Uncertainty clouds profits at yarn mills

Uncertainty clouds profits at yarn mills

The Union government has decided to cap yarn exports at 720 million kg for the current fiscal. Though this is higher than about 580 million kg exported last year, cotton yarn spinners were confident of cashing in on the buoyancy in global markets and exporting about 900 million kg.

With the restriction on exports, there will be increased supply in the domestic market, which should result in a softening of prices. Having said that, profitability of yarn mills over the next two quarters will depend on cotton prices, which account for nearly two-thirds of their costs. Cotton prices have dropped to 42,000/candy in the last few days from its all-time peak of 46,000/candy (1 candy=356kg). Even then, it amounts to a 56% jump from April. But spinning mills have been able to increase yarn prices by about 40% to offset much of the impact of rising cotton prices. This is thanks to the robust global and domestic textile markets, where demand for yarn has been rising for the last five-six quarters.

Large spinning mills such as Vardhman Textiles Ltd, Alok Industries Ltd, KPR Mill Ltd and Ambika Cotton Mills Ltd have, as a result, reported healthy revenue growth and operating profit margin in the past few quarters. For example, in the September quarter, Alok Industries clocked a 49% year-on-year (y-o-y) jump in sales with a 120 basis points increase in operating margin to about 29%. Likewise, Ambika, which gets almost 70% of its annual revenue from export of cotton yarn, registered a 300 basis points y-o-y expansion in its margin during the same quarter.

As pointed out above, the key to profitability in the near term is the outlook on cotton prices. A note from Citi says that against the Cotton Advisory Board’s estimates of 32.5 million bales, actual output of cotton in the country during the current year may be less than 30 million bales due to excessive rains in Andhra Pradesh, Gujarat and Maharashtra. Meanwhile, global output is also expected to be lower than estimated as China and Pakistan willregister a lower harvest.

But what could temper domestic cotton prices is the cap on exports at 5.5 million bales. Further, industry experts say that due to logistics constraints and a softening of demand from China (though temporary), cotton exports could be only half of the notified quantity.

If this brings greater cotton supply into the local markets, domestic prices could soften. Yarn mills would then be able to maintain profitability. Of course, integrated players such as Vardhman and Alok would be better off in managing this raw material price risk.

Yarn mills are expected to report strong y-o-y growth in revenues and profits for the December quarter, thanks to increased demand and prices. But this should be no reason for euphoria among investors, as domestic government policy and international market trends could swing long-term fortunes. Besides, it must be noted that most spinning mills expanded capacity in the last one year and funded this through debt. This would lead to higher interest costs and impact net profit, especially if yarn prices move in the opposite direction.

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