy shortages.

16

AKD Securities Limited

June 2012

Budget Review 2012-13

Cements
Relative Performance
1M Absolute (%) Rel. Index (%) 1.4 2.2 3M 44.6 37.4 6M 91.6 71.5 12M 75.0 61.9

Budget Implications - Positive

FED on cements has been reduced by PkR100 per ton which though positive, is lower than initial market expectations. The reduction, nevertheless, provides manufacturers with space to cut prices by PkR5 per bag. Customs duty on scrap of rubber / shredded tyres has been reduced to 10% from previous 20%. While positive owing to implementation of Tyre Derived Fuel (TDF) technology by players such as LUCK, DGKC et al, the impact on cost savings from TDF remains a bit of an unknown. PSDP target for FY13 has been set at PkR873bn (Provinces: PkR513bn; Federal: PkR360bn) compared to PkR730bn in FY12 - up 19.6%YoY which should help continue the dispatch growth momentum from last year.

Performance Chart
100% 80% 60% 40% 20% 0% -20% May-11 Aug-11 Nov-11 Feb-12 May-12

KSE-100 Index

Cements

The Finance Bill provides for exporters to move towards the normal tax regime (NTR) from current final tax regime (FTR), should they decide to avail it. Clause 41AA provides an option to opt for the NTR instead of the FTR, however, stipulates that minimum tax liability under NTR should not be less than 50% of the realized proceeds at the time of exports. Given, however, that even the biggest cement exporter (LUCK) is currently paying a tax (turnover) that translates to just 4.2% (9MFY12 current tax), it would be ill-advised to enter into NTR and therefore, we deem it unlikely that any manufacturer will opt for it.

Banks
Relative Performance
1M Absolute (%) Rel. Index (%) -3.2 -2.3 3M 7.7 0.5 6M 25.1 5.0 12M 8.4 -4.8

Budget Implications - Neutral to Negative

Dividend income arising from money market/income funds to be taxed at 25% in FY13 and at 35% in FY14, up from 10% at present. More affected banks, in our view, are ABL, MEBL and HMB. From a macro perspective, this may lead to shift towards alternative investment avenues including the stock market. 0.2% WHT now deductable on cash withdrawals of PkR50k/day, up from PkR25k/day previously. Budgetary impacts are slightly negative at the margin. However, considering that the much feared increase in corporate tax rate/ tax on T-bills did not materialize, we believe Banks are in for a sustained bull run across 2HCY12. Despite higher regulatory risk, our optimism is based on 1) robust balance sheet growth - deposits up QoQ in 1QCY12, bucking seasonal trend, 2) sustained focus on risk-free investments and resultant decline in provisions, 3) Likelihood of a reversal in the interest rate cycle - spreads to sustain at >7% and 4) capital strength amidst zero risk weight of GoP securities leading to higher payouts. Risks to materialization of foreign flows (e.g. Eurobonds) as well as selected domestic proceeds (e.g. privatization) should lead to higher than budgeted bank borrowing which buttresses our bull case. Our top picks are BAFL and UBL.

Performance Chart
25% 20% 15% 10% 5% 0% -5% -10% -15% -20% -25% May-11 Aug-11 Nov-11 Feb-12 May-12

KSE-100 Index

Banks

17

AKD Securities Limited

June 2012

Budget Review 2012-13

Oil & Gas

Relative Performance
1M Absolute (%) Rel. Index (%) -2.6 -1.8 3M -2.1 -9.3 6M 4.9 -15.2 12M 0.4 -12.7

Budget Implications - Positive

For the tax year 2012 and onwards, the GoP has provided a one time tax regime for upstream Oil & Gas companies at 40% of profits and gains, net of royalty, subject to withdrawal of all pending appeals etc and clearance of outstanding tax liability up to tax year 2011. This is against long standing disputes created over inconsistency between the Schedule to the Mining Act 1948 and Petroleum Concession Agreements. E&P companies discharge tax obligations as per respective PCA's at the higher of 55% on profits and gains or 50% of profits and gains before deducting royalty. The FBR's contention includes the Mining Act providing a floor and ceiling at 55% and . 50% before royalty while PCA's are framed for profit and gains only. Budget remains largely silent for gas distribution however GDS collection is expected to improve by 29%YoY to PkR30bn. This underscores improving gas production as well as downward sticky consumer gas tariffs particularly in 2HFY12 as international prices come off. Removal of FED on lubricants ranging from 10% of retail price to PkR7.5/litre on base oil is positive to improve overall consumption levels as well as for Lube Oil producers such as NRL which may retain the benefit

Performance Chart
25% 20% 15% 10% 5% 0% -5% -10% -15% -20% May-11 Aug-11 Nov-11 Feb-12 May-12

KSE-100 Index

Oil & Gas

Autos
Relative Performance
1M Absolute (%) Rel. Index (%) -1.6 -0.8 3M 12.4 5.1 6M 31.5 11.4 12M 6.4 -6.7

Budget Implications - Neutral to Positive

Status quo as far as import duty on CBUs is concerned which is a big relief for the OEM sector. Custom duty on imported CKD units reduced to 30% from 35% previously which will reduce the manufacturing costs for car as well as tractor manufacturers. Negative for auto parts manufacturers (Thal Engineering and Agri Autos). Advance tax on 1300cc-1600cc vehicles has been raised by PkR8,125/unit to PkR25k. We view this as slight negative for INDU but positive for PSMC given its dominance in the economical category (below 1300cc). Auto sector has gained 30%CYTD and has outperformed the broader market by 8% in the said period. However, there has been a recent sell-off in the sector due to fear of reduction in CBU imort duties in budget FY13. With status quo on import duties maintained, we believe autos are ripe for a relief rally.

Performance Chart
25% 20% 15% 10% 5% 0% -5% -10% -15% -20% -25% May-11 Aug-11 Nov-11 KSE-100 Index Feb-12 May-12 Automobile and Parts

Electricity
Relative Performance
1M Absolute (%) Rel. Index (%)
25% 20% 15% 10% 5% 0% -5% -10% -15% May-11 Aug-11 Nov-11 Feb-12 Power May-12

Budget Implications - Neutral

6M 12.4 -7.6 12M 8.7 -4.4

3M 3.8 -3.4

A non-event for the Electricity (Power) sector where the government announced no tangible steps for curbing or even controlling circular debt. Total subsidy for tariff differential has been projected at PkR185.3bn compared to revised figure of PkR464.2bn for FY12, indicating further round of tariff hikes. That said, we remain skeptic of subsidy targets being met, given revision in FY12 targets from initial allocation of PkR147.3bn. Electricity tariffs and loadshedding will likely be one of the focal points of all political parties in the election year expect subsidy targets to be revised upwards again!

3.6 4.4

Performance Chart

KSE-100 Index

18

AKD Securities Limited

June 2012

Budget Review 2012-13

Insurance
Relative Performance
1M Absolute (%) Rel. Index (%) 5.3 6.1 3M 1.7 -5.5 6M 27.0 6.9 12M 11.6 -1.5

Budget Implications - Neutral to Slightly Positive

For tax credit purposes, limit of investment in securities and insurance as proportion of taxable income increased from 15% to 20% and from PkR500k to PkR1mn, whichever is lower. Required retention period of shares is also being reduced to 2yrs from 3yrs. The purpose of these budgetary measures is to encourage retail investment in insurance schemes, where insurance penetration is extremely low (premiums as % of GDP are less than 1% with non-life penetration at 0.5% compared with emerging markets average of 1.3%). At the same time, FED on livestock insurance has been eliminated which should prove to be uplifting at the margin.

Performance Chart
25% 20% 15% 10% 5% 0% -5% -10% -15% -20% May-11 Aug-11 Nov-11 Feb-12 May-12

KSE-100 Index

Insurance

We see FY13 Budgetary proposals as Neutral to slightly Positive for the Insurance sector. Potential increase in funds flow to the equity market (as Banks shift away from money market funds) may be positive for overall stock price recovery, which should bode well for listed Insurance companies given their hefty reliance on investment income. At current levels, we retain our preference for AICL.

Fixed Line Telecom

Relative Performance
1M Absolute (%) Rel. Index (%) 15.8 16.6 3M 30.1 22.8 6M 45.6 25.5 12M -14.5 -27.7

Budget Implications - Neutral

GoP has announced a 20% hike in government employee salaries which is negative for the service oriented telecom sector. The GoP has maintained its FY12 dividend target for PTC at PkR6.5bn (DPS PkR2.05) and the FY13 target has also been kept at PkR6.5bn. We believe that PTC is likely to announce a dividend this month, which is likely to keep the stock in limelight in the near term. Recall, GoP has 62% shareholding in PTC. GST on telecom services has been kept unchanged at 19.5%. The already ambitious 3G auction target has been increased by PkR4bn to PkR79bn. The budget appears Neutral on the telecom sector, however, an interim dividend announcement by PTC is likely to excite in the near term. Furthermore, any tangible development on ICH will likely lead to a sector re-rating.

Performance Chart
30% 20% 10% 0% -10% -20% -30% -40% -50% May-11 Aug-11 Nov-11 Feb-12 May-12

KSE-100 Index

Fixed Line Telecommunication

Food Producers
Relative Performance
1M Absolute (%) Rel. Index (%)
60% 50% 40% 30% 20% 10% 0% -10% -20% May-11 Aug-11 Nov-11 Feb-12 May-12

Budget Implications - Positive

A 100% tax credit for corporate dairy projects for upto five years, given that the investment is fully equity funded. The move will stimulate development of dairy farming in the country, and may result in new corporate players in the field. We flag FFC as a potential beneficiary, as the company seeks to diversify its business operations, inline with peer ENGRO. GST on tea has been reduced to 5% from 16% previously, which is essentially catered to tackle tea smuggling and will be beneficial for ULEVER.

3M 20.7 13.5

6M 49.1 29.0

12M 45.2 32.0

3.3 4.1

Performance Chart

KSE-100 Index

Food Producers

19

AKD Securities Limited

June 2012

Budget Review 2012-13

Fertilizer
Relative Performance
1M Absolute (%) Rel. Index (%) -3.5 -2.7 3M -7.5 -14.7 6M -0.6 -20.7 12M 0.9 -12.3

Budget Implications - Negative

The much feared Gas Infrastructure Development Cess (GIDC) has been increased. Resultantly, GIDC on feed stock and fuel stock has been enhanced by PkR103/mmbtu and PkR87/mmbtu respectively which would collectively raise urea production costs by PkR138/bag. Urea import subsidy has been set at PkR26bn, which is lower than FY12s revised number of PkR45bn. Assuming the current landed cost of US$525/ton and retail price of PKR1600/bag (PkR1379/bag ex-GST), the GoP can import upto 1.2mn tons of urea in FY13, which will be sufficient to cover up the production loss from Sui supplied plants, and keep the industry well supplied. Despite the election year and recent slide in soft commodity prices (cotton in particular), the government has not announced any targeted relief measures for the agriculture sector (e.g. increase in wheat support prices), which is likely to keep farmer economics weak over the near term. Budget FY13 is broadly negative for the sector given the hike in gas prices and threat of further urea imports. Urea pricing power is likely to remain depressed owing to the supply glut as well as threat of further imports which is likely to accrue in less than full pass-through of GIDC impact. On the flipside, Jun12 urea sales may pick up significantly ahead of an expected price hike in Jul12. We highlight FATIMA as the key beneficiary as GIDC is not applied on locked in feedstock rate for new plants. .

Performance Chart
25% 20% 15% 10% 5% 0% -5% -10% -15% May-11 Aug-11 Nov-11 Feb-12 May-12

KSE-100 Index

Fertilizers

Textiles
Relative Performance
1M Absolute (%) Rel. Index (%) 2.3 3.1 3M 13.9 6.6 6M 26.8 6.8 12M -1.8 -15.0

Budget Implications - Neutral to Negative

In FY13 budget, PkR5.068bn is allocated for export development fund, up by modest PkR50mn compared with revised estimate of FY12, which is unlikely to make any material impact on textile exports. Gas Infrastructure Development Cess (GIDC) on captive power producers is increased from PkR13/mmbtu to PKR100/mmbtu (17.1% surge in natural gas cost), further increasing cost of production of textile manufacturers which have captive power facility fueled by natural gas. Exporters (including textile exporters) are provided an option to opt out of Final Tax Regime (FTR) provided their tax liability does not fall below 50% of tax liability computed under FTR. The difficulties related to documentation may refrain most of the exporters to opt out of FTR.

Performance Chart
25% 20% 15% 10% 5% 0% -5% -10% -15% -20% -25% -30% May-11

Aug-11

Nov-11

Feb-12 Textile

May-12

KSE-100 Index

Among textile sector, we retain our liking for NML where recent dip in price should be taken as an attractive entry point.

Chemicals
Relative Performance
1M Absolute (%) Rel. Index (%) 7.2 8.0 3M 5.4 -1.9 6M 20.0 -0.1 12M -2.5 -15.7

Budget Implications - Negative

No news in itself is bad news as far as LOTPTA is concerned as the budget was silent on PTA import duty implying status quo (import duty at 3%). Higher gas prices (GIDC) will increase costs for both EPCL and LOTPTA.

20

AKD Securities Limited

June 2012

Budget Review 2012-13

Annexure
Salient features of the FY13 Budget are as follows: Taxation slabs for individuals and AOPs to be reduced to 5 from earlier 17. Further, taxable income for salaried individuals and AOPs to be increased to PkR400k p.a from previous PkR350k p.a. Moreover, AOPs will also be taxed at progressive rates rather than previous flat rate of 25%. CGT related changes approved by Finance Ordinance, 2012 will now gain statutory status through Finance Bill 2012. Expenditure made on BMR will be get tax credit of 20% and shall be adjustable upto 5 years. Stock exchanges will not collect WHT on carry over trades. NCCPL will collect WHT @10% on margin financing in share business. Investment in IPOs and insurance premium will obtain a tax credit; higher of 20% (15% in FY12) of taxable income or PkR1mn (PkR0.5mn in FY12). Moreover, retention period has also been reduced from 3 years to 1 year. Property sold before 2 years of possession will be subject to CGT ranging from 5% to 10%. Dividend and profit from intra group debt is to be exempted from WHT for the companies entitled to group taxation. Tax arbitrage opportunity for banks has been purged by imposing 25% tax in FY13 and 35% in FY14 on dividend received from money market funds and income funds. Retailers having revenue up to PkR5mn will be subject reduced tax rate of 0.5% from earlier 1%. E&P companies have been provided with option to pay tax@40% of profits and net of royalty gains from FY12 onwards provided these companies withdraw pending appeals and payment of tax liability up to FY11 by Jun 30'12. Exporters, importers and suppliers are provided an option to exit Final Tax Regime (FTR) and enter Normal Tax Regime (NTR). Manufacturers will act as withholding agents to collect 1% tax from traders and distributors which will be adjustable against tax liability of those traders/distributors. Expansions in PPE made before Jul 1'11 through 100% fresh equity will get tax credit for 5 years from commencement of commercial production. Initial depreciation on building will be reduced to 25% from earlier 50%. Tax exemption granted on venture companies and private equity is to be extended for 10 years period. FED on cements will be reduced by PkR100/ton.

21

AKD Securities Limited

June 2012

Budget Review 2012-13

Import duty on rugged tryres to be reduced to 10% from 20%. Additional GIDC is to be imposed on fertilizer sector by PkR103/mmbtu on fuelstock and on PkR87/mmbtu. GST has been rationalized at 16% for goods. Sales tax on steel sector enhanced from PkR6/Kwh to PkR8/Kwh. Minimum price for new brands is floored to 95% of most popular price category brands. Limit of taxable cash withdrawals (subject to 0.2%WHT) has been on enhanced to 50k pd from previous 25k pd. 100% tax credit will be provided against tax payable to industrial undertakings including dairy farming. 15 items, including lub oils, have been exempted from FED. FED on 88 pharmaceutical raw materials has been reduced.

22

AKD SECURITIES LIMITED

Member: Karachi Stock Exchange

PAKISTAN

Muhammad Farid Alam Chief Executive Officer Tel: (9221) 111 253 111 farid.alam@akdsecurities.net

AKD Sales Team

Domestic and International Sales Team Sheikh Zia-ur-Rehman Head of Institutional Sales Tel: (9221) 111 253 111 (Ext:696) sheikh.zia@akdsecurities.net Salman Zahur Head of Foreign Equities Tel: (9221) 111 253 111 (Ext:674) salman.zahur@akdsecurities.net Qasim Anwar Equity Dealer Tel: (9221) 111 253 111 (Ext:696) qasim.anwar@akdsecurities.net

AKD Research Team

Naveed Vakil Director, Research & Business Development Sector: Strategy, Oil & Gas, Power Tel: (9221) 111 253 111 (Ext:692) naveed.vakil@akdsecurities.net Anum Dhedhi Economist/Investment Analyst Sector: Pakistan Economy/Banks Tel: (9221) 111 253 111 (Ext:693) anum.dhedhi@akdsecurities.net Qasim Anwar Technical Analyst & Equity Dealer Tel: (9221) 111 253 111 (Ext:680) qasim.anwar@akdsecurities.net Nasir Khan Database Officer Tel: (9221) 111 253 111 (Ext:639) nasir.khan@akdsecurities.net

Raza Jafri, CFA Head of Research Sector: Commercial Banks, Insurance, Economy Tel: (9221) 111 253 111 (Ext:693) raza.jafri@akdsecurities.net Usman Zahid Senior Investment Analyst Sector: Cement, Power Tel: (9221) 111 253 111 (Ext:693) usman.zahid@akdsecurities.net Hassan Quadri Research Database Manager Tel: (9221) 111 253 111 (Ext:639) hassan.quadri@akdsecurities.net Tariq Mehmood Library Incharge Tel: (9221) 111 253 111 (Ext:643) tariq.mehmood@akdsecurities.net

Ayub Ansari Senior Investment Analyst Sector: Fertilizer, Chemicals, Telecom Tel: (9221) 111 253 111 (Ext:693) ayub.ansari@akdsecurities.net M. Naeem Javid Investment Analyst Sector:Fertilizer, Textile Tel: (9221) 111 253 111 (Ext:643) tariq.mehmood@akdsecurities.net Azher Ali Quli Database Officer Tel: (9221) 111 253 111 (Ext:639) azher.quli@akdsecurities.net

The information and opinion contained in this report have been complied by our research department from sources believed by it to be reliable and in good faith, but no representation or warranty, express or implied, is made as to their accuracy, completeness or correctness. All opinions and estimates contained in the document constitute the department's judgment as of the date of this document and are subject to change without notice an are provided in good faith but without legal responsibility. This report is not, and should not be construed as, an offer to sell or a solicitation of an offer to buy any securities. AKD Securities (the company) or persons connected with it may from time to time have an investment banking or other relationship, including but not limited to, the participation or investment in commercial banking transaction (including loans) with some or all of the issuers mentioned therein, either for their own account or the account of their customers. Persons connected with the company may provide corporate finance and other services to the issuer of the securities mentioned herein, including the issuance of options on securities mentioned herein or any related investment and may make a purchase and/or sale of the securities or any related investment from time to time in the open market or otherwise, in each case either as principal or agent. Neither the company or any of its affiliates, nor any other person, accepts any liability whatsoever for any director or consequential loss arising from any use of this report or the information contained therein. Subject to any applicable laws and regulations, AKD, its associate or group companies or individuals connected with AKD may have used the information contained herein before publication and may have positions in, may from time to time purchase or sell or have a material interest in any of the securities mentioned or related securities or may currently or in future have or have had a relationship with, or may provide or to have provided investment banking, capital markets and or other services to, the entities referred to herein, their advisors and/or any other connected parties. This document is being distributed in the United State solely to "major institutional investors" as defined in Rule 15a-6 under the U.S. Securities Exchange Act of 1934, and may not be furnished to any other person in the United States. Each U.S. person that receives this document by its acceptance hereof represents and agrees that it: is a "major intuitional investor", as so defined; understands document wishing to follow-up any of the information or to effect a transaction in such securities should do so by contacting a registered representative of AKD Securities Limited. The securities discussed in this report may not be eligible for sale in some states in the U.S. or in some countries. Any recipient, other than a U.S. recipient that whishes further information should contact the company. This report may not be reproduced, distributed or published, in whole or in part, by any recipient hereof for any purpose.

June 2012