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Morning Call about Cotton Outlook – Arif Habib Limited

Karachi: Higher anticipated production is pushing the prices down

Local cotton arrivals are up by 15.47%
According to data released by Pakistan Cotton Ginner Association (PCGA), arrival of cotton bales in the country reflected a jump of 15.47% YoY to 9.65mn bales as on Dec 01’ 2011, mainly due to bumper production from Punjab which jumped by 43.30% mitigating the effect of 31.84% fall in Sindh production due to flood in the province.

According to Arif Habib Limited, in Pakistan cotton production is being targeted to 13.5mn bales for FY12 against last year’s production of 11.7mn bales, which was ravaged by the floods. The expected jump in cotton output is mainly because of an anticipated 8% YoY increase in the area under cultivation, coupled with higher usage of BT Cotton Seeds.

Global Demand and Supply of Cotton
According to the estimates published by United States Department of Agriculture (USDA), world cotton output is expected to jump by 7.06% to 123.42mn bales in FY12 on the back of 7% increase in harvest area to 35.8mn hectares. China and India will remain the major contributors with growth of 10% (to 35.8mn bales) and 8% (to 27.5mn bales) respectively.

On the other hand world cotton consumption is expected to decline from 114.17mn bales in FY11 to 111.34mn bales in FY12 showing a dip of 2.5% mainly due to slowdown in global growth outlook, particularly that stemming from the recent EU debt concerns and sluggish US economic growth.

Cotton Prices on the decline
Cotton prices, both in international and local markets have witnessed a massive decline as international cotton prices have reached to USD 0.85 per pound whereas the domestic cotton prices have trenched to PKR 5,100 per maund. On domestic front cotton prices remained under pressure as cotton arrivals have started to pick up.

On the other hand decline in international cotton prices are following other commodities as fear of global economic turmoil magnifies. Arif Habib Limited believes local price will continue to remain under pressure as local millers are reluctant to buy at current levels.

Margins may squeeze for Ginners and Spinners
Cotton prices in the local and international markets have dropped to the level of PKR 5,100 per maund and USD0.85 per pound; the ginning and spinning sector seem to be in stormy waters as their margins will be squeezed as cotton prices are continuously declining. However, Weaving, Composite and other value added units like NML and NCL will benefit from lower yarn prices. Usually NML buy its raw material twice in a year in the month of May and October.

Recommendation
Arif Habib Limited is reiterating Arif Habib Limited’s Buy stance on the stock of Nishat Mills Limited (NML) with Sum of the part (SOTP) based June 2012 target price of PKR 66.75 per share. At the closing price of PKR 40.54 per share, the scrip offers an upside potential of 64.6% from Arif Habib Limited’s target price. NML is trading at a forward P/E and P/BV of 3.24x and 3.68x respectively.

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