Nishat Chunian Ltd (NCL) recently announced intentions to separate its subsidiary Nishat Chunian Power Ltd. (NCPL) as an independent entity. That is, it will transfer its holding in NCPL to the existing shareholders of NCL, in turn becoming a pure textile company itself. To recall, NCL presently has a 51% stake and controlling interest of NCPL. We think this is a wise move by NCL management, which will unlock greater value for its shareholders than by keeping NCPL as a subsidiary.

For the past few years, NCPL has faced many predicaments – mounting circular debt, a NAB investigation, and other litigations. NCPL is among RFO based power plants, which are being phased out in Pakistan; therefore, its probable under-utilization in future casts doubt over its profitability and cash-flows, in our view.

We estimate for every 1 share held by NCL shareholders, 0.782 of NCPL will be received (or for every 128 shares of NCL, shareholders will receive 100 shares of NCPL). NCPL contributes PKR6.0/sh to our SoTP based valuation of NCL (TP: PKR60/sh). Post divestment of NCPL, our TP for NCL will be PKR54/sh, all else the same.

Benefits for NCL and its shareholders

Less cash-flow drain for NCL: The spin-off would save NCL from injecting cash in NCPL through future loans, in our view. Instead, NCL can invest money into its core textile business, which is thriving amid healthy export demand for Pakistani textiles. Other large textile companies, such as Gul Ahmed (GATM) and Interloop Ltd (ILP) are investing much more than US$100mn each into capacity expansions.

Potentially value unlocking event: NCPL’s woes have overshadowed the stock price performance of NCL, despite stupendous earnings growth of the core textile business. Note that in recent past, most holding companies on the PSX – such as Engro Corp, Nishat Mills, and Kohinoor Textile Mills – have tended to trade at a big discount to the sum of values of their constituent companies and have underperformed the stocks of underlying companies.

For comparison, we look at two past transactions: (i) Akzo Nobel divesting non-paint businesses of ICI Pakistan in 2012-13, and (ii) GSK Pakistan (GLAXO) demerging its Consumers business into GSK Consumer Healthcare (GSKCH) in 2017-18. In both cases, the original shareholders (of ICI and GLAXO) benefitted from significant returns post demerger, even though the stocks of the holding companies declined post demerger. In both cases, the market assigned greater value to the asset being demerged and as a result the shareholders of ICI and GSKCH earned a 1yr return of c.45%/c.6.0x from their investment (though c.15% less than index return for the latter, while the former earned c.6.0x more than the index return). However, the difference between those two transactions and NCL’s case is the fact that NCL is a more attractive asset than that it is demerging. We think that post demerger, NCL shareholders will benefit from monetizing the NCPL shares and potentially realize greater capital upside on NCL (a pure textile company with strong earnings growth in the medium term).

Outlook on NCL’s core textile business

NCL’s core profitability will remain robust, as strong yarn margins and inventory gains on cotton are likely to recur in the coming quarters (inventory procured until September-October 2022, as per channel checks). However, rising gross margins will be checked by multiyear high coal prices. Nonetheless, the Spinning segment of NCL will continue to ride the growth in demand for Textile exports. The recently approved Textile Policy 2020-25 will ensure that the industry remains competitive in the global markets, in our view. We reiterate our Buy stance on NCL and look to revisit our estimates on availability of quarterly accounts.

Courtesy- Intermarket Securities Limited.