AKD Quotidian about — Cotton outlook – ‘May you live in interesting times’

Karachi, December 12, 2012 (PPI-OT): As is with the famous saying “May you live in interesting times”, these are definitely interesting times for the global cotton prices scenario as despite a bumper global cotton crop in FY12 and EU slowdown, prices have surprisingly held up, primarily due to aggressive Chinese imports prompted by domestic state reserve purchases.

According to AKD Securities, however, heading into the next year, AKD Securities could sees significant reduction in Chinese cotton imports, which in turn could depress global cotton prices, as well as Chinese yarn import demand, which could potentially result in downward revisions to AKD Securities’ Textile Universe earnings estimates for FY14F.

Key takeaways from USDA: According to USDA’s Dec’12 cotton report released yesterday, global cotton inventories in FY13 will surge to a record 79.6 million bales (75% of annual consumption), following bumper cotton crop in FY12 as well as moderation in demand. Importantly, Chinese imports are forecast to fall by 53% YoY in FY13, where aggressive Chinese imports during 1QFY13 helped stabilize global cotton prices. Now Chinese import demand is expected to taper off heading into 2013 as state cotton reserves are estimated to reach 45 million tons this season, accounting for -65% of the domestic crop. Weak Chinese cotton imports next year could potentially have a hard landing effect on cotton prices. In this regard, Chinese Cotton Futures are already growing increasingly backwardated with yesterday’s 6-month future closing price settling at CNY 19,175/ton, down 1% from 30 sessions ago and 3% from 60 sessions ago.

Domestic cotton rose 6%MoM in Nov’12: Cotton prices in the month of Nov’12 averaged at PKR 6,250/maund, up by 6%MoM, indicating robust domestic demand as int’l prices during Nov’12 actually slipped by 1%MoM. As a consequence the discount between domestic and int’l cotton prices has narrowed to 9% against a historic average of 18%.

Will the textile spinners’ bonanza end? Riding on the surge in Chinese yarn imports, textile spinners profitability has bounced back sharply over the last two quarters. AKD Securities expects profitability to remain healthy in the next two quarters (Oct-Mar) till the new Chinese Cotton Reserve policy is announced (possibly in Mar’13), where AKD Securities expects considerable reduction in state support price, which could result in cheaper domestic Chinese prices, and thus reduced demand for yarn imports. As such earnings outlook for yarn manufacturers will be highly leveraged to China’s cotton procurement policy. For AKD Securities’ cotton price estimates, AKD Securities has assumed a price of USc85/lb for FY13 (USc83/lb FY13TD) and USc80/lb going forward. Weaker cotton price outlook going forward could result in downward revision in AKD Securities’ EPS estimates. As for AKD Securities’ Universe companies, earnings of NCL are more sensitive to cotton prices than NML where AKD Securities estimates that a USc10/lb reduction in cotton price will have an annualized EPS impact of PKR 2 for NCL and PKR 1.4 for NML. Impact for NCL will be higher than NML primarily