TJL reported its seventh consecutive quarter of top-line and bottom-line growth, with the company reporting net profits of LKR 454mn in Q1 FY 20, up 62.4% yoy. As the impact of the incremental capacity normalised during the period, TJL saw its volume growth slowdown, as the revenue growth of 19.2% was predominantly driven by the FX impact yoy. Gross margins improved on a yoy basis as cotton prices remained subdued while improved efficiencies also helped. We expect the company to continue to post bottom line growth in the next quarter and believe that the stock is fairly valued at the current forward multiple. As such, we maintain our TP of LKR 38.00/share (+0.5% upside; +5.8% TSR) and reiterate Hold.
Capacity reaches maximum in Q2; outsourcing for volume growth
TJL posted revenue growth of 19.2% yoy during the quarter driven by, a c6.0% increase in volumes, 1.0% price growth due to a better mix and the remainder coming from FX depreciation. With the incremental capacity impact normalising in Q1 FY 20 and the company operating at full capacity, we expect volume growth to remain in mid-to-high single digit levels. Heading into Q2 FY 20, TJL reports of a strong order book however, operating at 100% capacity, the company looks to outsource c10.0% of its volumes during the quarter, which we note will come at lower margins. Coupled with stable cotton prices, we expect TJL to end the first half of FY 20 strong.
Cotton prices to trend upwards in H2 FY 20
Subdued cotton prices helped TJL post margins of 11.9% for Q1 FY 20 (+1.4ppts yoy). We note that average Indian cotton prices were up 0.5% qoq in Q2 CY 19 (-5.5% yoy). While prices are expected to remain stable in Q2 FY 20e, TJL does not expect prices to weaken any further as Indian yarn spinners have been impacted adversely from a drop in orders from China due to the ongoing US China trade wars. This has resulted in lower cotton yarn prices to keep the capacities running. However, with these firms incurring financial losses at current prices, TJL does not expect yarn prices to weaken further. In addition, the November crop of India cotton is expected to come in 10-15% lower than last year, according to management. Apart from the government increasing the minimum support price, we believe lower supply will also result in higher cotton prices in H2 FY 20.
We maintain our margin estimates for FY 20
As noted above, TJL will outsource c0.0% of its volumes in Q2 FY 20, which will come in at lower margins. However, TJL will invest US$2.5mn on new machinery which will come into production in September, thereby increasing capacity by 5-10% and help accommodate additional volumes. With cotton prices expected to strengthen later in the year, we continue to expect gross margins to come in at 11.6% for FY 20.
We maintain our TP of LKR 38.00 and reiterate Hold
We adjust our estimates for additional capital investments coming in, but maintain our TP of LKR 38.00/share (+0.5% upside; +5.8% TSR) based on our target multiple of 13.0x P/E FY 20e. Reiterate Hold.