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Pakistan Textile Sector: Beneficiary of Govt. Export Focus

• Pakistan Textile Sector is all set to benefit from new Government’s export led policies and rupee devaluation of around 22% against US$ since Dec 2017. Even though sector’s market cap has improved by 12% FY19TD (vs. market return of -2%), we believe the following positive  developments have yet to be priced in: 1) Govt. aggressive focus on exports, 2) reduction in RLNG tariff to US$6.5/mmbtu, down 35-50%, 3) rupee devaluation of 22% since Dec 2017, 4) US China Trade war and 5) Pak China Free Trade Agreement (FTA) Phase II.
• Our sample of textile companies is trading at FY19E P/E of 6.1x, 24% discount to market PE. Our preferred stocks in textile are NML, KTML, NCL, and GATM.
• to focus on exports to curb current account deficit (CAD): To curb rising CAD, Govt. is striving to increase exports among other options, by reducing energy tariffs, providing incentives like drawback duties, and cheaper financing under Long Term Financing Facility (LTFF) and Export Refinance Facility (ERF). Further Govt. is negotiating on  Free Trade Agreements (FTA) with countries like China to enhance exports. Reportedly, under Strategic Trade Policy Framework (STPF), Govt. is aiming export target of US$46bn by 2023. Moreover, after recent visit of Pakistan officials to China, doubling of exports to China in one year is being worked upon. We believe, aforementioned measures/steps are likely to help Pakistan textile sector to achieve its ambitious exports target.
• Reduction in energy tariff for Textile Sector in line with regional countries: New Government has substantially reduced energy (RLNG) tariff for Punjab based 5 export oriented sectors (including textile) to US$6.5/mmbtu, down by 35-50%. With this move, Pakistan’s energy tariff comes in tandem with its regional countries (like, India and Bangladesh) at US$5-7/mmbtu, which will help Pakistan in competing with these countries.
• PKR/USD devaluation will help to regain international market share: Pakistan Rupee Devaluation of 22% since 2017 after 3 years of no exchange rate flexibility is likely to restore the lost competency of textile companies. We believe companies having largest exports exposure like Nishat Mills (NML), Gul Ahmed (GATM), Feroze Mills (FML), and Nishat Chunian (NCL) are likely to be the beneficiaries from this development.
• US-China trade war, an opportunity for players who are already present in US: Due to the ongoing trade war between world’s two largest economies, United States (US) has imposed tariff on Chinese goods worth US$250bn and has threatened to impose further US$267bn in tariff. Reportedly, US imports from China are down 30% in Aug and Sept 2018. This provides an opportunity to countries like Pakistan, Vietnam, Bangladesh and India to expand their footprint in the US market.
• China-Pak FTA Phase II on cards: Pakistan is in negotiation phase of FTA Phase II with China, which would be a breakthrough for Pakistan’s textile sector as currently Pakistan is paying tariff of 3.5% on yarn vs. 0% on Bangladesh and ASEAN countries (Indonesia, Malaysia, Thailand, Philippines, Vietnam among others). While tariffs on Pakistan’s other textile products ranges from 4-9% vs. 0% in ASEAN countries. We believe rationalization of these tariff rates in FTA Phase 2 would unlock potential of Pakistan’s textile exports to China.
• Textile Allied Industry, the indirect beneficiary: With likely support to textile exports, we expect its allied industry to also benefit in coming years, especially chemicals and polyester. Where companies like (DOL, SPL, LOTCHEM, ARPL, ICI, EPCL, SITC, NRSL, and NICL) can potentially benefit from rising textile exports.