Credit profile of cotton spinners to deteriorate

Covid-19 is expected to lead to drop in the revenue along with moderation in profitability margins and debt coverage indicators apart from impacting the liquidity profiles of most of the companies engaged in the sector.

Indian cotton spinning industry, which was already facing multiple headwinds such as low demand, unfavourable duty structure and fluctuating cotton fibre prices, is confronting another challenge in the form of Covid-19 pandemic. After lean demand since FY15, with intermittent spells of good periods, the Indian cotton yarn industry was expecting a change of fortune in FY20. CS 2019-20 was expected to bring some respite in the form of bumper cotton crop. The benefit which was anticipated to come from lower fibre prices is now expected to be more than offset by the fresh set of challenges brought in by the Covid-19 outbreak. 

With shutdown of manufacturing units and weak downstream demand in both domestic and export markets expected in the near term, the cotton yarn industry is staring at extremely challenging next two quarters. Covid-19 is expected to lead to drop in the revenue along with moderation in profitability margins and debt coverage indicators apart from impacting the liquidity profiles of most of the companies engaged in the sector. Smaller companies with high debt level, limited access to bank funding and limited liquidity buffer are expected to be impacted more, compared with their larger counterparts.

Challenges confronting the industry 

For the last few years, Indian cotton yarn spinners have been jostling with various headwinds including subdued export and domestic demand coupled with fluctuating cotton fibre prices. Cotton yarn exports over the last few years have taken a hit, mainly on account of subdued demand from China (largest contributor to India’s cotton yarn export). After more than doubling in FY13 (in volume terms) and increasing by more than 50 per cent in the subsequent year (on a higher base), the yearly shipments to China in FY17 slumped by more than 25 per cent from the FY14 level. Though exports to China increased by around 47 per cent in FY19, over FY18, it declined significantly by 43 per cent in 10MFY20, on a year-on-year basis. China’s major cotton yarn demand is now being catered to by Vietnam which enjoys duty-free access to China. 

In the last few years, Chinese companies have invested heavily in Vietnam to expand their spinning capacities leveraging low labor cost in Vietnam along with favorable trade agreements. In 2019, China also allowed Pakistan to supply 350,000 tonnes of yarn at nil rate of duty, while Indian cotton yarn, on the other hand, attracts a duty of 3.5 per cent in China making Indian cotton yarn less competitive in the Chinese market.

In 10MFY20, average monthly exports of cotton yarn stood at Rs.1,616 crore, significantly lower than the monthly average of Rs 2,278 crore, witnessed in the same period last year. Indian cotton fibre prices remained firm, especially in the first quarter of FY20, contrary to the international cotton prices, which made domestic cotton yarn spinners less attractive in the export market.

In addition to lower exports, demand of cotton yarn from the domestic apparel industry has also remained muted in the recent past. After witnessing a decline in two consecutive years (FY18 and FY19), apparel exports remained almost flat (marginal increase of 0.2 per cent) in 10MFY20, compared with the same period last year. Domestic demand for apparels has also remained subdued during this period.

Lower exports and muted domestic demand has resulted in an oversupply situation in the domestic market resulting in lower realisations for cotton yarn which has subsequently led to lowering of the spread (per kg of yarn sold) and weakening of PBILDT margins and interest coverage ratios, for the companies engaged in the sector. Spread (per kg), between the prices of cotton yarn and raw cotton, which remained firm in Q1FY20, started declining in Q2FY20 and remained much lower in Q3FY20, compared with the same period last year.

Financial performance of the companies in the industry

Operating income for the sample of leading companies (listed on Indian stock exchanges) in the industry increased by 11 per cent in FY19 (compared with FY18), on the back of increased export demand. However, it remained flat in 9MFY20, on a year on-year basis. In line with the operating income, the PBILDT margin also improved by 220 bps in FY19, compared with FY18. However, it declined by more than 330 bps in 9MFY20, compared with 9MFY19, on account of low demand, subdued yarn realisations and firm fibre prices. This has also led to a significant moderation in the Interest Coverage ratio from 7.79x in 9MFY19, to 5.35x in 9MFY20.

No respite despite soft cotton prices 

The Cotton Association of India (CAI) has projected a record cotton crop of 354.5 lakh bales for CS2019-2020, which is around 14 per cent higher than the last season crop of 312 lakh bales. In anticipation of higher output, and in-line with the international cotton prices, domestic cotton prices also started correcting in Q2FY20. Average prices of Shankar-6 variety remained around 9 per cent lower in the July 2019 to February 2020 period compared with the same period last year. However, owing to subdued demand, yarn prices have also started correcting, leading to diminishing spreads. 

The last quarter of the financial year, which is usually the best quarter for the Indian cotton spinners, was expected to bring some cheer in the form of better spreads and better profitability margins (on the back of lower cotton prices), and start the recovery process for the industry. However, with Covid-19 pandemic leading to shutdown of manufacturing facilities and retail outlets in India and abroad, along with supply chain disruptions at various places, domestic spinners are staring at a long recovery road ahead. 

Credit perspective

Owing to the Covid-19 pandemic, the demand for cotton yarn is expected to decline significantly in Q1FY21 and Q2FY21 leading to deterioration in the operational and financial performance of the companies engaged in the segment. Cotton yarn prices, which were already under pressure in FY20, are expected to decline further in FY21. However, cotton being a seasonal crop, major procurement by spinning mills happens till February/ March, thereby fixing their procurement costs. With yarn realization expected to decline, and majority of the procurement cost already fixed, the spread and profitability margins of the industry players are expected to witness a further deterioration. Also, with declining cotton prices, domestic spinners could be looking at inventory losses in the future.

With major procurement of cotton almost done, majority players will be having limited cushion available in their working capital borrowings. Delay in payment from customers has also increased their reliance on the external borrowings. To address the liquidity concerns of the industry, some solace has been provided by the Reserve Bank of India (RBI) in the form of three-month moratorium announced on the payment of term loan installment and interest on working capital borrowings along with easing of working capital financing. This will lead to many companies resorting to incremental working capital borrowings from banks. 

CARE Ratings does not expect any major capacity increase in the industry in the next one year, with only a few large integrated players expected to undertake some capacity expansion. However, with declining profitability and increased working capital borrowings, CARE expects debt coverage indicators of the companies in the industry to remain under pressure at least in the next two quarters. 

Large companies having sufficient liquidity cushion in the form of cash and liquid investment and/ or unused working capital lines are expected to be better placed compared to their counterparts with limited liquidity cushion and holding large inventories.

Courtesy: Care Ratings

Sudeep Sanwal, Senior Manager

Email: sudeep.sanwal@careratings.com

Pulkit Agarwal, Associate Director

Email: pulkit.agarwal@careratings.com

This report is prepared by CARE Ratings. CARE Ratings has taken utmost care to ensure accuracy and objectivity while developing this report based on information available in public domain. However, neither the accuracy nor completeness of information contained in this report is guaranteed. CARE Ratings is not responsible for any errors or omissions in analysis/inferences/views or for results obtained from the use of information contained in this report and especially states that CARE Ratings has no financial liability whatsoever to the user of this report.