FALLING cotton prices, reversal in China’s cotton-stockpiling policy and a depreciating euro have remained the cause of concern for the country’s largest listed textile composite, Nishat Mills.

NML has resultantly underperformed the benchmark KSE100 index by 7pc since June 2014. However, revenues are likely to improve from FY15 onwards due to the management’s continuing efforts to tap new markets, rising production capacities, GSP Plus status and positive implications of the new domestic textile policy.

On top of this, lower/stable cotton prices and subdued energy prices are expected to help margins expand. Further impetus to profits is likely come from declining interest rates and a gradual reduction in debt levels, which would help the company to keep its finance cost in check.

The expected revenue growth should come from stabilising yarn prices, normalising demand, tapping of new markets and additional sales generated by the new garments factory

By last June, the company had Rs26bn in debt, which translated into a debt-to-equity ratio of 24pc.

Revenue and profit: Though stable FY15 revenues are expected due to low garment volumes and depressed yarn prices, sales (in rupee terms) are likely to improve at a five-year (FY15-19) CAGR of 6pc to reach Rs72bn in FY19 and net earnings to grow 10pc CAGR during the period.

The revenue growth would come from stabilising yarn prices, normalising demand, tapping of new markets and additional sales generated by the new garments factory. Gross margins, which remained between 14-17pc during the last three years, declined to 11.3pc in the first half of this fiscal (1HFY15).

However, we foresee reviving margins in coming quarters as cotton prices have stabilized while yarns prices are adjusting accordingly. In addition, lower fuel costs, rising contribution of high margin garment sales and gradual shift to alternative fuels (coal and synthetic gas) would also help margins expansion.

Investment portfolio: Cotton prices and currency rates have large implications for the textile sector’s profits. However, NML is an anomaly here, as it manages a large, well-diversified investment portfolio that includes MCB, DGKC, NPL and AICL.

At current market prices, the value of its portfolio stands at Rs58.4bn. Within this, MCB contributes 38pc (Rs63 per share for NML) as the company holds 80.79mn shares of the bank, while DGKC’s contribution stands at 30pc (Rs50 per share). The NML stock is trading at FY15 (forecasted) price-to-earnings (PE) of 9.59x.

Exports to EU: The euro has depreciated by 21pc since the start of the fiscal year, making Pakistani commodities bound for Europe more expensive, despite their unchanged dollar prices.

Furthermore, an expected fall in consumer purchasing power in Europe would affect demand of exports from Pakistan and other Asian nations to the EU. As NML derives 26pc of its revenues from exports to EU nations, the euro’s depreciation would hurt the company’s competitive advantage.

In 7MFY15, the country’s overall value-added textile exports to the EU region improved by 12.9pc. The euro’s depreciation would partially neutralise this positive impact, as witnessed by the 12.9pc yearly drop in exports in February.

Rupee’s depreciation against dollar: Despite its strong performance last year, we expect the rupee to depreciate by an average of 4pc per annum from FY16 onwards, keeping in line with the fact that it has depreciated by an average 5.4pc per annum against the greenback in the past 10 years.

A depreciating rupee would act as a boon for export-oriented textile companies like NML. This would also help partially counter against the local currency’s appreciation against the euro.: The Economic Coordination Committee has approved the much-awaited Textile Policy 2014-19, with a budgeted allocation of around Rs65bn. The policy aims to double textile exports to $26bn.

New textile policy: It further targets increasing the proportion of foreign garment sales from 28pc to 45pc of total textile exports and facilitate further investment of $5bn in new plant and machinery. Meanwhile, textile units in the value-added sector would be provided with long-term financing facility (LTFF) for upgradation of technology from the central bank at a subsidised rate of 4.5pc for 5-10 years and at 5pc for 3-5 years.

As a leader in the value-added segment, NML will benefit from the policy.

Falling energy prices: Due to the persistent energy crisis, manufacturers have to rely on alternative fuels, including furnace oil, to meet their energy needs. However, the situation has turned around as international oil prices market have fallen a steep 48pc since the start of FY15.

Due to lower furnace oil cost, we estimate NML to save Rs959mn on its fuel and power cost; gross margins are estimated to rise by 181bps owing to this factor.

However, amid media reports that the government intends to rationalise the gas tariff for all consumers, the positive impact of lower fuel oil charges would be somewhat muted. As NML meets about 25pc of its energy needs from gas, we estimate a Rs0.4 per share annualised earnings impact if the base tariff is raised to Rs750/mmbtu.

However, there would be a minimal risk to earnings for this fiscal, as the expected rise in tariffs would only affect the last quarter of FY15.

Published in Dawn, Economic & Business, March 23rd, 2015

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