The European Union (EU) has granted duty free access to Pakistani made-ups under the Generalized System of Preference (GSP) Plus status from January 01, 2014. The GSP Plus status will provide Pakistan duty free or preferential duty rate access on 3,500 products to EU markets where currently Pak textile exports to the EU draw an 11% duty. We believe the new trade concessions are likely to bode well for the Pak textile chain and should augment export revenues where the EU is one of Pakistan’s major trading partners. With the approval of GSP Plus status, Pakistan’s export revenues are likely to be enhanced by US$500mn-US$1bn annually, as the industry will look to maximize capacity utilization. From our vantage point, textile exporters with (1) a higher share of value-added and made-up goods in their product mix and (2) spare capacity they can harness to ramp up production on short notice would be the biggest beneficiaries. With 35% of its revenue driven by EU exports, we flag Nishat Mills Ltd (NML: TP Rs125; Buy) as a key beneficiary while Nishat Chunian Ltd (NCL: TP Rs65; Buy) with 8% of revenues linked to EU export should also reap some benefits.
Yesterday, the International Trade Committee (INTA) of the EU parliament voted in majority to approve duty free access for Pakistan and 9 to the EU, effective January 1, 2014 under the GSP Plus status. Currently, Pakistani textile exports to the EU are subject to 11% duty, which makes it difficult for Pakistani products to compete against cheaper alternatives available from India and Bangladesh, where both countries already hold GSP Plus status. Under the new trade concessions, almost 20% of Pakistani exports will be allowed to enter the EU at zero tariff while a further 70% will be allowed to enter at preferential rates. To recall, in FY13 the textile sector contributed 53% (US$13.1bn) to Pakistan’s total exports of US$24.6bn where as per available data, the EU’s share in Pakistan’s textile exports stands at ~27-30% (FY12 detailed numbers are the latest available).
With the approval of GSP Plus status, Pakistan’s export revenues are likely to be enhanced by US$500mn-US$1bn annually, as the domestic textile industry will look to maximize capacity utilization. While first round impact is likely to be visible in those categories which are most exported to the EU (made-ups, home textiles etc), we also see a potential second round upside for Pak exporters. Note that according to Pakistan Textile Export Association (PTEA), Pakistan exports ~US$5.0bn worth of yarn, plain & dyed fabric to different countries which in turn add value to Pakistani yarn and fabric and re-export it to the EU. Post GSP Plus status; we believe the domestic textile industry is likely to take the benefit of adding value itself and increase direct exports to EU on preferential of zero rates. With the GSP plus scheme kicking in from January 2014 (2HFY14), we raise our FY14E textile export target by 3% to US$14.6bn (from US$14.2bn earlier) and lift FY15F textile export target by 5% to US$16.3bn.
For Pak textile companies under our coverage, we see both Nishat Mills Ltd (NML) and Nishat Chunian Ltd (NCL) as key beneficiaries of the new trade concessions to EU where both companies derive more than 70% of their revenues by export sales. That said, our discussion with management suggests NML is likely to be the frontrunner in terms of GSP Plus gains where EU exports account for 35% of NML’s revenue vs. 8% of NCL’s. That said, with the onset of GSP Plus status this share is likely to grow, where NCL gains from the new concessions could grow on the back of a possible strategic shift in the geographical and product mix of its exports.
NML: We maintain our liking for Nishat Mills Ltd (NML) with a Target Price of Rs125 where the stock offers a potential upside of 34% at current levels. We anticipate net revenues for NML to grow at 4-year (FY14E-18F) CAGR of 7% coupled with steady-to-higher margins. In addition, healthy dividend stream from group companies is likely to keep supporting the bottom line. We eye (1) sharper Pak Rupee depreciation against US Dollar (likely to result in better margins), and (2) higher revenues from exports to EU (35% of total export revenue in FY13), as key triggers for earnings. Currently, NML is trading at FY14E PE of 5.0x and we maintain our ‘Buy’ call on the stock.
NCL: NCL had a dismal start to FY14 posting below expected EPS (diluted) of Rs1.12, down 40%YoY mainly on account of higher fuel and power costs. However, going forward we anticipate earnings to pick up on account of (1) the company’s 14MW grid station is anticipated to come online in FY14 and reduce energy costs and (2) dividend income from its power arm (Rs750mn to be recognized in 2QFY14 and Rs281mn in 3QFY14). In addition, acquisition of Taj textile and new expansion of 22k spindles (operational from November) are likely to kick start revenues during the coming quarters. We eye a 4-year (FY14E-18F) revenue CAGR of 7%. With almost 8% of revenue coming from exports to EU, NCL stands at a sweet spot to reap benefit for its home textile segment by exporting to EU under the GSP plus status from January 1, 2014. Post 1QFY14 result, our FY14E earnings outlook stands at Rs3.0bn (EPS: Rs15.19), up 34%YoY and 4% higher than our earlier expectation of Rs2.9bn (EPS: Rs14.54). We maintain our ‘Buy’ call on the stock with our Target Price of Rs65.