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Textured Jersey Lanka PLC (TJL)

Target price

LKR 18.92|BUY 31 December 2013

Bloomberg: TJL SL Equity

Fundamentally sound counter backed with good business acumen

Key Data

TJL is a brand which is synonymous with commitment to innovation, quality and speed in its production of weft-knit fabric. It has created a unique positioning with its brand among its clientele as a dynamic textile mill adhering to global standards with a Sri Lankan touch. TJL is a brand recognized with eco friendly manufacturing initiatives being a leading green mill in the region. We recommend a BUY for TJL as we believe the company will (1) carry forward its improved margins to the future reverting only minimally to a sustainable level, (2) continue to improve/build/maintain on their existing portfolio of clients building critical mass to further its client base, (3) have minimal financial stress on the company’s earnings due to the capital structure reflecting a position free from debt capital and, (4) the potential upside of the stock at current prices.

Company as a % of Total Market Cap (%) 52 Week High (LKR)

0.40% 12.70

52 Week Low (LKR) Free float (%)

7.6 15.83

Focus on business process improvements complementary to margins The company has been successful in maintaining its margins with FY2012 being the marginal exception (due to volatility in cotton prices affecting the margins). In the most recent financial year (FY2013) TJL recorded 11.59% and 9.28% as its gross and net profit margins respectively, which are the highest recorded margins since the company’s listing. Client centred efficient Customer Relationship Management A key strength of TJL is the approach utilized to manage relationships with its international clientele. The company takes a considered approach in terms of managing each of its clients and respective needs. Unique propositions have been built and we believe this will contribute positively to their relationships with their respective brand as well as to widen their client portfolio, contributing to the company’s growth plans as well.

655.00

Price at evaluation (LKR) Market Capitalization (LKR b)

15.2 9.96

Market data as at 31 December 2013 Key Shareholders (As at 31 March 2013) Pacific Textured Jersey Holdings Ltd

40.00%

Brandix Lanka Ltd

30.08%

Y S H I Silva

2.44%

Employees Provident Fund

2.11%

Melstacorp Limited

1.93%

J.B. Cocoshell (Pvt) Ltd

1.86%

MAS Capital (Private) Limited

0.83%

Financial snapshot FY ends 03/31/XX

2012

2013

2014

2015

2016

LKR (Mn) Revenue

12,364

10,951

12,594

14,357

16,511

EBIT

833

955

976

1,077

1,230

Net profit

629

1,016

1,057

1,170

1,343

Valuation EPS (FY2014)

1.61

Applied P/E (X)

11.61

FMV (Earnings)

18.73

BVPS (FY2014)

9.88

Applied PBV (X)

1.71

FMV (Equity)

16.89

DCF Valuation

18.92

Share price performance 7,500

Minimal financial stress on bottom-line As a result of the recent change in TJL’s capital structure, the absence of long term borrowing will have a positive impact on the company’s bottomline with finance service obligations being minimal. The current structure will also offer alternatives in terms of financing with favourable terms given its current structure.

6,500

Index value

7,000

6,000 5,500 5,000 4,500 4,000 3,500 3,000

18.0 Market TJL

15.0 12.0 9.0

LKR/share

Number of issued Shares (m)

6.0 3.0 -

Source: Bloomberg, Candor

Valuation of TJL is attractive at current prices. Our DCF valuation suggests a value per share of LKR 18.92 which translates to an upside of 22.10% to the current price of LKR 15.50. Our P/E and P/BV based valuation also support the DCF valuation. Given the prospects for Textured Jersey we are positive on the return potential that the Company can generate in the medium to long term holding period.

M. Usama Jiffry usama.jiffry@candorh.com +94 112 359 135

1


The investment case Business process improvements contributing to improved margins The Company’s performance when considering its profit margins since its IPO period has been noteworthy. The GP margin picked up from 8.45% in 2009 and has continuously been in excess of 11.5%, the only exception being FY2012 due to the volatility in cotton prices. Net profit margins also followed suit witnessing a constant growth, 2012 though being the outlier again. The 2013 period for TJL was a notable one, as the company displayed one of its best performances despite the drop in the top line. Margins at the gross level recorded 11.6% versus the previous year’s 10.3% mainly due to the focus on process efficiencies, innovation and marketing. Cost control strategies and working capital management coupled with the depreciation of the Sri Lankan Rupee contributed to the improved performance measures at the net margin levels. In spite of the challenging environment with the decrease in average selling prices and drop in volume the company surpassed the Rs. 1b net profit milestone. Profitability analysis Profitability analysis

Margin analysis Margin analysis

1,400,000

14.0%

1,200,000

12.0%

1,000,000

10.0%

800,000

8.0%

600,000

6.0%

400,000

4.0%

200,000

2.0% 0.0%

2011A Gross profit

2012A Net profit

2013A

2011A Gross Profit Margin Net Profit Margin

2012A 2013A EBIT Margin

Source: Company information and Candor Analysis

Sustainable client base and goodwill TJL has over the years built a strong relationship with the international brands it interacts with. The company has been committed to reliability and this has contributed positively to their association with the respective brands. TJL’s leading customers include some of the most recognized brands the world over including Victoria’s Secret (United States), Marks and Spencer (British), Intimissimi (Italian), Decathlon (French) and DBA. Business development being a continuous pursuit, the company has in the recent past been successful in adding further heavy weights to its portfolio. Unique selling propositions have been developed to manage clients in responding to individual clients unique positioning and requirements, putting the company in good stead with its clientele. We believe this will bode well for the company in its future business development initiatives. 2


Key Clients of the Company Marks and Spencer - United Kingdom

Intimissimi - Italy Intimissimi is a part of Calzedonai S.p.A Group in Italy. The brand has become one of the largest intimate apparel suppliers for the EU. TJL is the sole fabric provider for Intimissimi in Sri Lanka.

A company with over a 129 year history operating in over 50 territories worldwide employing almost 82,000 people. M&S is one of the market leaders in the UK for womenswear, lingerie and menswear.

Victoria's Secret - United States

Decathalon - France

Victoria's Secret is a US based global leader in women's intimate apparel. TJL has been a continuous supplier to VS since 2003. The brand has been the largest growing brand year on year for TJL.

Decathalon is a french retailing company which is considered one of the largest sports retailers in the EU. TJL's association with Decathalon goes back 3 year's, and is considered as one of the fastest growing brand under the emerging brands category.

Minimal financial stress with long term borrowings being settled TJL’s capital structure has changed to reflect a debt free position. The company’s net cash position was utilized to pay down debt and in its recently concluded financial period (FY2013), the company’s balance sheet was free from long term debt. From a Rs. 2.3b debt value in FY2011, the Company now only carries the bank overdraft as a debt obligation to the value of Rs. 359.9m. As a result of the capital structure being debt free, the company recorded a net finance income for the period of Rs. 59m. The obligation free status coupled with the cash position of the company (FY2013 cash balance Rs. 2.1b.) offer TJL more flexibility in its operations without burdening the bottom-line. Cost control, a notable efficiency measure Energy being a component of the manufacturing process, the increase in the cost of energy is a salient risk to maintaining the company’s operating margins. During the 2013 financial year the company has invested in a multi-fuel boiler that meets the steam requirements for manufacturing as well as contributes one megawatt of electricity to the Company’s electricity requirement. Reduced dependency on furnace oil and the national grid for energy needs from this strategy is expected to bring in substantial energy cost savings. Continuous dividend play TJL is a company with a substantial dividend payout ratio. The company had a dividend payout of 48% and 66% respectively in 2012 and 2013. Following a residual dividend policy taking into consideration the future growth prospects and the remainder being distributed to the shareholders, TJL has been rich in providing a current income to its shareholders.

3


Strategic long term focus TJL envisions itself to be the leading weft-knit fabric solutions provider in South Asia by offering innovations in products and processes. The company in the past has been adept at displaying an innovative culture, both in its products and process efficiencies. We believe the company will leverage its competencies and the expertise of the parent company, Pacific Textiles (one of the largest and most profitable mills in China) to make the company’s presence felt in the South Asian region. We forecast a notable growth for the company’s top-line in the medium to long term, with the somewhat normalizing international markets in which TJL’s key customers operate in. Regional expansion and product innovation are also an area we see the company engaging in more visibly and therefore adding to its repertoire. The most recent additions to the client portfolio including the likes of G-Star, Calvin Klein and PVH is also a positive factor contributing to the diversification of the clientele and consequently reducing dependency/risk from a particular client. New clients represent slightly different geographical areas, in North America and in Europe; this would assist the company to further penetrate into the respective markets.

4


Future opportunities Regional expansion… looking further down the line TJL envisages being the leading weft knit fabric solutions provider in South Asia. The company’s continuous quest for innovation and quality will hold it in good stead in competing with the regional players. The foreign parent of the company Pacific Textiles, being one of the largest and most profitable mills in China, will also add to the repertoire of expertise for the company. The company is looking at regional expansion strategies and is exploring the channels by which to exercise the same. We expect only limited investments to the local expansions but a more focused and amalgamated approach for the regional expansion integrating the business effectively to create value. The company has shown acumen in controlling its overheads and managing costs, to even bring out one of the best performances despite a notable top line decline (FY2013). We believe the potential to expand in the region and the objective of efficiency improvements will contribute positively to the company’s future. Sustainability of client portfolio TJL has in the past maintained a solid partnership with its clientele. We believe the rapport built with the clients will hold the company in good stead. The company has expanded its client base to include additional brands which are also leading names in the industry. In addition to the world renowned Victoria’s Secret, Marks and Spencer, Intimissimi, etc, TJL has also added on Calvin Klein, PVH and G-Star to its client portfolio. As part of the product improvement pursuit TJL is also looking at upgrading its cotton based products portfolio to include value added goods. This development has allowed the company to use its reputation with existing clients to penetrate the value added fabric market. This is also complementary as a means of gathering further business in the respective segment. New product development allows the opportunity to diversify the client base thus trimming down the reliance on the existing clients. The strategy is also supportive to shift into high value products from cotton blends. As per company information value added products currently account for 20% of the turnover.

5


Key risk Key risk factors

Economic concerns in key client markets

Volatility in yarn prices Escalating energy costs

Notable International client markets The European Union and US markets being key markets for TJL, the respective economies seeing constrained growth presents a risk. Nevertheless, long run remedial strategies to address the respective economic circumstances faced by the countries will contribute positively to TJL’s position. Volatility in cotton prices will affect the company in direct proportions given that yarn is a key ingredient as a direct cost. TJL being in the business of knitted fabric, cotton is the main component of the raw materials. Unlike in a conventional setting, where when the raw material prices increases the company’s margins are tightened, TJL has the opportunity to pass on these direct cost fluctuations to the customers. Fact remains though from a demand side perspective the cost will have a knock on effect on the end users demand for the output. Thus the manufacturer’s derived demand will also be compromised, and will hence influence the company’s performance as well. In the event that there is a significant volatility in the cotton prices this will cause concern for the company. Energy being a core cost component, the impact of escalating energy costs in Sri Lanka... a potential weakness The rising energy prices present an impediment to the company. This is a salient risk given the high energy consumption in its manufacturing process. The energy cost factor will have direct implications to the margins of the company and hamper the company’s pursuit of continuous improvement in margins.

6


Mitigating the risks Margins and quality TJL has invested in new machinery facilitating innovative manufacturing processes. The processes are expected to be more effective and increase efficiencies thus complementing the company’s margins. In the pursuit of improving margins further the company is also revisiting the current traditional dyeing process with the intention of reducing the dyeing time, energy usage and cost associated as well as normal loss/margin of error. Energy cost escalation The operations being dependent on energy increasing energy prices have a direct influence on the company’s performance. The performance of the company was faced with a concern as a result of the most recent electricity tariff amendments. TJL’s investment in a multi fuel boiler which meets the steam requirements in the manufacturing process will also be generating one megawatt of electricity as well contributing to reduced dependency on electricity from the national grid. The company expects the combined results to substantially reduce the dependence on furnace oil and the national electricity grid thus complementing the margins further from energy savings. Product development and client sourcing TJL’s business development perspective is a continuous process looking at augmenting their client portfolio as well as new product development. Increasing the number of clients will diversify the company’s risk of any reliance on a single customer. The new product development initiatives will look to value added products which can be channelled through the existing clients themselves given the reputation of the company. The value added products strategy will also complement the company to penetrate this related market further in the respective international market.

7


Valuation Our DCF valuation suggests a value per share of LKR 18.92 which translates to an upside of 22.10% to the current price of LKR 15.10. Given the potential of the company to leverage its competencies backed by a strong parent and brand we expect the company to see an encouraging growth. We expect the growth in revenues to continue whilst maintaining its margins at a sustainable level which will give stability to its bottom-line. At an FMV value range of Rs. 16.89 – 18.92 we believe this is an opportunity for the medium to long term investor and hence our BUY recommendation.

Valaution summary 52 week range

DCF Value

P/E based value

PBV based value

0

5

10

15

20

Investor ratios 14.00

25.00%

12.00

20.00%

10.00 8.00

15.00%

6.00

10.00%

4.00 5.00%

2.00

0.00

0.00% 2011A

2012A

Source: Candor Analysis EPS (LKR)

2013A

2014E BVPS (LKR)

2015F

2016F ROE (%)

8


Income Statement FY ends 03/31/XX 000's LKR Revenue Cost of Sales Gross profit Othe income Distribution expenses Administrative expenses EBIT Finance income Finance cost Net foreign transaction and translation losses / (gains) Net finance income/(cost) Profit before tax Income tax Net profit Balance Sheet FY ends 03/31/XX 000's LKR Non current assets Property, Plant and Equipment Capital work in progress Intangible assets Lease rentals paid in advance Current assets Inventories Trade and other receivables Cash and cash equivalents Total Assets Current liabilities Trade and other payables Borrowings-current Bank Overdrafts Non Current Liabilities Borrowings Deferred tax liabilities Retirement benefit obligations Capital and reserves Stated capital Exchange equalisation reserve Retained earnings Equity Equity and Liabilities

2011A 9,284,583 (8,195,116) 1,089,467 7,889 (78,665) (287,867) 730,824 1,375 (32,946) 6,598 (24,973) 705,851 (21,119) 684,732

2012A 12,363,531 (11,088,147) 1,275,384 48,177 (93,462) (397,460) 832,639 72,626 (78,616) (164,677) (170,667) 661,972 (33,041) 628,931

2013A 10,951,455 (9,681,753) 1,269,702 29,097 (78,544) (265,083) 955,172 78,614 (5,006) (14,447) 59,161 1,014,333 1,614 1,015,947

2014E 12,594,173 (11,133,249) 1,460,924 25,188 (100,753) (409,311) 976,048 98,235 (15,000) 83,235 1,059,283 (2,436) 1,056,847

2015F 14,357,358 (12,691,904) 1,665,453 28,715 (114,859) (502,508) 1,076,802 111,270 (15,000) 96,270 1,173,071 (2,698) 1,170,373

2016F 16,510,961 (14,562,668) 1,948,293 33,022 (132,088) (619,161) 1,230,067 131,262 (15,000) 116,262 1,346,329 (3,097) 1,343,232

2011A

2012A

2013A

2014E

2015F

2016F

2,473,360 71,527 50,871 81,454 2,677,212

2,592,635 16,646 45,017 98,176 2,752,474

2,288,643 67,758 41,082 93,396 2,490,879

2,232,397 167,758 41,082 93,396 2,534,633

2,316,509 267,758 41,082 93,396 2,718,745

2,478,528 417,758 41,082 93,396 3,030,764

3,215,671 1,310,853 22,357 4,548,881 7,226,093

2,075,471 1,464,775 1,279,261 4,819,507 7,571,981

1,795,172 1,382,736 2,196,949 5,374,857 7,865,736

2,196,148 1,621,715 1,795,737 5,613,600 8,148,233

2,538,381 1,888,091 2,047,977 6,474,449 9,193,194

2,952,431 2,171,304 2,245,183 7,368,919 10,399,683

1,897,909 2,259,408 4,157,317

1,303,948 594,208 62,993 1,961,149

1,632,736 359,897 1,992,633

1,677,613 1,677,613

1,912,479 1,912,479

2,234,272 2,234,272

2,301 43,071 54,154 99,526

72,772 54,071 126,843

67,678 55,154 122,832

67,678 55,154 1,677,613

67,678 55,154 1,912,479

67,678 55,154 2,234,272

1,597,229 194,105 1,177,916 2,969,250 7,226,093

2,797,229 991,335 1,695,425 5,483,989 7,571,981

2,797,229 908,971 2,044,071 5,750,271 7,865,736

2,797,229 900,000 2,773,391 6,470,620 8,148,233

2,797,229 900,000 3,583,486 7,280,715 9,193,194

2,797,229 900,000 4,468,181 8,165,410 10,399,683

9


Key Financial Indicators 2011A Earnings and profitability Gross Profit Margin EBIT Margin Net Profit Margin Return on equity Per share data Earnings per share (LKR) Book value per share (LKR) Dividend per share (LKR) Capital and Leverage Avg. capital employed Net debt (cash) Valuation multiples P/E (times) EV/EBITDA (times) P/BV (times) Dividend yield Workig capital ratios Inventory turnover (days) Debtors turnover (days) Creditors turnover (days)

2012A

2013A

2014E

2015F

2016F

11.7% 8% 7% 23.06%

10.3% 7% 5% 14.88%

11.6% 9% 9% 18.09%

11.6% 8% 8% 17.30%

11.6% 8% 8% 17.02%

11.8% 7% 8% 17.39%

1.19 4.53 -

1.00 8.37 0.48

1.55 8.78 0.66

1.61 9.88 0.50

1.79 11.11 0.55

2.05 12.47 0.70

5,914,234 (685,053)

6,110,446 (2,196,949)

6,875,668 (1,795,737)

7,723,063 (2,047,977)

8,165,410 (2,245,183)

na na na na

7.19 5.32 0.86 6.7%

6.38 6.62 1.13 6.7%

9.61 8.88 1.57 3.2%

8.68 8.19 1.39 3.5%

7.56 7.32 1.24 4.5%

na na na

87.09 40.97 52.70

72.96 47.45 55.36

65.43 43.54 54.26

68.08 44.61 51.62

68.81 44.87 51.97

5,654,578 2,239,352

Disclaimer: The report has been prepared by Candor Equities Limited (CEL). The information and opinions contained herein are based upon information obtained from sources believed to be reliable and made in good faith. Such information has not been independently verified and no guarantee, representation or warranty, express or implied is made as to their accuracy, completeness or correctness. All such information and opinions are subject to change without notice. This document is for information purposes only, and the description of any company or their securities mentioned herein is not intended to be complete and this document is not, and should not be construed as, an offer, or solicitation of an offer, to buy or sell any securities or other financial instruments.

10


tjl_jan10_2014