It certainly looks as if textile mills took rising demand for granted. Even as cotton prices more than doubled in the last year or so, prices of yarn cruised in tandem as booming demand for fabric—both in the local and world markets—enabled mills to pass on the price rise. Cotton spinning mills such as Vardhman Textiles Ltd, KPR Mill Ltd, Alok Industries Ltd and Ambika Cotton Mills Ltd ended fiscal 2011 (FY11) with record revenue and profit growth.
But with cotton prices on a roller-coaster ride since January, mills may well spin a doleful story in the next few quarters. After a 40% jump between January and March, cotton prices nosedived in April by a similar magnitude. Normally, this would benefit spinning mills. Instead, crashing prices left mills holding high-cost inventory, which they had piled up fearing a further surge in cotton prices.
Compounding this, domestic demand for cotton yarn, too, snapped last month. Demand in world markets has also cooled off. Therefore, yarn prices are now down to two-thirds of March levels and are expected to soften further. Most mills are stuck with huge stocks of unsold yarn, forcing a production cut of at least 25%.
Lower offtake and lower prices will result in revenue contraction in the near term. Also, marking down of high-cost inventory will drag down operating margins, and translate into cash losses for some mills. The scenario is in sharp contrast with FY11, when the industry was operating at 90% capacity utilization, enjoying average operating margins of around 22%, and net profit of most large mills nearly doubled.
The volatility in stock prices of market leaders such as Vardhman Textiles, AlokIndustries and KPR Mill, and those of mid-cap firms such as Precot Meridian Ltd in the last five months signalled difficult times. A research report by Crisil Ltd last year had cautioned about a deterioration in financial risk profiles of spinning mills in the short term, especially for those that were expanding capacity on borrowed funds. Rising interest rates will raise finance costs and weigh on profitability.
The industry is hoping that this will be a temporary blip. As yarn prices stabilize at more reasonable levels and cotton output improves, demand may pull back gradually. Yet, the first six months will see cotton mills post a relatively poorer performance when compared with the year before, which in turn will hit stocks.