CotlookA index has rebounded by 6.2% in just 5 working days to reach at US$0.83/lb. Concerns over tighter than expected cotton supply has fanned the recovery in int’l cotton prices as competing cash crops gain acreage. Further, lower precipitation levels in India, world’s second largest cotton producer, are also casting doubts on expected cotton production in FY13. That said, FY13 is still forecasted to be a third consecutive year of excess cotton supply where global cotton stock is forecast by USDA to reach a record high level of 74.5mn bales, up 11%YoY. Considering the weak global macroeconomic conditions and cotton production estimates, we forecast CotlookA to average at US$0.85/lb during FY13, down by 18%YoY. Within the textile sector, we retain our liking for NML (Jun’13 target price of PkR69/share). Taking a longer term perspective, NML is shifting towards cheap alternative fuel where a 6MW combined heat and power plant is scheduled to be installed by next month. The new EU law that focuses on providing preferential trade tariffs to poor countries may remove hurdles in Pakistan’s way to gain GSP plus status where NML, along with other finished or semi-finished product manufacturers, will be biggest beneficiaries. Recall, sales to EU comprise 27% of NML’s total sales mix.
Recovery in Cotton prices: CotlookA index has rebounded by 6.2% in just 5 working days to reach at US$0.83/lb. Concerns over lower than expected cotton supply fanned the recovery in int’l cotton prices as competing cash crops gain acreage. Further, lower precipitation levels in India, the world’s second largest cotton producer, are also casting doubts on expected cotton crop for FY13. In this regard, USDA has revised down its global cotton production estimates in Jun’12 to 115.3mn bales (-6%YoY). Cotton consumption is forecast to register at 109mn bales, up by ~3%YoY, primarily due to high mill use in India (+6%YoY). Despite the expected decline in production, FY13 is still forecast to be a third consecutive year of excess cotton supply where global cotton stock is projected to reach a record high level of 74.5mn bales (+11%YoY). Given the weak global macroeconomic outlook and large crop surplus, we expect FY13 int’l prices to fall by 18%YoY, with CotlookA estimated to average at US$0.85/lb. As for Pakistan, USDA estimates cotton production to decline by ~6%YoY, which we view as a conservative given i) water shortages, ii) shortage of certified seeds and iii) preference of farmers for other cash crops following the sharp fall in cotton this year. Furthermore, the discount of domestic cotton to int’l cotton has declined sharply in recent times and currently stands at just 11.4% compared with 20% historical average discount. Given the mean reverting nature of local cotton discount to int’l cotton price, local cotton prices should correct in the near term assuming stable int’l prices.
Hope for GSP plus status revives: EU has passed a new law, abolishing preferential trade tariffs to a number of countries. Now the preferential trade tariffs will be offered to poor countries which can apply for GSP plus status that require no custom tariffs in return for commitments for human rights and democracy. Pakistan may be one of the key beneficiaries of this development. Recall, EU accounts for ~30% of Pakistan’s total textiles exports. NML, along with other finished or semi-finished textile producers, will gain the most as EU’s finished and semi-finished products constitute a major chunk of EU’s textile imports. Sales to EU comprise 27% of NML’s total sales mix.
NML – The preferred player in textile sector: Despite, higher dividend income from portfolio companies, especially PKGN (PkR5/share), NML posted subdued results during 9MFY12 with NPAT of PkR2.5bn, down by 27.4%YoY. Poor spinning segment performance and enduring energy crisis (fuel and power cost surged by 34.3%YoY) dragged NPAT. For FY13, we estimate NML to post NPAT of PkR3.48bn (EPS: PkR9.91) in FY13, which would represent a slight decline of 2%YoY. Gross margins are expected to improve by 90bps YoY to 16.2% on cheaper local cotton procurement cost as well as the recent depreciation in PkR. Taking a longer term perspective, NML is shifting towards cheap alternative fuel where a 6MW combined heat and power plant is scheduled to be installed by next month. At current levels, we retain our liking for NML with rolled over Jun’13 target price of PkR69/share, implying a 38% upside. NML is trading at an undemanding FY13 P/E and P/B multiples of 5.05x and 0.43x respectively. Buy!
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