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 Pakistan Textiles Ample supplies to keep prices of cotton depressed Thursday March 19, 2015 Personal Goods Sector Performance 1M 3M 12M Absolute % ‐8%
‐5%
‐2%
Relative to KSE % ‐1%
‐7%
‐18%
Relative Chart KSE100 vs Personal Goods Personal Goods (Textile) KSE100 Index
40%
30%
20%
10%
0%
‐10%
Mar‐15
Jan‐15
Feb‐15
Dec‐14
Oct‐14
Nov‐14
Sep‐14
Jul‐14
Aug‐14
Jun‐14
Apr‐14
May‐14
Mar‐14
‐20%
Source: KSE, BMA Research
As per latest USDA report, total cotton production of the world is expected to be around 119mn bales (as against the earlier target of 115mn bales) in FY15 which will take the world’s total stock to use ratio to an all time high of 99%. The biggest additions are coming from India, which has dislodged China as the biggest producer of the commodity, where its production is likely to touch ~31mn bales. On the other hand, the local production of the commodity is also likely to clock around 14mn bales (up 10%YoY). The prices of the commodity have remained between the band of PKR4,600‐
PKR5,100/maund CY15TD in the local market while the prices in the international market have remained in the band of USc62/lb‐USc68/lb over the same period. Lower cotton prices have also dragged down the prices of yarn in the country squeezing the core yarn margins. Despite the decline in prices of cotton by 20%YoY, the core yarn margins of spinning segment failed to improve significantly as the prices of cotton yarn declined by 18%YoY. Impending increase in gas tariffs by ~53%, which will likely come into effect from Apr’15 will further hit the margins of the textile sector. NML, with its ability to protect margins at the higher end of value chain, is our top pick in the sector with a target price of PKR161/sh and offering an upside of 45% on the last closing. However, the negative consequences of lifting of moratorium on death penalty will remain key downside risk to our base case estimates. World Inventory levels at record levels: On back of i) strong production data from India, Pakistan and US, ii) higher opening inventory and iii) limited demand of cotton as China rolled back its aggressive procurement policy, the current stock to use ratio of the world for the commodity stands at 99% as per USDA’s latest reports. Resultantly in 2015‐16, cotton is likely to be much less attractive to plant due to falling cotton prices while prices for competing crops such as maize and soy have recovered from price downturns witnessed in Sep’14‐Oct’14. Consequently, the area under cultivation for cotton is likely to fall by 5%‐7% across all the major cotton producing countries, excluding Pakistan. On the demand side, USDA expects the global consumption to remain flattish in 2015/16. However, prices for polyester have also fallen much faster than cotton prices for much of the season, eroding the price attractiveness of cotton. On back of the said reasons, we expect the prices to remain range bound in the next cotton season and prevent a free fall similar to the one we saw in 2014‐15 season where the cotton prices declined by ~20%. Pakistan on course for record production: Pakistan is on course to record ~11%YoY jump in the cotton production which is going to take the production of the commodity to historical high levels of 14.5mn bales. The prices of cotton have hovered around PKR4,600/maund – PKR5,100/maund since the turn of year as the cotton season draws close. Government has set the area under production target for 2015/2016 at 3.2mn hectare which will be 14%YoY higher. However, we expect the target to be downward revised given depressed prices of the commodity. Yarn prices shrinking in tandem: Given persistent dumping of Indian yarn coupled with falling international prices, local yarn prices remained under pressure posting decline of 18%YoY in 8MFY15. Despite the imposition of 15% import duty on Indian yarn, the outlook on cotton yarn prices remains bleak due to falling prices of close substitute polyester. Jehanzaib Zafar jehanzaib.zafar@bmacapital.com +92 111 262 111 Ext: 2062 Investment Perspective: NML, with its diversification throughout the value chain, and its ability to protect margins at the higher end of value chain, is our top pick in the sector with a target price of PKR161/sh and offering an upside of 45% on the last closing. However, the negative consequences of lifting of moratorium on death penalty and hike in gas tariffs will remain key downside risk to our base case estimates. 1