Inter Market Perspective

Transcription

1 Inter Market Perspective Research Entity Number REP 085 Nishat Mills Limited Discounted proxy to Pakistan; initiate with a Buy 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 3 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 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$1,858mn for LUCK. Is NML a value trap? Our TP of PkR151/share comprises of PkR33/share for the textile business and PkR118/share for the portfolio at a 3 holding company discount. Although we believe textile dynamics certainly act as a trigger, the market has historically tied NML s share price performance with MCB s price performance but not so much with DGKC. That said, we highlight that (i) the DGKC stake is now worth more than the MCB stake and (ii) MCB s dividends have increased over time. In our view, the market has failed to reconcile these where NML trades at a forward P/B of 0.5x, at the lower end of its historical band. Besides the textile turnaround, triggers that can help NML s price performance include possible rebound in MCB share price (MSCI EM inclusion; decision due in Jun 16) and, over the medium term, projected increase in DGKC s dividends that will help reduce MCB s overarching dominance. Key risks: These include (i) volatility in cotton prices, (ii) adverse currency movements, (iii) shortage of raw materials, (iv) reduction in dividend payouts from associates, and (iv) any significant reduction in portfolio value particularly MCB and DGKC. 25 May 2016 Tanveer Ahmad tanveer.ahmad@imsecurities.com.pk Ext. 102 Nishat Mills Ltd. Price (PkR/sh) TP (PkR/sh) Stance Buy Upside 32% Fwd D/Y 5.8% Total Return 38% Bloomberg / Reuters NML PA / NISM.KA Mkt Cap (US$mn) wk Hi Low (PkR/sh) m Avg. Daily Vol ('000 shrs) 1,556 3m Avg. Traded Val (US$mn) 1.51 NML Valuation Snapshot* FY15 FY16F FY17F FY18F EPS (PkR) EPS Growth (%) 29% 25% 18% 9% P/E (x) ROE (%) 5.1% 6.2% % ROA (%) 3.9% 4.8% 5.4% 5.7% DPS (PkR) Div Yield % 5.8% 7.9% BVS (PkR) P/BVS (x) Non Core Inc (PkR) Core Income (PkR) Non Core Inc. % 91% 76% 71% 63% Core Income % 9% 24% 29% 37% * as of 23 rd May NML vs. KSE100 index 3 15% 15% 3 May 15 Jul 15 Aug 15 NML Oct 15 Nov 15 Jan 16 Feb 16 Apr 16 KSE100 Index May 16 To find our Research on Bloomberg, please type - IMKP <GO>

2 Nishat Mills Limited Chart Bank Core income is rebounding Value Addition: Garments contribution to revenue on the rise (PkRmn) 4,000 3,500 3,000 2, % 8% 33% 44% 19% 37% 2,000 1,500 1, % 24% 21% 28% 24% 2 FY10 FY11 FY12 FY13 FY14 FY15 FY16E Core Textile Income FY17F FY18F FY19F FY20F FY10 FY15 FY20 Spinning Weaving Processing & Home Textile Garments Non core income (dividends) to still dominate NML s underappreciated holding company franchise (US$mn) ,000 1,685 1, ,600 1, , FY13 FY14 FY15 FY16E FY17F FY18F FY19F FY20F Core Non Core EPS PkR Rhs AHCL NML FFC ENGRO LUCK DGKC stake is now the most valuable (US$mn) Stock at lower end of P/B band; portfolio not fully priced in (x) NCL LPL PKGP NPL MCB DGKC Jul 08 Jan 09 Jul 09 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

3 PLANT CAPACITY AND ACTUAL PRODUCTION (3 shifts per day) Spinning 20s 000 Capacity 76,412 (Kgs.) Actual production 66,668 Utilization 87% Weaving 50 picks Capacity 292,757 (Sq.Mtr.) Actual production 279,676 Utilization 96% Dyeing and Finishing Capacity 54,000 (Mtr.) Actual production 49,921 Utilization 92% Garments Capacity Pieces 7,200 Power Plant Capacity 698 (MWH) Actual production 340 Utilization 49% Source: Company Reports Pattern of shareholding % Sponsors Associted Cos./RPs Modarabas & MFs G. Public Foreign Cos. Others Source: Company Reports Investment thesis The 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. 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 5 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 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 CM Tsudakoma looms which will start production in 4QFY16. The company is planning to replace CM 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. 3 P age

4 Core EPS on rise... (PkR) FY15 Export Elasticity: effect of a 1 rise in Chinese prices on Apparel exports From U.S. EU Pakistan 25.3% ~ Bangladesh 13.6% ~ Sri Lanka < 1% 22.5% India 14.6% 19. Source: World Bank FY16E GM Rhs Core EPS EPS Source: Company Reports, IMS Research NML's Margin Growth 15% 14% 14% 13% 13% 12% 12% 11% 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. We foresee sustainably improving core earnings % 1 5% FY13 FY14 FY15 FY16E FY17F FY18F FY19F FY20F EPS PkR Lhs GM NM FY10 FY11 FY12 FY13 FY14 FY15 FY16E FY17F Core Pre tax EPS (PkR) FY18F FY19F FY20F 4 P age

5 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. 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 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., through FY16 20F. Garments: Mounting constituent of net sales % 3 12% 2 8% 1 4% No more expansion projects may be planned before a full revival of the textile business. FY13 FY14 FY15 FY16E FY17F FY18F FY19F FY20F Spinning Weaving Processing & HT Garments GM Rhs 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 ). 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). 5 P age

6 For every 1% depreciation in PkR against US$, NML s EPS increases by PkR0.19/share. Expect normal PKR depreciation rate: We think PKR appreciation without discreet government intervention in currency markets is elusive, even as the present macroeconomic backdrop is much better than that seen in period. In our view, the PKR will continue to follow the historical average depreciation against the USD of 4 6% per annum in the future. This view is supported by (1) the long term interest rate differential of the two currencies; (2) Pakistan likely to remain a net importer (particularly of oil); (3) end of IMF program this year; and (4) uptrend in oil prices. Having said that, an FDI led and triggered by the onset of CPEC projects may serve to preserve the currency s value in the near term. All in all, appreciation is a far cry phenomenon, in our view, and the 4 6% annual run rate is adequate for NML s export competitiveness and profitability. DuPont Analysis FY16 20F Cotton prices and PkR/US$ exchange rate are the two key factors to track for NML s core profitability. ROE 8% Net Profit Margin 4% Financial Leverage 1.8x Asset Turnover 1.0x 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) 3.9% 5.3% 2.8% Cotton Avg. US$ Rate Avg Volume Source: Company Reports, Bloomberg & IMS Research 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 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) Rhs, Bloomberg 6 Page

7 For every US 1/lb increase in international cotton prices, NML s EPS increases by PkR0.6 per share. Cotlook A (US /lb) vs. Local Cotton Prices 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 crop failure; production down 3YoY) 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. NML (PkR/Share) vs. Cotlook A (US /lb) , , , , Mar 11 Mar 12 Mar 13 Mar 14 Apr 15 Apr Jul 11 Mar 12 Nov 12 Aug 13 Apr 14 Dec 14 Aug 15 May 16 COTLOOK A Index PkR/Maund Rhs NML PkR/Shr. COTLOOKA Index Rhs, Bloomberg, Bloomberg 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. NML Sales Breakup NML's Exports Break up ,000 60,000 50,000 40, , ,000 10, FY13 FY14 FY15 FY16E FY17F FY18F FY19F FY20F Exports Local Sales PkR mn Rhs 0 FY13 FY14 FY15 FY16E FY17F FY18F FY19F FY20F Europe Asia, Africa and Australia U.S. & Canada 7 P age

8 Fuel costs to increase only gradually ' FY11 FY12 FY13 FY14 FY15 FY16E FY17F FY18F FY19F FY20F Source: Bloomberg, IMS Research Richards Bay (API4) US$/MT FO Import (PkR/ton) Lhs Furthermore, according to the World Bank, a 1 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 3 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 1 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. 8 P age

9 NML flagship of the Nishat Group Perspective 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). Market value of listed portfolio: US$559mn BV of Investments: US$26mn NML s major holdings MCB Bank Ltd. Nishat Power Ltd. DG Khan Cement Company High CAR (~2) 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. 9 P age

10 Dividend income is significant The bulk of NML s dividend income arises from its three biggest investments MCB, NPL and DGKC which together contributed 9 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 2 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. Other Income to PAT (PkR mn) 5,000 4,500 4,000 3,500 3,000 2,500 2,000 1,500 1, FY11 FY12 FY13 FY14 FY15 FY16E FY17F FY18F FY19F FY20F Contribution to Dividend Income FY15A FY16E FY17F FY18F FY19F FY20F NPL DGKC LPL PKGP SGICL NCL MCB Div/Year Rhs (PkRmn) 5,000 4,000 3,000 2,000 1,000 Attractive high growth ventures can potentially rerate valuations. 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. 10 P age

11 Is NML a value trap? Perspective 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 3 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 mediumterm, 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 3 holding company discount. We have used risk free rate of 8.5% and market risk premium of 6.5%, resulting in WACC of 15%. Beta 1.3 RfR 8.5 Market risk premium 6.5 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 Enterprise Value 11,728 Core business Valuation 33 Nishat Mills Limited FY16E FY17F FY18F FY19F FY20F Valuation EBITDA Core 4,748 5,349 6,255 7,030 7,615 Tax (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 3,599 Terminal growth rate 3% Discounted FCFF 1,065 1,820 1,794 1,537 2,042 Listed Portfolio Value Target Price Holding (mn shrs) NPL 8, DGKC 27, PKGP 2, LPL 2, MCB 16, NCL AICL Value of Portfolio 59,041 Conglomerate discount 3 Listed Portfolio Value/share after discount 118 Core Valuation/share 33 SoTP Based TP 151 Holding Company Discount % 3 35% 4 WACC 13% % % % % P age

12 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. NML s portfolio provides strong exposure to banks, construction and energy. NML a value trap? 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 3 in FY15 to 4 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 2+ 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 8 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 tied with MCB Jul 03 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 Portfolio NAV (PRs) NML (PRs) Prem./Disc. Rhs to Portfolio Value Jul 03 Jan 04 Jul 04 Feb 05 Aug 05 Mar 06 Sep 06 Apr 07 Oct 07 Apr 08 Nov 08 May 09 Dec 09 Jun 10 Jan 11 Jul 11 Jan 12 Aug 12 Feb 13 Sep 13 Mar 14 Oct 14 Apr 15 Nov 15 May 16 MCB PkR NML PkR DGKC PkR 12 P age

13 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 3, 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. 13 P age

14 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 8 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 P age

15 Nishat Mills Limited Financial Snapshot 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 Core EBIT 3,932 2,130 2,628 3,157 3,900 Core Income EBT 2, ,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 NPAT 5,513 3,911 4,904 5,784 6,307 Key Ratios FY14 FY15 FY16F FY17F FY18F EPS (PkR) EPS growth 6% 29% 25% 18% 9% P/E (x) BVS (PkR) P/BVS (x) DPS (PkR) D/Y (%) 3.5% % 5.8% 7.9% ROE (%) % 6.2% % ROA (%) 5.7% 3.9% 4.8% 5.4% 5.7% P/CFS (x) Non Core Inc (PkR) Core Income (PkR) 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 1 8% 1 11% 11% Debt/Equity 33% 25% 23% 22% 21% NML P/E Band (FY16F) (x) 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, , , , ,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, , , , ,960 Jul 08 Jan 09 Jul 09 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 NML P/B Band (FY16F) (x) 1.00 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, (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, ,703 Cash at end of year 2, ,703 5,878 Jul 08 Jan 09 Jul 09 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 P age

16 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 15% Sell Below *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. This document is being distributed in the United States solely to major institutional investors as defined in Rule 15a 6 of the US Securities Exchange Act of 1934, and may not be furnished to any other person in the United States. Each US person that receives this report by its acceptance thereof represents and agrees that it: is a major institutional investor as so defined, and understands the whole document. Investors should contact their Intermarket Securities representative if they have questions concerning this report. 16 P age