The textile sector in Pakistan is gradually recovering as fundamentals improve. The sector has rallied 3.36% since May 2015, outperforming the broader market index. Multiple interest rate cuts, the weaker Pakistani rupee, lower fuel costs, and budget incentives are boosting sector sentiment. Within the sector, the report maintains a positive view on Nishat Mills and expects it to benefit from various positive developments.

1.
Doom and gloom surrounding the country’s textile sector is slowly subsiding as the
fundamentals of the sector are recovering gradually. Consequently, the sector has
rallied by 3.36% since May’15 and in process has outperformed the index by 1.1% over
the same period. Aggressive cut in DR on back of receding inflation in the country,
recovery in PKR/EUR parity, fall in fuel and power cost and budgetary incentives given
to the sector are the key reasons behind the improvement in the sentiments. The
budgetary incentives given to the sector included, i) further cut in LTFF and EFF rates, ii)
duty draw‐backs, iii) less than anticipated increase in sales tax on exports and iv) zero
rating maintained on import of textile machinery. Though increase in minimum wage
rate to PKR13,000/month will likely increase the cost of production; overall the budget
FY16 was positive for textile sector. We maintain our conviction on NML as our top pick
in the textile sector, offering a total of return of 27% on the last closing.
Outperformance on multiple triggers: Improving textile fundamentals are slowly
beginning to be reflected in the index as the sector posted gains of 3.4% since May’15,
outperforming the KSE‐100 index by 1.1%. The positive factors that underpinned the
outperformance were i) monetary easing (cumulative cut of 300bps FYTD), ii) 8%
appreciation of EUR against PKR since its nadir in mid Mar’15 and iii) favorable FY16
budget for textile sector. The prime performer was NML giving absolute returns of 5%
over the last fortnight. On the budgetary front here are few of the biggest developments
Budget FY16; favoring textile sector:
1. The sales tax on the exports of the non value added items (yarn and greig cloth) has
only been increased from 2% to 3% while the sales tax on all the remaining categories
has been kept at their previous levels. The status quo in sales tax on value added
items will continue to keep Pakistan competitive in the EU market.
2. The cut in EFF rates to 4.5%, presents a good opportunity for textile companies
having debt availed from other sources since the rates have declined 300bps in the
last 1 year. The prime beneficiaries of this development are expected to be NML and
GATM (two companies with highest proportion of exports to the total sales) as they
can easily mobilize their short term debt from conventional borrowing to EFF.
3. The custom duty on the textile machineries have been maintained at 0%. The key
beneficiary of this consideration will be NML which is in midst of its expansion spree
and is going to reinforce its production facilities of the garments segments by 4.8mn
garments per year. In this regard, the company is behind schedule and the facility
that was to start operations by the start of FY16 will now come online towards the
end of 1HFY16.
4. In a bid to encourage new investments in the sector, LTFF rate has been reduced from
7% to 6%, which again bodes positive for the sector. NML will primarily benefit from
this cut as it has financed most of its recent expansions through LTFF.
5. As per a recent International Labor Organisation (ILO) survey, country’s labor is
amongst the cheapest in the world. However, the increase in minimum wage rates to
PKR13,000/month is likely going to add to the cost base of the industry. As per our
back of envelope working, on annualized basis this will have a negative impact of
PKR0.15/sh – PKR0.2/sh on BMA Textile Universe
Cautious optimism on improving fundamentals
Pakistan Textiles
Friday, June 19, 2015
Jehanzaib Zafar
jehanzaib.zafar@bmacapital.com
+92 111 262 111 Ext: 2065
Source: BMA Research
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Personal Goods (Textile)
KSE100 Index
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Personal Goods Sector Performance
1M 3M 12M
Absolute % 8% ‐1% ‐1%
Relative to KSE % 3% ‐8% ‐20%
Relative Chart KSE100 vs Personal Goods

2.
What now for the textile sector? Things are finally looking up for the textile sector given i)
multiple DR cuts, ii) recovery in EU zone and iii) slight increase in retention rates of the
end products. Within the BMA Textile Universe we continue to prefer NML over NCL and
GATM. NCL, given its current liquidity crunch and leveraged books, may issue another
right issue to finance its acquisition of 40MW coal fired plant which is going to keep the
price performance of the scrip in check. GATM, on the other hand, has to book huge one‐
time GIDC expense (EPS impact: PKR3.85) it reversed earlier. Nishat Mills, not with‐
standing a likely delay in the commissioning of garment unit (capacity: 4.8mn units/year),
is expected to witness a better FY16 on back of i) lower fuel and power expense due to
commissioning of 9MW coal fired plant, ii) decline in finance cost on back of easing DR, iii)
economic recovery in EU region and iv) eventual commissioning of garment unit. On last
closing, NML offered an upside of 27% on our TP of PKR148/sh.
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