Cotton prices have been punctured by recent forecasts of a close to 10% increase in production in the country in the 2011-12 season, coming at a time when global demand for yarn and readymade garments has been lacklustre. The price of cotton (Sankar-6 grade) has fallen from an all-time high of Rs 59,700 per candy of cotton by 43%. On the brighter side, will the resulting fall in input costs lift the profit margins of yarn spinning mills, which hit an abyss in the past two quarters?
Crisil Research, in its optimistic report last week, says that yarn mills’ operating margin could improve by 200-300 basis points (bps) in fiscal 2013, from a low of about 8% estimated in the current year. One basis point is one-hundredth of a percentage point.
Traders believe that cotton prices have bottomed out—they are down to August 2009 levels, from where they had begun spiralling month-after-month until March this year.
However, the key determinant for yarn offtake will be demand growth for readymade garments, which ultimately depends on the economic well-being of developed markets—Europe and the US. The outlook in these markets is expected to be dull for the next two quarters at least.
Only the depreciating rupee could boost export revenue, since volumes are likely to remain subdued.
But what may bring marginal relief to the yarn mills is improved demand on the home turf. This fact, and low cotton prices, could ease pressure on their profitability. The situation was slightly different in the first half of the current year. In spite of a 15-20% year-on-year growth in revenue, yarn mills’ profits tanked.
According to D.K. Nair, secretary general of the Confederation of Indian Textile Industry, of the 226 listed cotton textile firms, 187 reported poor performance with 126 posting net losses, while only a handful of integrated firms clocked decent profit growth during the September quarter.
Most spinners had stocked high-cost inventory anticipating sustained demand growth, which led to high interest cost dragging most firms into the red. For example, during the quarter, large companies such as Vardhman Textiles Ltd and KPR Mills Ltd clocked only one-third the profit of the year-ago period. Further, the southern yarn mills are plagued with a 20% power cut, which, in turn, is affecting utilization levels and operating profits. Present valuations of the yarn mills mirror the negative industry sentiments with the share prices of firms down to less than half the year-ago levels.
The good news is that most mills have cleaned both inventories and losses. The Crisil report adds, “The stock-to-use ratio, which drives the sentiments regarding cotton prices, is estimated to return to the normal level of about 2.5 months in cotton season 2011-12 from a low of 1.2 months in the previous cotton season.”
That said, the December quarter may only be a tad better as high interest costs and power paucity in some regions continue to plague firms.
A pullback in domestic demand, along with lower cotton prices, will help mills turn out better profitability. The question is, when? Ideal conditions would be when demand from the developed world improves, and the rupee remains at these elevated levels. Both, together, may be too much to ask for, but some improvement in global demand itself can provide a boost to the performance of textile companies.