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AFC Asia Frontier Fund - Pakistan - "More Gas in the Tank"

Dear Investors and Newsletter Readers , As part of our continuing on the ground research, Thomas Hugger, CEO of Asia Frontier Capital and

Dear Investors and Newsletter Readers,

As part of our continuing on the ground research, Thomas Hugger, CEO of Asia Frontier Capital and Fund Manager of the AFC Asia Frontier Fund, traveled to Pakistan recently. Photos are by Asia Frontier Capital.

I attended an annual Pakistan investor tour organized by our broker in December 2019. We met with senior representatives of 21 listed companies in Islamabad, Rawalpindi, Lahore and Karachi. This time I was particularly excited to attend the trip since it was the first time I visited Islamabad (the capital of Pakistan) and Rawalpindi.

I arrived in Islamabad late at night on a Thai Airways flight from Bangkok which, as usual, was completely full, mainly with Pakistani passengers, since Thai Airways is one of the few remaining international airlines still serving Pakistan while most other Asian airlines have stopped flying there due to security and commercial reasons. The new Islamabad International Airport terminals commenced full operations on 3rd May 2018 and it took me just 5 minutes and about 300 meters of walking from the airplane door to the greeting area outside of the airport, passing through the super-efficient immigration in the process. What a difference to JFK in New York or Dhaka in Bangladesh! Unfortunately, the hotel car pick-up was not there yet and I had to wait about 30 minutes in the 9 degree Celsius cold without a proper coat (my bad planning).

Islamabad became Pakistan’s capital on 14th August 1967, exactly 20 years after the country’s independence, taking over from Rawalpindi which was the “provisional capital” for a couple of years and from Karachi, the country’s first capital and which today boasts a population of 14 mln people, making it the largest city in Pakistan. In comparison, Islamabad only has about 1.1 mln inhabitants and together with its “twin city” Rawalpindi, which hosts the Army headquarters, the metropolitan area has a population of 4 mln. The city’s master plan was designed by Greek architect Apostolou Doxiadis and is like other newly planned capitals like Brasilia, Canberra and New Delhi, divided into residential, commercial and most importantly diplomatic zones. However, the city is considered as one of earliest sites of human settlement in Asia since some of the oldest Stone Age artefacts in the world have been found on the plateau dating back 100,000 to 500,000 years. The city is also very different to other Pakistani cities due to its altitude of 540 meters and its proximity to the Margalla Hills (highest point 1,604 meters), the westernmost foothills of the Himalayas. As can be seen from the pictures below, the city doesn’t have many high-rise buildings but boasts a lot of trees.


View over Islamabad from the OGDCL building



One of the landmark buildings and tourist attractions in Islamabad is the Faisal Masjid Mosque which was completed in 1987 and can host 300,000 worshippers. It was the largest mosque in the world until 1993.


Faisal Masjid Mosque in Islamabad



Due to the fact that Islamabad is the capital city, many government-owned or government-related companies have their headquarters there. During the day I met with two companies in Islamabad and one in Rawalpindi. I had the pleasure of meeting with the senior management of Oil & Gas Development Company (OGDC), one of the three remaining Pakistani companies in the MSCI Emerging Market Index and the largest listed company on the Pakistan Stock Exchange “PSX” with a market cap of USD 4.1 bln. I met with the CEO, CFO, Head of Exploration, Company Secretary and Head of IR at the same time, something which you will only see in frontier or smaller emerging markets.


Meeting the management of Oil & Gas Development Company (OGDC)



I also met with the senior representatives of a company from the telecommunication sector in Islamabad and one fertilizer company in Rawalpindi. After our last meeting we were driven by an excellent chauffeur from Islamabad to Lahore on the recently completed 367 km long M-2 highway. But before joining the M-2 highway we passed by the “ISE Tower” which used to host the Islamabad Stock Exchange “ISE” and was subsequently merged into today’s Pakistan Stock Exchange “PSX” (headquartered in Karachi) together with other regional stock exchanges.


Pakistan Stock Exchange in Islamabad – when will they put back the missing “K”?



I had to laugh out loud when I saw the top of the building. The letter “K” in Stock was missing. Back in Hong Kong this would be immediately replaced since this symbolizes bad luck…

The 375 km drive on the M-2 to Lahore took about 4 ½ hours. The highway has 3 lanes in each direction and the surface is smooth without potholes. The driving of other cars was generally very disciplined and our driver occupied the furthest right lane at a speed of about 130 km/hour, which is above the official speed limit of 120 km/hour, almost the entire time. There was, unlike in Germany or Switzerland, no construction work on the highway and every 60 to 70 kilometers a “service area” was available with a sophisticated and clean petrol station, including a sizeable shop, and additionally many food outlets serving fast food (McDonalds and KFC among others) or local cuisine.

At the beginning of the trip the traffic was most of the time light since we drove through the agricultural heartland of Punjab. It was only several kilometers before reaching Lahore where the highway became more congested since we arrived in Lahore during the evening rush hour. The highlight of the M-2 (from a visual point of view) passes through the “Salt Range” mountains where the road winds down several hundred meters through a picturesque and mountainous landscape. Otherwise the highway passed through green and hardly inhabited agricultural land. One of the attractions on the roads in Pakistan are the numerous trucks, most of which are nicely and colourfully painted with mainly Pakistani landscapes.


One of the many beautifully painted trucks in Pakistan



I was glad to finally arrive in Lahore where our broker invited me to a delicious Pakistani kebab dinner in our hotel’s restaurant since it was unfortunately too late to explore the many tourist spots of the city. Lahore has a population of 11.1 mln people and is also the capital of Punjab province which, with a population of over 110 mln is the most populous province in Pakistan. Lahore was controlled by numerous empires throughout the course of its history and today still has many major tourist attractions like “the Walled City”, various Mosques, Sikh shrines and the UNESCO World Heritage sites “Lahore Fort” and “Shalimar Gardens,” but unfortunately we did not have time to visit any of these during this trip.

The next day we went to the offices of five companies: two from the cement sector, one bank and two industrial companies. The cement sector suffered in 2018-2019 due to increased capacity (mainly in the North where Punjab province is located), lower demand due to slower economic growth, certain large CPEC (China Pakistan Economic Corridor – part of China’s “Belt and Road Initiative”) projects being completed and higher energy costs (most of the cement companies import coal from South Africa) because of the sharp depreciation of the Pakistani Rupee (PKR) versus the US Dollar. Due to the dire cash flow situation of some cement producers as well as industry overcapacity, the “price agreement” in the North of Pakistan was undercut by certain players and the price of a 50kg bag of cement in the North dropped from a high of Rs. 620 a bag to a low of Rs. 450. The price had recovered to Rs. 520 when we visited Lahore in early December 2019. At the then current price level, some of the cement producers were selling cement at a loss. Despite the gloomy outlook for the cement sector, the stock market reacted positively and the share price of D.G. Khan Cement (DGKC), for example, rallied from a low of Rs. 41.2 on 31st July 2019 to Rs. 78.4 on 2nd January 2020 which is a gain of 90.2% in 5 months, something the CFO’s of the cement companies could neither understand nor explain.

After lunch and a company briefing with Q&A at Pak Elektron’s (PAEL) office, we had the opportunity to visit PAEL’s factory next door where we were allowed to tour the assembly lines for fridges and freezers and also for washing machines, the latter of which is a new product segment for the company.


Washing machine assembly line



The last company meeting in Lahore was with the CFO of Packages Limited (PKGS). Founded in 1957 the company produced razor blades and a few years later went into packaging with the assistance of Tetra Pack from Sweden. The company consequently built a paper mill with huge warehouses beside the administration building. Later, PKGS went into other businesses and countries (PKGS was the first Pakistani company to expand abroad) and its venture into dairy products was later sold to Nestle, but Packages still remains today a significant shareholder of Nestle Pakistan which is also listed on the PSX. Over time, 15 acres of PKGS 100 acres of land previously occupied by warehouses and factories was turned into the “Packages Mall” which is today one of the two leading shopping malls in Lahore. The mall was completed in 2017 and offers over 200 brands, a multiplex cinema, food court, play area and a Carrefour supermarket all under one roof. 96% of the space is currently leased out. Before heading to the Lahore Airport to catch our flight to Karachi, we had a quick stroll around the nicely designed shopping mall where a lot of international brands have opened. This is still a very underpenetrated segment relative to other markets in Asia and it would not be surprising to see more modern malls coming up across major Pakistani cities in the future.


Packages Mall in Lahore





During my two days in Karachi we met a total of 13 companies at our hotel. The companies were from the automobile, banking, cement, chemical, fertilizer, insurance, IT, oil distribution, pharmaceutical, power generation and textile sectors.

One of the highlights was a meeting with a deputy governor of the State Bank of Pakistan and his staff at their fortified office in downtown Karachi. Our group was briefed about the economic situation and outlook and especially the situation of the Pakistani Rupee (PKR) and the team’s expectations for interest rates and inflation. Imran Khan, the new Prime Minister and former captain of the Pakistani cricket team which won the 1992 World Cup, became the country’s 22nd Prime Minister on 27th July 2018 and since then he and his ministers have achieved, after some initial hiccups, a remarkable stabilization of the economy.

More or less all of the company officials we met gave very positive feedback about the outlook for the economy and generally it seems that everybody we talked to had much more confidence in the current government and were decisively more positive about a possible turnaround of the economy in the near future. A good example for the increased trust in a turnaround of the Pakistani economy is the PKR which appreciated by about 5% since its low on 27th June 2019 after falling from 105 to the USD to 163 within 18 months. This impacted almost all industries negatively with the exception of oil and gas producers and IT companies. It is further expected that monetary easing will start from the 2nd quarter of 2020 onwards, after the inflationary pressure due to higher prices of imported food, electricity, and gas, has peaked.

After the International Monetary Fund (IMF) loan program was executed in July 2019, the foreign exchange reserves of Pakistan began to stabilize and in the past weeks finally started to increase. The FX reserves currently stand at USD 18.1 billion, which compared to other economies is still low. It is further expected that the current account deficit will go down to 2.6% of GDP in FY 2020 compared with 4.6% in FY 2019 thanks to lower imports (about 21% lower) and slightly higher exports (+5%).

The government is now also focusing on bringing improvements into the real economy through inclusive growth in agriculture and the industrial and services sectors (especially IT). Another major achievement of the current administration has been the broadening of the tax base which has resulted in higher tax revenues, which again compared with other countries is still far too low (only 11.6% of GDP) but at least the current government is tackling the problem with some tough measures. For example, the government has implemented a higher sales tax for buyers without tax identification numbers for certain luxury products such as cars.

However, Imran Khan’s government has also had to make some unpopular decisions like increasing electricity and gas prices for industrial users and private consumers, but surprisingly without too much resistance. Hopefully these measures will sooner or later end the “circular debt crisis” which impacts suppliers and producers related to gas and electricity. The IMF now forecasts that Pakistan’s GDP should grow this fiscal year by 2.4%, followed by 3% and 4.5% in FY 2021 and FY 2022 respectively. Obviously, most of these decisions related to gas and electricity price increases are part of the IMF loan program.

On a slightly negative note is the issue regarding the upcoming decision by the Financial Action Task Force “FATF”, the international body which oversees a country’s money laundering and illicit financing regulations, to potentially put Pakistan (and Mongolia) on the black list which could have significant ramifications for the country and especially the banks and FDI (foreign direct investments). However, Pakistan has made progress in overcoming many of the issues with respect to financial and money laundering regulations which has so far allowed it to remain on the grey list.

In the evening, we ventured out to have a quick stroll through Karachi’s largest shopping mall, the “Dolmen Mall” in Clifton, which was built in 2011 with an integrated underground car park. It hosts lots of smaller local and international shops such as a Carrefour Hypermarket, a Debenhams department store, many restaurants, coffee shops, and a food court. As can be seen from the picture taken below, on an early Thursday evening, the mall was crowded with shoppers.


Dolmen Shopping Mall, Clifton, Karachi



Finally, we had a delicious dinner with the team of the brokerage company at a local seafront restaurant overlooking the turquoise blue waters of the Arabian Sea. We enjoyed some nice curries and kebabs and the CEO of the brokerage company insisted that we foreign visitors also try “Brain Masala” (“Bheja Fry” in local parlance) but I have to admit that I prefer the kebabs!

The Pakistani economy and stock market have had a tough two years but it appears to us that the cycle is now turning as the macro situation has stabilized, the currency has weakened substantially, and interest rates have peaked. It is not surprising therefore that the KSE100 Index has rallied by 46% since its low at the end of August 2019. With earnings growth expected to post a recovery from the latter half of 2020 and the index trading at a P/E of 7x based on 2020 earnings, there is more room for the market to recover, or to quote the Head of Research of the Pakistani brokerage company: “There is still a lot of gas in the tank”!

For further viewing here are some interesting, relevant news links related to Pakistan:

For information about the AFC Asia Frontier Fund click one of the following links:


I hope you have enjoyed reading this travel report. If you would like any further information about the AFC Asia Frontier Fund, please get in touch with me or my colleagues.

With kind regards,
Thomas Hugger
Fund Manager

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