Southern India Mills Association’s (SIMA’s) statement assuring spinning mills of stable cotton prices and supply should provide mills some comfort. The sharp 10-15% rise in cotton prices in the domestic markets between October and February had led to concerns about cotton supplies for the season.
But latest estimates indicate that cotton production of around 34.5 million bales for the 2016-17 season should be more than adequate to meet the demand from spinning mills. This should check a further rise in the price of cotton. Moreover, international prices are expected to be benign as well, thanks to a bumper crop in Australia, an 18% increase in production in the US and restricted imports by China.
If cotton prices remain stable from here on, it will help contain raw material costs for a few quarters ahead. Meanwhile, higher domestic demand for textiles and garments and higher exports will improve demand for yarn. Price of yarn (40s count) is up by around 14% over 12 months.
Leading mills such as Vardhman Textiles Ltd, KPR Mills Ltd and Ambika Cotton Mills Ltd have reported double-digit year-on-year (y-o-y) growth in sales over the past three quarters, although exports have been subdued during this period.
And despite the high cotton prices and the challenges related to demonetization, these companies managed stable operating margins over the past three quarters in the range of 18.5% to 20%. Thanks to the robust performance, stocks of these firms have rallied substantially in the past year and are now trading close to the 52-week high prices.
To be sure, stocks of spinning mills still trade at relatively low valuations of 10-12 times estimated one-year forward earnings. The cyclicality and vagaries of the cotton crop tend to suppress valuation. And while SIMA’s assurance of stable cotton supply may support stock prices, the upside may well be limited for the above-mentioned reason. For any re-rating, investors will look for news of higher yarn exports on the back of higher global demand.