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Pakistan Alpha (KTML & FABL, Oct_27_2021)

AKD - Pakistan Alpha     

KTML: The real Kohinoor

• Our liking for KTML emanates from i) Robust growth in textile exports (+27.4%YoY in 1QFY22) amid higher US apparel demand and rerouting of orders from (China and Vietnam) due to massive energy/power shortage, ii) broad based growth in local spinning segment amid higher local yarn margins (49% local yarn margins vs 23.2% export yarn margin), iii) PkR depreciation, and iv) higher than expected local cotton production. We expect KTML to continue the same trajectory of topline growth with FY21-24F CAGR of 10%, similar to a growth experienced in FY21 where all the segments across the value chain contributed in growth (+40.7/43.3/30 in Spinning/Weaving/Home Textile).
• In the long run, KTML will be eyeing growth in export sales where Home textile sales in FY21 clocked in at PkR10.2bn out of which 48.2/27/20% of sales coming from US/Asia & Africa/Europe. In the Weaving segment, export sales clocked in at PkR2.34bn with Europe contributing 85.5% of the sales in FY21. Moreover, we expect KTML to continue to leverage its strong hold in US market where (US apparel imports have shot up 28.1% in 8MCY21 with Pakistan apparel exports to US increased by 66.7%YoY in 8MCY21). We expect, exports sales to register FY21-24F CAGR of 10-15%. Furthermore, on the macro front, Govt. has also provided incentives to support textile exports in the shape of financing facilities by SBP under ETF and LTFF with ~3% and 5%, respectively and reduction in turnover tax from 1.5% to 1.25% of sales. Moreover, recent release of PkR6bn under DLTL also helped textile exporters to solve liquidity problems.
• On the local front, higher cotton production target of 9.8mn bales for FY22 (expected to be surpassed) will provide breather for soaring local cotton prices (+10.7% FYTD vs 39% CYTD). We expect cotton prices, in the short term to remain elevated while in the longer run prices will retreat to last 3yr avg. of PkR10-10.5K/maund. Similarly, yarn margins will also retreat to last 3yr avg. of 45% vs 60% CYTD, in our opinion.
• KTML performance has remained sluggish (FYTD return: -ve 3%) despite robust earnings and positive outlook supporting future earnings. Moreover, taking MLCF and equity investments of Maple Leaf Capital at market value, KTML portfolio value arrives at PkR80.4/sh (incorporating 25% discount) which in essence provides core operations virtually free, while the value of company’s core operations is estimated at PkR34.4/sh using P/E ratio of 4.0x for FY22F. Consequently the fair value of KTML is estimated at PkR114.8/sh, offering 57.3% return on the last close.

FABL: Change in business model to drive value

• FABL’s net profit rose by a 7%YoY to PkR4.1bn (or PKR2.7sh) in 1HCY21. The primary reason for the improved performance was reduction in bank’s interest expense (down 33%YoY) and provisioning expenses (reversals of PkR11.5mn vs provisions of PkR521mn).Despite low interest rate environment denting the core earnings , the bank was able to grow its bottom-line through 9%YoY growth in Non Funded Income. In addition, the growth in administrative and operating expenditures were contained at 3%YoY.
• FABL is undergoing a shift in business model from conventional banking to Islamic banking where the management opted for asset led strategy for conversion where bank’s assets first will be converted first, before moving on to deposits/liabilities. Consequently, by 1HCY21, more than 70% of loans have already been converted but the process of conversion has been much slower for investments with 20% of total investment portfolio having been converted so far amid dearth of shariah compliant assets. About half the deposits now stand converted to Islamic as well, while, as per the management, another PKR100bn of deposits will be converted to Islamic by end CY21, taking total conversion ratio for deposits to 70%. If the estimated target for deposit conversion is reached, the management may succeed in achieving full conversion by 2HCY22.
• Bank’s NPLs encouragingly dropped in 1HCY21 to 6.5%, compared to 10.7% in CY17 despite an economic slowdown. This happened despite accelerated loan disbursements - gross advances grew at a +10% CAGR during CY16-20, pointing towards prudent lending policies of the bank. Resilience in bank’s NPL has so far been supported though substantial recoveries against loans and a continual decline in bank’s incremental NPL ratio, thus improving asset quality. With NPLs coming off the next matrix that needs improvement is the coverage ratio which currently stands at 82%, consequently, we may see provisioning expenses grow, however, the impact will likely be mitigated by recoveries made against toxic loans.
• During the height of its operational restructuring between CY16-CY18, the growth had stagnated somewhat, however, more recently the focus has changed where the bank is rapidly expanding branch network. Consequently, OPEX increased by 9.6% (3-yr CAGR) contrary to CY14-CY17 when OPEX witnessed a decline. However, in the long run, we expect the cost to income to settle around 55% as opposed to 60% seen in CY20.
• The scrip currently trades at price to book of 0.62x, however, conversion to Islamic banking may unlock  growth and re-rate the scrip to higher multiples.

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