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InterMarket Perspective

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Research Entity Number – REP‐085

25 May 2016

Tanveer Ahmad [email protected] +92‐21‐37131600 Ext. 102

• We initiate coverage on Nishat Mills Limited (NML), with a Buy* rating and a SoTP based TP of PkR151/share (upside: 32%). The textile business is valued at PkR33/share while the portfolio of group companies is worth PkR118/share, after applying a 30% holding company discount. NML trades at FY17F P/E of 6.9x, at a 29% discount to the market.

• After bottoming out in FY15, NML’s core textile dynamics are now on an uptick backed by cotton price stabilization and a tilt towards value addition underpinned by planned doubling of garment capacity to 14.4mn units by 2017. This should act as a trigger where we see core textile profits delivering a 56% CAGR across FY15‐20F, with EPS CAGR projected at 13%.

• NML has arguably been a value trap over the last few years, but this is set to change. We point to (i) improving textile dynamics, (ii) rally in DGKC share price which is now NML’s most valuable holding, and (iii) better outlook for MCB given expected interest rate upcycle from 1QCY17. The group’s new ventures in Hospitality, Entertainment and Dairy – NML has exposure to all – also provide a hidden growth element.

Core textile on uptick NML’s core pre‐tax profitability fell 84%YoY in FY15 to PkR385mn, the lowest since FY08, as yarn sales dropped due to curtailment of Chinese demand, coupled with collapse in cotton prices (down 24%YoY). Since then, the textile business has significantly improved with core pre‐tax profits up more than 5x in 9MFY16 on resilience in value‐added segment, slight improvement in pricing and sharp reduction in financial charges (down 45%YoY). While spinning dynamics remain challenging due to uncertain China cotton reserve policy, we believe the value add‐driven turnaround in textile dynamics is sustainable; we see a 56% CAGR for core textile income in next 5yrs on mix shift towards value addition with impetus from planned doubling of garments capacity to 14.4mn units by 2017 (denim additions). NML – flagship of the Nishat Group The Nishat Group maintains interlocking shareholdings, most prominent being 31% stake in DGKC (Cement), 51% stake in NPL (Power) and 7.5% stake in MCB (Bank). Dividend income from portfolio of group companies has over the last 10yrs contributed one‐third of NML’s pre‐tax profits. While we project dividend income to grow at a sedate 7% CAGR in next 5yrs, there is a hidden growth element where the group’s new ventures into hospitality, entertainment and dairy are primarily held within the NML umbrella. Given Nishat Group’s leading status in Pakistan, it is interesting to note that its main holding company NML is worth just US$384mn, significantly lower than market capitalizations of US$1,685mn for ENGRO, US$1,420mn for FFC and US$1,858mn for LUCK. Is NML a value trap? Our TP of PkR151/share comprises of PkR33/share for the textile business and PkR118/share for the portfolio at a 30% holding company discount. Although we believe textile dynamics certainly act as a trigger, the market has historically tied NML’s share price performance with MCB’s price performance but not so much with DGKC. That said, we highlight that (i) the DGKC stake is now worth more than the MCB stake and (ii) MCB’s dividends have increased over time. In our view, the market has failed to reconcile these where NML trades at a forward P/B of 0.5x, at the lower end of its historical band. Besides the textile turnaround, triggers that can help NML’s price performance include possible rebound in MCB share price (MSCI EM inclusion; decision due in Jun’16) and, over the medium‐term, projected increase in DGKC’s dividends that will help reduce MCB’s overarching dominance. Key risks: These include (i) volatility in cotton prices, (ii) adverse currency movements, (iii) shortage of raw materials, (iv) reduction in dividend payouts from associates, and (iv) any significant reduction in portfolio value particularly MCB and DGKC.

Discounted proxy to Pakistan; initiate with a Buy

Nishat Mills Limited

Nishat Mills Ltd. Price (PkR/sh) 114.52TP (PkR/sh) 151.00Stance BuyUpside 32%Fwd D/Y 5.8%Total Return 38%Bloomberg / Reuters NML PA / NISM.KAMkt Cap (US$mn) 38452wk Hi‐Low (PkR/sh) 122.05‐86.833m Avg. Daily Vol ('000 shrs) 1,5563m Avg. Traded Val (US$mn) 1.51

NML Valuation Snapshot*

FY15 FY16F FY17F FY18F EPS (PkR) 11.13 13.95 16.45 17.94 EPS Growth (%) ‐29% 25% 18% 9% P/E (x) 10.3 8.2 6.9 6.3 ROE (%) 5.1% 6.2% 7.0% 7.4% ROA (%) 3.9% 4.8% 5.4% 5.7% DPS (PkR) 4.5 5.6 6.6 9.0 Div Yield 4.0% 4.9% 5.8% 7.9% BVS (PkR) 216.6 224.9 234.8 243.8 P/BVS (x) 0.53 0.51 0.48 0.47 Non‐Core Inc (PkR) 10.1 10.5 11.7 11.3 Core Income (PkR) 1.0 3.4 4.7 6.7 Non‐Core Inc. % 91% 76% 71% 63% Core Income % 9% 24% 29% 37% Source: IMS Research

* as of 23rd May NML vs. KSE100 index

‐30%

‐15%

0%

15%

30%

May‐15

Jul‐1

5

Aug‐15

Oct‐1

5

Nov‐15

Jan‐16

Feb‐16

Apr‐1

6

May‐16

NML KSE100 Index

Source: IMS Research

Perspective

NML’s underappreciated holding company franchise (US$mn)

175 384

1,420

1,685 1,858

‐

400

800

1,200

1,600

2,000

AHCL NML FFC ENGRO LUCK


Core income is rebounding

0500

1,0001,5002,0002,5003,0003,5004,000

FY10

FY11

FY12

FY13

FY14

FY15

FY16

E

FY17

F

FY18

F

FY19

F

FY20

F

(PkRmn)

Core Textile Income


Value Addition: Garments contribution to revenue on the rise

28% 24% 20%

27%24% 21%

33%44%

37%

6% 8%19%

0%

20%

40%

60%

80%

100%

FY10 FY15 FY20

Spinning Weaving Processing & Home Textile Garments


Non‐core income (dividends) to still dominate

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25

0%

20%

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100%

FY13 FY14 FY15 FY16E FY17F FY18F FY19F FY20F

Core Non‐Core EPS PkR‐Rhs


DGKC stake is now the most valuable (US$mn)

0

50

100

150

200

250

NCL LPL PKGP NPL MCB DGKC


Stock at lower end of P/B band; portfolio not fully priced in

Jul‐0

8

Jan‐09

Jul‐0

9

Jan‐10

Aug‐10

Feb‐11

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Sep‐12

Mar‐13

Sep‐13

Apr‐14

Oct‐14

Apr‐15

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May‐16

(x)1.00

0.75

0.50

0.25


Nishat Mills Limited – Chart Bank

3 | P a g e

Perspective About Nishat Mills Limited (NML) Bearing its Group’s name, NML commenced its business in 1951 and today is the most modern and largest vertically integrated textile company in Pakistan. The Nishat Group is one of the leading business entities is South Asia, with highly diversified presence in all mainstream sectors including Textile, Banking, Cements, Power generation, Insurance, Hospitality, Dairy, Real estate, Paper products and Aviation. NML’s operations are divided into six segments: Spinning, Weaving, Dyeing, Home textile, Garments and Power generation. Overall the company has 32 specialized manufacturing units located in Lahore, Faisalabad, Ferozewatan and Sheikhupura. Major chunk of revenue, 44%, is constituted by Processing and Home textile while Spinning and Weaving each contribute 24%. Garments add 8% to Revenue.

• Existing capacity of garments division is 7.2mn units per year. After becoming operational in 4QFY16, the new denim Garment plant, with production capacity of additional 7.2mn garments per year, will touch 50% of its available capacity by the end of Dec’16. The total production of the Garments division will escalate up to 12 million garments per year in the first phase by the end of Dec’16 and will touch 14.4 million garments per year during the year 2017. NML’s expansion in garments capacity is a key driver for our estimates for NML’s sales growth.

• To enhance the product range in Weaving division, the company has procured 16 210CM Tsudakoma looms which will start production in 4QFY16. The company is planning to replace 68 170CM looms with wider width looms; 280/340CM, by the end of FY17.

• In Power generation division, to ensure the availability of energy at low Fuel cost, 9MW coal fired plant has been commissioned at Lahore. For Spinning production in Faisalabad, a 9.5MW Wartsila tri‐fuel generator is expected to be commissioned in Nov’16. For garments division, a coal fired boiler is under planning. Currently, NML generates and distributes power using all major fuels i.e. oil, gas, coal, steam and biomass.

PLANT CAPACITY AND ACTUAL PRODUCTION (3 shifts per day)

Spinning 20s ‘000 Capacity (Kgs.) 76,412 Actual production 66,668 Utilization 87% Weaving 50 picks Capacity (Sq.Mtr.) 292,757 Actual production 279,676 Utilization 96% Dyeing and Finishing Capacity (Mtr.) 54,000 Actual production 49,921 Utilization 92% Garments Capacity Pieces 7,200 Power Plant Capacity (MWH) 698 Actual production 340 Utilization 49% Source: Company Reports

Pattern of shareholding %

25.22

8.97

7.6724.12

24.58

9.44

Sponsors Associted Cos./RPsModarabas & MFs G. PublicForeign Cos. Others

Source: Company Reports

Investment thesisThe textile business suffered in FY15 but is now rebounding, where we estimate 56% core profits CAGR across FY15‐20F (FY16‐20F: 28%pa). We conservatively value the textile business at PkR33/share. Triggers include: (i) higher garments capacity, (ii) some PkR weakness post IMF program completion in Sep’16, and (iii) stability in cotton prices.

NML’s market cap of US$384mn is at a 31% discount to the value of its holdings in listed group companies (US$559mn). Given the value of the textile business, we believe this is too steep a discount, particularly as underlying unlisted companies offer exciting growth potential in Dairy and Hospitality segments. Portfolio triggers include: (i) possible rebound in MCB share price (MCB is MSCI EM‐eligible) and (ii) expected increase in DGKC’s dividends going forward.

NML trades at a FY16F P/B of 0.5x, at the lower end of its historical valuation band. In our view, the market has not properly appraised NML’s portfolio – despite DGKC now being NML’s most valuable holding, the market continues to tie NML’s price performance with MCB’s, which we believe is not justified.

4 | P a g e

Perspective Core textile on uptick NML’s core pre‐tax profitability fell 84%YoY in FY15 to PkR385mn, the lowest since FY08, as yarn sales dropped due to curtailment of Chinese demand, coupled with collapse in cotton prices (down 17%YoY). Since then, the Textile business has significantly improved with core pre‐tax profits up more than 5x in 9MFY16 on resilience in value‐added segment, slight improvement in pricing and sharp reduction in financial charges (down 45%YoY). While spinning dynamics remain challenging due to uncertain China cotton reserve policy, we believe the value added driven turnaround in textile dynamics is sustainable; we see a 56% CAGR for core textile income in next 5yrs on mix shift towards value addition with impetus from planned doubling of garments capacity to 14.4mn units by 2017 (denim additions).

FY15 was a tough year… NML faced sluggish demand and sharp competition in FY15, compounded by a sharp fall in cotton prices (down 17%YoY) to their lowest levels in 5yrs. China played the key role in depressing cotton prices on account of lower international cotton purchases and uncertain cotton reserve management policy. Cotton yarn prices fell more steeply as customers were expecting further decline in cotton prices. In addition to lower sales (down 6%YoY), NML’s core pre‐tax profitability was adversely affected (down 84%YoY) due to PkR’s appreciation against US$, increase in minimum wages of workers from PkR10,000 to PkR12,000/month and declining cotton prices.

…but FY16 has been better Notwithstanding the 8%YoY decline in Pakistan’s 10MFY16, textile exports (US$10.4bn), which are primarily driven by weak Spinning & Weaving segments, FY16 has so far been a better year for NML. In this regard, garments exports for same period increased 4%YoY while average unit price also rose 3%YoY. For 9MFY16, despite the 7%YoY decline in NML’s topline, core pre‐tax profit was up 5xYoY, with impetus provided by improved performance of value added business, lower finance cost (down 45%YoY), lower fuel costs on better mix (down 21%YoY) and overall better cost controls. Value added business performance is attributed to improved global demand and resumption of PkR weakness against the US$.

FY16 can set stage for strong medium‐term performance We see core textile profits delivering a 56% CAGR across FY15‐20F, with EPS CAGR projected at 13%. In doing so, they will contribute an estimated 24%‐44% to NML’s profitability across the medium‐term. Key factors in driving this robust turnaround in profitability are (i) higher garments capacity, (ii) gradual uptick in cotton prices, (iii) improved exports outlook, and (iv) more cost efficient fuel mix.

Export Elasticity: effect of a 10% rise in Chinese prices on Apparel exports

From U.S. EU Pakistan 25.3% ~0% Bangladesh 13.6% ~0% Sri‐Lanka < 1% 22.5% India 14.6% 19.0% Source: World Bank

Core EPS on rise...

11%

12%

12%

13%

13%

14%

14%

15%

‐2 4 6 8

10 12 14 16

FY15 FY16E

(PkR)

GM‐Rhs Core EPS EPS

Source: Company Reports, IMS Research

NML's Margin Growth

0%

5%

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20%

0

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10

15

20

25


EPS PkR‐Lhs GM NM


We foresee sustainably improving core earnings

0.0

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4.0

6.0

8.0

10.0

12.0

FY10

FY11

FY12

FY13

FY14

FY15

FY16

E

FY17

F

FY18

F

FY19

F

FY20

F

Core Pre‐tax EPS (PkR) Source: IMS Research

5 | P a g e

Perspective

Higher garments capacity NML’s expansion in garments capacity should be a major sales driver; total production of the Garments division is set increase to 12mn garments per year in the first phase by the end of Dec’16, up from 5.8mn garments last year. Production is then slated to touch 14.4mn garments per year during 2017. The impetus for this increase in garments capacity emanates from NML’s new denim plant (effectively doubling NML’s total garment production capacity). It is estimated that Global denim market will cross US$64.1bn by 2020, where we believe NML has significant room to penetrate. We point to Indian Denim industry catering to only 5% of global demand despite utilization levels pegged at 80‐85%. Being higher up the Textile chain, value‐added sections, especially garments, have higher gross margins. Moreover, the make‐to‐order feature of garments makes them less price elastic. From FY10‐15, NML had average GMs of 17.8% on garments as compared to 16% on home textiles and 13% on spinning. Additionally, NML has long‐term working relationships with top global brands such as Carreman, Chaps, John Lewis, Revman, J.K.N. International, Next, Pincroft Dyeing, Ocean Garments, Tommy Hilfiger, and Tommy Bahamas, which provide dependable revenue streams for existing and prospective productions. We forecast NML to sustain a 5 year average gross margin of 14.7% and an average net profit margin of 11.0%, through FY16‐20F.

Stability in prices to support core ROE A simple DuPont analysis (break‐up of core‐ROE) reveals that the most important driver of core ROE in near future will be price growth. This is because NML will likely not change its capital structure in the future, as no more expansion projects may be planned before a full revival of the textile business; and, depressed commodity prices will further diminish the need for incremental leverage, in our view. Further, we note that historically NML has maintained net margins at around 11% (adjusted for one‐off events like unusual spike in cotton prices in 2011 and PKR appreciation in 2014‐15). This is in part attributed to NML operating a vertically‐integrated business model, size of operations, and adequate contribution from value‐added products. This leaves Asset Turnover as the major driver of ROE, in our view. In a modest volume growth environment, price growth therefore becomes paramount.

What drives price growth? Broadly, cotton prices and exchange rate. A further break up of sales CAGR of NML since 2003 shows that cotton price CAGR and average PKR depreciation together have contributed more than volume growth (taken as residual). The present depressed scenario in the Textile industry of Pakistan has not surprisingly coincided with a stable currency (improving macros; IMF) and declining cotton prices (precisely, China).

Garments: Mounting constituent of net sales

0%

4%

8%

12%

16%

20%

0%

10%

20%

30%

40%

50%


Spinning Weaving Processing & HT Garments GM‐Rhs


Garments capacity of NML is projected to rise to 14.4mn garment per year vs. 5.8mn garments in 2015, underpinned by new Denim Plant.

No more expansion projects may be planned before a full revival of the textile business.

6 | P a g e

Perspective Expect normal PKR depreciation rate: We think PKR appreciation without discreet government intervention in currency markets is elusive, even as the present macro‐economic backdrop is much better than that seen in 2008‐11 period. In our view, the PKR will continue to follow the historical average depreciation against the USD of 4‐6% per annum in the future. This view is supported by (1) the long‐term interest rate differential of the two currencies; (2) Pakistan likely to remain a net importer (particularly of oil); (3) end of IMF program this year; and (4) uptrend in oil prices. Having said that, an FDI led and triggered by the onset of CPEC projects may serve to preserve the currency’s value in the near term. All in all, appreciation is a far‐cry phenomenon, in our view, and the 4‐6% annual run rate is adequate for NML’s export competitiveness and profitability.

Rising cotton prices are beneficial for NML: Contrary to the general conception that higher raw material prices will cut into margins, NML evidently benefits with rising cotton prices, not the other way round. This is because product prices (down the chain) tend to move in tandem with cotton prices. We will be more positive about NML’s core profitability with rising cotton prices. It is worth mentioning that textile business inherently has high costs (plant O&M, wages, finance cost etc) which lends high operating leverage. Therefore, rising prices will benefit profitability. For cotton prices, we have used USDA and Bloomberg assumptions. Broadly, the commodity is expected to experience a period of steady and moderately rising prices in the next five years. Based on these reasons, we expect NML’s core ROE to rise from a low of ‐0.42% in FY15 to 9% by FY20.

Product prices tend to follow cotton prices very closely

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50

100

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‐

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4.0

6.0

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FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15

Garments (US$/pc) Made ups (US$/mtr) Gray Cloth (US$/mtr)

Yarn (US$/kg) COTLOOK‐A (US₵/lb) ‐RhsSource: IMS Research, Bloomberg

DuPont Analysis FY16‐20F

ROE8%

Net Profit Margin4%

Financial Leverage1.8x

Asset Turnover1.0x


Core NPM is projected to stay stable around 4%.

NML may not increase leverage in absence of expansion until full recovery of Textiles.

ATO is the key driver of ROE, led by cotton price growth and moderate PkR

depreciation.

Since 2003, price has contributed more in Sales than PkR depreciation & Volume (CAGR FY03‐15)

2.8%

5.3%

3.9%

Cotton Avg. US$ Rate Avg Volume

Source: Company Reports, Bloomberg & IMS Research

For every 1% depreciation in PkR against US$, NML’s EPS increases by PkR0.19/share.

Cotton prices and PkR/US$ exchange rate are the two key factors to track for NML’s core profitability.

7 | P a g e

Perspective Gradual uptick in cotton prices Over the short term, international cotton prices may remain stressed on account of China’s cotton reserve management. Currently, cotton prices are hovering around US₵60.8/lb. Over the medium term, we expect moderate and gradual recovery in cotton prices. We estimate cotton prices to clock in at US₵63/lb to US₵68/lb through FY16‐20F. On the local front, current cotton cultivation is going down by 28%YoY (after 2015‐16 crop failure; production down 30%YoY) and will stretch raw cotton prices on account of increase in demand following an improvement in the energy supply situation (uninterrupted gas supply to Punjab‐based textile mills after a gap of 6yrs). We see local cotton prices on a gradual uptick as well.

World Cotton Prices 2015/16: According to USDA, Cotlook A is estimated to average US₵69/lb for 2015/16, on account of lower demand growth for cotton and ambiguity for China’s cotton reserves policy. For NML in 2015/16, incorporating regional and global dynamics, we estimate average cotton cost of US₵63/lb.

2016/17 Projection: World Cotton Production, Consumption, Prices: USDA projected Cotlook A index for 2016/17 at US₵67/lb, complemented by China’s cotton reserve management policies, low manmade fiber prices and weak demand growth. For marketing year 2016/17, the U.S. upland average farm price is projected to rise to US₵63/lb. For NML, we estimate cotton cost of US₵66/lb for 2016/17.

Improved exports outlook As per FY15 financial statements, export sales accounted for 78% of NML’s revenue where EU and the US are the two major markets. Export potential is certainly available. As per ITC, despite Pakistan being the lowest cost supplier to EU, it still has a relatively small share in Ready Made Garments compared to its non‐EU competitors.

Cotlook A (US₵/lb) vs. Local Cotton Prices

500

3,500

6,500

9,500

12,500

25

75

125

175

225

275

Mar‐11 Mar‐12 Mar‐13 Mar‐14 Apr‐15 Apr‐16

COTLOOK A Index PkR/Maund‐Rhs

Source: IMS Research, Bloomberg

NML (PkR/Share) vs. Cotlook A (US₵/lb)

10

60

110

160

210

260

10

35

60

85

110

135

160

Jul‐11 Mar‐12 Nov‐12 Aug‐13 Apr‐14 Dec‐14 Aug‐15 May‐16

NML PkR/Shr. COTLOOKA Index‐Rhs

Source: IMS Research, Bloomberg

NML Sales Breakup

0

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100%


Exports Local Sales PkR mn‐Rhs


NML's Exports Break‐up

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60%

FY13 FY14 FY15 FY16E FY17F FY18F FY19F FY20FEurope Asia, Africa and Australia U.S. & Canada


For every US₵1/lb increase in international cotton prices, NML’s EPS increases by PkR0.6 per share.

8 | P a g e

Perspective Furthermore, according to the World Bank, a 10% increase in China’s apparel prices due to increased labor cost would result in about 8% (~US$700 million) decrease in US apparel imports from China. It is estimate d that almost half of this shortfall (~US$336mn) could be filled by incremental demand from Pakistan. This can dovetail with gradual market share enhancement; in 2015, Pakistan had an estimated 3% share in the US apparel import market, which could grow as Pakistani textile manufacturers including NML tilt further towards value added segments.

Margin uptick amid commodity down‐cycle In 9MFY16, NML witnessed handsome jump of 5.5x YoY in core profitability. With no material change in the overall textile supply‐demand dynamics, this was largely attributed to the ongoing plunge in finance cost, oil prices and the consequent energy cost savings. Furnace Oil (FO) is used in captive power plants, contributing about 30% to the overall energy mix. FO prices are down 42% in the past 12 months. Another hurdle in textile profitability has been gas outages, which not only had put pressure on energy costs (due to substitution to more expensive FO or national grid) but also disrupted important operations. Energy cost has on average been 10% of NML’s cost of sales.

The significance of falling energy costs also lies in the fact that Pakistan’s textile exports have not been competitive against those from regional counterparts like India, Bangladesh or Vietnam. One reason has been the disparity in energy costs in Pakistan and its competitors. This is also why the impact of EU GSP+ status has not led to significant jump in volumes, although weak euro and falling exports elsewhere are other reasons. Now, the cost disadvantages have fairly muddied matters as it is almost equivalent to generate power on gas, furnace oil and coal. NML’s decision to install tri‐fuel generators proved productive. For 9MFY16, NML’s management curtailed fuel cost by 21%YoY on account of massive reduction in FO and RLNG prices. This benefit can potentially sustain given management’s ongoing focus on in‐house energy generation. • In power generation division, to ensure the availability of energy at low fuel cost,

9MW coal fired plant has been commissioned at Lahore. In addition to electricity, it will also produce 25 tons of steam per hour.

• For Spinning production in Faisalabad, a 9.5MW Wartsila tri‐fuel generator is expected to be commissioned in Nov’16.

• For Garments division, a coal fired boiler is under planning.

Going forward, NML will continue to benefit from low oil price scenario and greater gas availability with increasing LNG imports.

Fuel costs to increase only gradually

020406080100120

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20

40

60

80

100

FY11

FY12

FY13

FY14

FY15

FY16

EFY17

FFY18

FFY19

FFY20

F

'000

Richards Bay (API4) ‐US$/MTFO Import (PkR/ton)‐Lhs

Source: Bloomberg, IMS Research

9 | P a g e

Perspective NML – flagship of the Nishat Group The Nishat Group maintains interlocking shareholdings, most prominent being 31% stake in DGKC (Cement), 51% stake in NPL (Power) and 7.5% stake in MCB (Bank). Dividend income from portfolio of group companies has over the last 10yrs contributed one‐third of NML’s pre‐tax profits. While we project dividend income to grow at a sedate 7% CAGR in next 5yrs, there is a hidden growth element where the group’s new ventures into Hospitality, Entertainment and Dairy sectors are primarily held within the NML umbrella. Given Nishat Group’s leading status in Pakistan, it is interesting to note that its main holding company NML is worth just US$384mn, significantly lower than market capitalizations of US$1,685mn for ENGRO, US$1,420mn for FFC and US$1,858mn for LUCK.

Shareholding across the Nishat Group NML has stakes in multiple group companies, both listed and unlisted. The listed companies are dominated by NPL (51%), DGKC (31.4%), and MCB (7.5%) with the market value of NML’s shareholding summing to PkR59bn (US$559mn). This portfolio results in significant dividend income for NML (FY15: PkR2.94bn; 67% of pre‐tax profits). At the same time, NML also has stakes in the group’s unlisted ventures including potentially high growth prospects such as Hospitality and Dairy which are as yet not contributing to the bottom line (only Security General Insurance Company is currently contributing from among the unlisted investments).

NML’s major holdings MCB Bank Ltd. Nishat Power Ltd. DG Khan Cement Company

High CAR (~20%) means that despite challenges to growth in near‐term, MCB provides strong anchor dividends to NML. Our TP of PkR199/sh for MCB implies a Sell but our valuations do not factor in NIB acquisition (due diligence underway).

NML’s marquee power sector exposure, NPL offers a forward D/Y of 9.8%, which is 376bps higher than 12m T‐bill yield. Power sector dynamics are improving, particularly with respect to circular debt, which bodes well for steady dividends from NPL.

Running at full capacity but poised to enter the South market in next few years with an eye on CPEC‐driven growth. Provided that pricing discipline sustains across the medium‐term, DGKC should be able to increase its dividends over time.

Market value of listed portfolio: US$559mn

BV of

Investments: US$26mn

10 | P a g e

Perspective Dividend income is significant The bulk of NML’s dividend income arises from its three biggest investments MCB, NPL and DGKC which together contributed 90% of FY15 dividends in a 42%/32%/16% split. We estimate dividend income to contribute PkR3.7bn in FY16F, 24%YoY higher than PkR2.94bn in FY15, with higher contributions from DGKC, NPL and MCB. Going forward, we conservatively project dividend income to grow at a 5‐yr CAGR of 7%. Of note is our expectation for higher dividends from DGKC. For FY16F, DGKC is forecasted to provide PkR688mn in dividends (up 43%YoY), which translates to about 20% of NML’s total dividend income. However, DGKC’s dividends are projected to grow at a 15% CAGR across the medium‐term, thereby increasing its contribution to NML’s dividend income to 24% by FY20F.

High growth ventures NML’s unlisted companies contain several high potential prospects, adding a growth flavor to the company. While most of these do not yet contribute to the bottom line, the Nishat Group’s track record gives us comfort on execution capability and eventual success. Some of these include Nishat Linen (Private) Limited: It sells garments, home linen and accessories through a network of 70 branded stores in 29 cities, both in Pakistan and abroad including the GCC, UK and North America. Nishat Hospitality (Private) Limited: Incorporated in 2011, Nishat Hospitality undertakes the business of hotels/apartment houses and restaurants/cafes both inside and outside Pakistan. FY15 revenue stood at PkR265mn (+5x YoY) although the company is currently operationally in losses. Nishat Hotels and Properties: Until June, 2015 NML has invested PkR500mn in Nishat Hotels and Properties so far against the approval of PkR1bn by Mar’14 for the period of three years. At the time of approval, the basic loss per share and break‐up value were PkR0.37 and PkR12.26 respectively. As of June 30, 2015 the basic loss per share is PkR0.09 and break‐up per share has worsened to PkR9.91. Nishat Dairy (Private) Limited: Operating since 2011, the dairy farm spreads over 165 acres, with the principal objective of carrying out corporate Dairy business in Pakistan (B2B). The farm has a capacity of 4,500 milking animals and with the total herd size of 6,200 cows, Nishat Dairy is the largest dairy farm in Pakistan. For clean energy supply to the farm, the company owns and operates 1MW solar power plant. Nishat Paper Products Company Limited: Nishat Paper Products Co. Ltd. specializes in customized paper sacks production (2‐4 ply Sacks and Roto Seal Sacks). Equipped with most modern and state‐of‐the‐art PLC system, the company has two Windmoller and Holscher’s sack converting machines. With production capacity of over 300 bags per minute by each converting line, these are the only machines available in Pakistan. The plant is situated adjacent to D.G Khan Khairpur cement unit and is in close vicinity of two other big cement producers. The major customers include MLCF, DGKC, LUCK, BWCL, FCCL and ACPL.

Other Income to PAT (PkR mn)

‐500

1,000 1,500 2,000 2,500 3,000 3,500 4,000 4,500 5,000

FY11 FY12 FY13 FY14 FY15 FY16E FY17F FY18F FY19F FY20F


Contribution to Dividend Income

‐

1,000

2,000

3,000

4,000

5,000

0%

20%

40%

60%

80%

100%

FY15A FY16E FY17F FY18F FY19F FY20F

(PkRmn)

NPL DGKC LPLPKGP SGICL NCLMCB Div/Year Rhs


Attractive high growth ventures can potentially rerate valuations.

11 | P a g e

Perspective

Is NML a value trap? Our TP of PkR151/share comprises of PkR33/share for the textile business and based on IMS internal valuations, we assign PkR118/share for the portfolio, at a 30% holding company discount. Although we believe textile dynamics certainly act as a trigger, the market has historically tied NML’s share price performance with MCB’s price performance but not so much with DGKC. That said, we highlight that (i) the DGKC stake is now worth more than the MCB stake, and (ii) MCB’s dividends have increased over time. In our view, the market has failed to reconcile these where NML trades at a forward P/B of 0.5x, at the lower end of its historical band. Besides the textile turnaround, triggers that can help NML’s price performance include possible rebound in MCB share price (MSCI EM inclusion; decision due in Jun’16) and, over the medium‐term, projected increased in DGKC’s dividends that will help reduce MCB’s overarching dominance.

Valuation We have valued NML using SoTP method. Our DCF based core business value is PkR33/share, using FCFF while the portfolio of group companies is valued at PkR118/share after applying 30% holding company discount. We have used risk free rate of 8.5% and market risk premium of 6.5%, resulting in WACC of 15%.

Nishat Mills Limited FY16E FY17F FY18F FY19F FY20F

Valuation EBITDA Core 4,748 5,349 6,255 7,030 7,615Tax (559) (659) (718) (775) (830)Capex (2,129) (2,164) (2,357) (2,610) (2,771)Working capital (996) (434) (801) (1,296) (415)FCFF 1,065 2,093 2,378 2,349 3,599Terminal growth rate 3%Discounted FCFF 1,065 1,820 1,794 1,537 2,042

Beta 1.3 RfR 8.50% Market risk premium 6.50% CAPM 17% WACC 15%

Debt weight 18% Equity weight 82%

PV FCFF 8,258 Terminal Value 31,314 PV Terminal Value 18,004 Less: Net Debt 14534 Enterprise Value 11,728 Core business Valuation 33

Listed Portfolio Value Target Price Holding (mn shrs)

NPL 8,995 50 181DGKC 27,377 199 138PKGP 2,572 25 103LPL 2,625 24 109MCB 16,526 199 83NCL 940 35 27AICL 6 54 0Value of Portfolio 59,041 Conglomerate discount 30% Listed Portfolio Value/share after discount 118 Core Valuation/share 33 SoTP Based TP 151

Holding Company Discount

WAC

C

151 20% 25% 30% 35% 40%

13% 181 173 164 156 147

14% 173 165 156 148 140

15% 168 159 151 143 134

16% 161 153 144 136 128

17% 157 148 140 131 123 Source: IMS Research

12 | P a g e

Perspective

Diverse underlying portfolio Practically a holding company for the Nishat Group, NML has holdings across a diversified set of sectors including Cements, Banks and Power, among others. The market value of NML’s stakes in listed group companies is US$559mn vs. NML’s own market capitalization of US$384mn.

DG Khan Cement: Third largest cement manufacturer (capacity: 4.2mn tons) which is set to increase by 2.8mn tons once South expansion is complete. DGKC stands out due to consistent cost reduction initiatives (e.g. 30MW coal CPP). We see DGKC raising its payout ratio from 30% in FY15 to 40% in FY20F.

MCB Bank: The fourth largest bank in Pakistan in terms of assets, MCB is a best‐in‐class bank as indicated by its 20%+ CAR, high NIMs (CY15 est.: 5.5%), strong asset quality (coverage: 91%; reversals in 7 of the last 10 quarters) and superior cost efficiency (CY15 C/I: 36%). Although banks may post soft earnings over the next year, medium to long term outlook is bright considering interest rates are anticipated to rise (current headline rates are at all‐time lows).

Nishat Power: The bellwether power company under the Nishat umbrella, NPL is a 200MW Residual Furnace Oil fired IPP, falling under the Power Policy 2002, located in District Kasur near Lahore. NPL has a PPA with NTDC. The plant achieved commercial operation in Jun’11 and operates on an average fuel efficiency of 46% vs. 45% benchmark, constantly generating at over 80% load factor.

NML has historically tracked MCB NML’s share price has long tracked MCB (10yr correlation: 53%). This is partly why NML has been a value trap over the last few years where banking sector price performance in general and MCB’s own price performance in particular have been under a cloud due to soft earnings growth outlook which is trimming ROE. That said, we believe the market has mispriced NML on two counts: NML’s DGKC stake is now worth more than its stake in MCB; US$236mn vs. US$178mn, but the market continues to move NML in tandem with MCB, ignoring DGKC’s performance in the process. MCB contributes (42%) more to NML’s divided income compared to DGKC (16%). If the market attaches more value to dividend receipts, then it is worth mentioning that MCB’s dividends have doubled over last 5yrs and are expected to continue rising. Specifically, we believe the market cannot have it both ways ‐ If the portfolio value is the key determinant for valuing NML, then the rise in DGKC share price must reflect in NML’s market cap. Alternatively, if dividend income is key, then there is limited rationale to penalize NML for fall in MCB share price as MCB’s dividends have increased over time.

NML’s portfolio provides strong exposure to banks, construction and energy.

NML‐ a value trap?

‐200%

0%

200%

400%

600%

800%

0

50

100

150

200

Jul‐0

3

Jun‐04

Jun‐05

Jun‐06

Jun‐07

Jun‐08

Jun‐09

Jun‐10

May‐11

May‐12

May‐13

May‐14

May‐15

May‐16

Portfolio NAV (PRs) NML (PRs) Prem./Disc. ‐Rhsto Portfolio Value


NML‐tied with MCB

‐50

100 150 200 250 300 350 400

Jul‐0

3Jan‐04

Jul‐0

4Feb‐05

Aug‐05

Mar‐06

Sep‐06

Apr‐07

Oct‐07

Apr‐08

Nov

‐08

May‐09

Dec

‐09

Jun‐10

Jan‐11

Jul‐1

1Jan‐12

Aug‐12

Feb‐13

Sep‐13

Mar‐14

Oct‐14

Apr‐15

Nov

‐15

May‐16

MCB PkR NML PkR DGKC PkR


13 | P a g e

Perspective

Discount to portfolio is too high NML’s market capitalization of US$384mn is at a 31% discount to the value of its listed portfolio, practically the same as 31% discount at the start of the fiscal year; this is despite core textile dynamics depicting an improvement in 9MFY16. Either the portfolio or the core textile operations are not being fully priced in.

We believe the current level of portfolio discount is excessively high; in comparison, ENGRO and DAWH trade at 7%‐26% discounts to the value of their listed underlying holdings.

This is further corroborated by NML’s P/B of 0.5x, which is at the lower end of its historical band (6yr average: 0.53x; with a high/low of 0.42/0.61x). As triggers unfold for NML, we believe NML’s valuations will likely expand. This could be more so the case after potential EM upgrade, where NML is a best‐in‐class textile play in Pakistan.

What can trigger NML’s price performance?

Factors that can result in improved price performance for NML include:

Turnaround in core textile dynamics: NML’s core textile dynamics have depicted improvement in 9MFY16. If this trend entrenches, it could turn market attention back to textile sector dynamics, which has been relegated to the background given a challenging operating environment. This could enable NML to partly break MCB’s hold on its price performance.

Potential key drivers of NML’s core profitability are; • cotton rebound at greater pace • improvement in global economy, and • PkR depreciation

Further rebound in MCB share price: MCB has gained 18% from its CYTD low on excitement over Pakistan’s potential reclassification as an EM market. In our view, price performance can extend upon successful NIB acquisition and/or reversal in the interest rate cycle (from 1QCY17 onwards). In this regard, we believe MCB’s high CY16F D/Y of 7.1% may provide some downward cushion if triggers do not materialize.

DGKC dividends: With a payout ratio of 30%, DGKC currently has a 16% share in NML’s dividend income. With DGKC going into expansion phase (up 2.8mn ton/pa) it will likely take on moderate debt; that said, we believe it will still be in a position to increase its dividends beyond the next 2‐3yrs. This can increase its share in NML’s dividends to 24% by FY20F.

IPOs of unlisted portfolio companies: NML contains stakes in several unlisted group companies involved in high growth areas including Real estate, Hospitality and Dairy, among others. Possible IPOs of some of these companies going forward can potentially unlock upside for NML.

14 | P a g e

Perspective

Key Risks

Unexpected cotton prices behavior Any deviation in cotton prices, materially different from our estimates, may adversely affect profit stability as the fixed costs of NML are unchanged. Ambiguity regarding China cotton dumping policy stands as a risk to cotton prices.

Adverse currency movements Almost 80% of NML’s revenue comes from exports. The appreciation of PkR against US$ and Euro will likely hurt sales volume and profitability of the company, because these also affect realized prices.

Drop in dividend income Over the years, sustained dividend income from NML’s underlying portfolio has provided cushion to the bottom line. Any decrease in our estimated dividend stream, may lead to earnings estimates being missed. The downward scenario may require poor macro environment leading to the low profitability of banks as well as price wars among cement players, but we expect otherwise.

MCB share price While we believe the market needs to give due importance to NML’s stake in DGKC, as of now there is significant correlation with MCB’s share price. In this regard, MCB may fail to perform on (i) Pakistan staying in FM space, (ii) failure to complete NIB acquisition and (iii) retention of a conservative lending stance. Alternatively, positive trigger for MCB can be anticipated increase in domestic interest rates from Jan’17.

15 | P a g e

Perspective Nishat Mills Limited – Financial Snapshot

Key Ratios FY14 FY15 FY16F FY17F FY18F EPS (PkR) 15.68 11.13 13.95 16.45 17.94 EPS growth ‐6% ‐29% 25% 18% 9% P/E (x) 7.3 10.2 8.2 6.9 6.3 BVS (PkR) 195.1 216.6 224.9 234.8 243.8 P/BVS (x) 0.6 0.53 0.51 0.48 0.47 DPS (PkR) 4.0 4.5 5.6 6.6 9.0 D/Y (%) 3.5% 4.0% 4.9% 5.8% 7.9% ROE (%) 8.0% 5.1% 6.2% 7.0% 7.4% ROA (%) 5.7% 3.9% 4.8% 5.4% 5.7% P/CFS (x) 6.0 5.6 6.6 5.3 5.1 Non‐Core Inc (PkR) 9.6 10.1 10.5 11.7 11.3 Core Income (PkR) 6.1 1.0 3.4 4.7 6.7 Non‐Core Income % 61% 91% 76% 71% 63% Core Income % 39% 9% 24% 29% 37% Gross Margin 14% 12% 13.5% 14% 15% Operating Margin 7% 4% 5% 6% 7% Net Margin 10% 8% 10% 11% 11% Debt/Equity 33% 25% 23% 22% 21%

NML – P/E Band (FY16F)

Jul‐0

8

Jan‐09

Jul‐0

9

Jan‐10

Aug‐10

Feb‐11

Aug‐11

Feb‐12

Sep‐12

Mar‐13

Sep‐13

Apr‐1

4

Oct‐1

4

Apr‐1

5

Oct‐1

5

May‐16

(x)

15

12

9

6


Income Statement (PkRmn) FY14 FY15 FY16E FY17F FY18F

Net Sales 54,444 51,178 48,182 50,710 54,885

Cost of sales 46,580 45,153 41,672 43,466 46,664

Gross profit 7,864 6,024 6,511 7,244 8,220

Dist cost 2,555 2,426 2,401 2,520 2,646

Admin cost 1,032 1,102 1,138 1,204 1,282

S&A 3,587 3,528 3,538 3,724 3,928

Other operating expenses 345 366 345 363 393

Core EBIT 3,932 2,130 2,628 3,157 3,900

Core Income EBT 2,322 385 1,335 1,857 2,614

Other operating income 3,653 4,000 4,127 4,586 4,412

Income from fin. assets 3,364 3,453 3,933 4,392 4,218

Profit from operations 7,586 6,130 6,755 7,743 8,312

EBIT 7,586 6,130 6,755 7,743 8,312

EBITDA 9,027 8,153 8,875 9,935 10,667

NPBT 5,976 4,389 5,462 6,443 7,026

Tax 463 478 559 659 718

NPAT 5,513 3,911 4,904 5,784 6,307

Balance Sheet (PkRmn) FY14 FY15 FY16E FY17F FY18F

Paid up capital 3,516 3,516 3,516 3,516 3,516

Reserves 65,073 72,627 75,569 79,040 82,193

Total Equity 68,589 76,143 79,085 82,556 85,709

Non‐current Liabilities 6,906 5,830 5,480 4,658 3,791

Current Liabilities 21,553 19,167 18,503 19,323 20,459

Total Liabilities 28,459 24,997 23,983 23,980 24,251

Total Equity and liabilities 97,049 101,140 103,069 106,536 109,960

Non‐current assets 68,274 76,950 76,956 76,928 76,930

Current assets 28,775 24,190 26,112 29,608 33,030

Total Assets 97,049 101,140 103,069 106,536 109,960

Cashflow Statement FY14 FY15 FY16E FY17F FY18F

CF from Oper. Activities 6,683 7,193 6,029 7,543 7,861

CF from invest. Activities (15,240) (9,756) (2,127) (2,164) (2,357)

CF from Fin. Activities 10,321 41 (3,032) (2,597) (3,330)

Net dec./incr. in cash 1,673 (2,750) 870 2,781 2,175

cash at beginning 1,129 2,802 52 922 3,703

Cash at end of year 2,802 52 922 3,703 5,878

NML – P/B Band (FY16F)

Jul‐0

8

Jan‐09

Jul‐0

9

Jan‐10

Aug‐10

Feb‐11

Aug‐11

Feb‐12

Sep‐12

Mar‐13

Sep‐13

Apr‐14

Oct‐14

Apr‐15

Oct‐15

May‐16

(x)1.00

0.75

0.50

0.25


16 | P a g e

Perspective

I, Tanveer Ahmad, certify that the views expressed in the report reflect my personal views about the subject securities. I also certify that no part of my compensation was, is, or will be, directly or indirectly, related to the specific recommendations made in this report. I further certify that I do not have any beneficial holding of the specific securities that I have recommendations on in this report.

Ratings Guide* Total Return Buy More than 15% Neutral Between 0% ‐ 15% Sell Below 0% *Based on 12 month horizon unless stated otherwise in the report. Upside/Downside is defined as the percentage difference between the Target Price (TP) and the Market Price (last close).

Valuation Methodology: Please refer to page 11.

Risks: Please refer to page 14.

Disclaimer: Intermarket Securities Limited has produced this report for private circulation only. The information, opinions and estimates herein are not direct at, or intended for distribution to or use by, any person or entity in any jurisdiction where doing so would be contrary to law or regulation or which would subject Intermarket Securities Limited to any additional registration or licensing requirement within such jurisdiction. The information and statistical data herein have been obtained from sources we believe to be reliable where such information has not been independently verified and we make no representation or warranty as to its accuracy, completeness and correctness. This report makes use of forward looking statements that are based on assumptions made and information currently available to us and those are subject to certain risks and uncertainties that could cause the actual results to differ materially. No part of the compensation of the author(s) of this report is related to the specific recommendations or views contained in this report.

This report is not a solicitation or any offer to buy or sell any of the securities mentioned herein. It is meant for information purposes only and does not take into account the particular investment objectives, financial situation or needs of individual recipients. Before acting on any information in this report, you should consider whether it is suitable for your particular circumstances and, if appropriate, seek professional advice. Neither Intermarket Securities Limited nor any of its affiliates or any other person associated with the company directly or indirectly accepts any liability whatsoever for any direct or consequential loss arising from any use of this report or the information contained herein.

Subject to any applicable law and regulations, Intermarket Securities Limited, its affiliates or group companies or individuals connected with Intermarket Securities Limited directly or indirectly may have used the information contained herein before publication and may have positions in, or may from time to time purchase or sell or have a material interest in any of the securities mentioned or may currently or in future have or have had a relationship with, or may provide investment banking, capital markets and/or other services to, the entities mentioned herein, their advisors and/or any other connected parties.

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