AKD Securities Limited Equity Research – Daily Report

Karachi, January 05, 2018 (PPI-OT): Textiles: Rupee devaluation paves the road to recovery

Remaining under pressure despite PM’s export package, textile sector witnessed significant margin deterioration in 1QFY18, where our textile universe’s gross margin went down by 3.32ptsYoY. Rising input costs particularly fuel, power and manpower in the backdrop of static final product prices have dented the sector’s margin. In a bid to ease pressures on the export sector especially textiles, the GoP has finally allowed rupee to depreciate against the greenback (~5% since Dec 07’17). Holding substantial ~60% share in the country’s export mix, textile sector emerges as a key beneficiary from the devaluation exercise resulting in easing off competitive pressures from regional countries in the export market, leading to higher volumes going forward. Incorporating recent rupee depreciation, our FY18F earnings estimates for NML/NCL has increased by 1.05%/2.3% to PKR14.47/9.11/sh (previously PkR14.25/PkR8.9/sh). However, recent spike in cotton prices (up 23%FYTD) touching 6yr high may limit earnings upside.

Rupee depreciation to drive recovery in textile sector: Despite GoP extending export subsidy in the range of 4-7%, textile sector remained under pressure in 1QFY18, as the sector’s gross margin saw significant compression (AKD textile universe GMs: down 332bpsYoY). Conceding to external account pressures, rupee finally depreciated by ~5% against US$ in early Dec’17 after remaining fairly stagnant at PkR105.39 throughout the year. With ~60% share in the total exports, textile sector emerges as a key beneficiary of currency devaluation, resulting in easing off regional competitive pressures. Incorporating recent rupee depreciation, our FY18F earnings estimates for NML/NCL has increased by 1.05%/2.3% to PKR14.47/9.11/sh (previously PkR14.25/PkR8.9/sh).

Rising cotton prices another drag on margin profile: Against expectations of bumper crop in MY18, the country’s cotton crop merely witnessed an increase of 7%YoY with total cotton production standing at 11.10mn bales until Jan 03’18. This along with fog impacting crop quality has led to rallying cotton prices in 2HCY17, with cotton prices surging to PkR8100/40kg (up 23%FYTD), a level last seen in Jul 2013. With local industry’s heavy reliance on natural fiber, rising cotton prices could lead to further decline in margins. However, supportive domestic yarn prices (up on avg. by 5.1%FYTD) may limit adverse price hike impact for low value added players.

Investment perspective: Our preferred play in the textile sector, NML, remains key beneficiary of: 1) PM’s export package with higher benefits accruing on account of higher value added exports and 2) rupee depreciation due to higher export share in the total sales mix (exports/local:77%/23%). Additionally, NML offers thematic exposure to various growing sectors such as banks (MCB: expected to gain from monetary tightening) and cements (DGKC: anticipated to benefit from ongoing infrastructural activity). Moreover, NML is further diversifying its business into auto sector through JV with a Hyundai Motor Company, where developments over the same can keep the conglomerate in the limelight.

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