Positive signs limited

Cotton to remain stable, MMF looks at a lacklustre year, and export to stay subdued: An Ind-Ra Report reveals some of the grey areas, possibilities and challenges facing the Indian textile industry in the FY 2016-17.

An India Ratings and Research (Ind-Ra) report has maintained a stable outlook for cotton textiles for FY16-FY17. This will be led by a marginal expansion in the cotton space on the back of lower cotton prices, even as revenue growth will be slower, mirroring lower sales realisations. Ind-Ra expects most of the revenue growth to come from higher production efficiency rather than significant capacity additions.

However, Ind-Ra continues to maintain a negative outlook on synthetic textiles for FY17 on continuing overcapacity, falling capacity utilisations, dumping from China, and continuously falling raw material prices (led by crude prices) which could translate into inventory losses.

Revenue growth in FY17 is likely to be driven by enhanced domestic consumption of fabrics, apparels and home textiles in view of lowering interest rates, rising discretionary income, (Ind-Ra?s GDP growth projection for FY17 is 7.9 per cent), favourable demographics and moderating inflation. The stressed rural economy is however a dampener for demand in FY17. The value-added textile segment continues to witness stable demand despite the macroeconomic data not seeming to be encouraging.

Ind-Ra has also maintained a stable rating outlook for textile companies, as working capital optimisation and low capex appetite will lead to debt containment.

This combined with a margin improvement will drive the improvement in credit metrics in FY16-FY17.

Improved credit metrics: The interest cover for textile companies improved in 1H16 and is likely to improve further in FY17 on the back of debt containment, working capital optimisation and fiscal incentives. Backward integration and a value-added product mix are helping more established players to improve their operating performance in the present challenging operating environment.

Export challenges: Ind-Ra believes that the export performance will be subdued over FY17 due to the Chinese demand slowdown, absence of free-trade agreements with key end-markets of the US and Europe, and competitive pricing pressure. Yuan depreciation could emerge as a key concern for textile exporters as India and China cater to common large markets of the US and Europe. Ind-Ra believes that level-playing field for India will also weaken led by competitors such as Vietnam gaining duty-free access to the US and Europe, although their level of backward integration to fulfill the eligibility requirement under the trade agreement would be important.

Investment impetus from ATUFS: The amended textile scheme Amended Technology Upgradation Fund Scheme (ATUFS ) cleared by the Cabinet Committee of Economic Affairs is likely to encourage fresh investments into the sector, which is sluggish at present. However, the total benefit to textile companies is likely to reduce due to the change in the nature and quantum of subsidy, and target segment for benefits under the scheme. The subsidy will be largely capital based, a change from the earlier interest and capital base. Also, the possibility of large-scale greenfield capex remains low in FY17.

Outlook sensitivities

Prospects of a positive outlook are limited for FY17. Fundamental issues of taxation and duty structure in synthetic textiles, need for modernisation in the weaving/processing sector, and expansion of scale need to be addressed in the long run.

Global factors: A cotton/yarn price crash led by uncertainty from China on buying/stocking of cotton/yarn is a key risk, and could lead the outlook revision to negative for cotton textiles. Uncertainty stemming from China?s policy and production strategy remains a threat. Stability in crude oil prices is critical for a revision of the outlook on synthetic textiles to stable.

Demand drivers: Recovery of export demand and sustenance of domestic demand are key sensitivities for textile and apparels.

Key issues

Input prices to remain range-bound: Drivers for Indian cotton prices point towards a range bound movement in FY17. This is despite the cotton acreage coming down, as yields are likely to improve leading to similar production levels as previous year?s. Prices will be weighed down by a lower export demand from China, a key consumer of Indian cotton and cotton yarn.

As China shifts from price-based support to income-based support (subsidy) for its cotton growers, the demand for lower cost cotton and yarn imports into China becomes lower. With lower domestic cost of cotton, Chinese mills could become competitive again, thereby lowering reliance on imported yarn. Export demand for superior and finer counts of yarn is likely to be stable. Significant uncertainty remains about how China will deal with its large accumulated stocks, but it will lead to lower imports by China in the medium term, and lower closing stocks.

Spinning lower revenue growth, higher margins: Ind-Ra has analysed the interim results of the top 10 listed cotton yarn spinners. In 1H16, cotton yarn spinners reported an average revenue growth of 4.9 per cent, which is largely reflective of lower yarn pricing and moderate volume growth. However, as cotton prices had declined by a higher rate than the yarn prices, most of the spinners reported a margin expansion in 1H16, which is likely to continue in FY17. The top 10 cotton yarn spinners reported an average 178 bp YoY.

Ind-Ra assumes various scenarios for FY17 revenue growth using a range of volume growth of 3 to 7 per cent coupled with a product pricing range of negative 1 to 4 per cent, reflective of the lower price outlook for fibres. The base case revenue growth for yarn manufacturers comes at 7 per cent for FY17.

Ind-Ra expects most of the revenue growth to come from a higher production efficiency rather than significant capacity additions in the backdrop of a demand slowdown. Yarn pricing would also remain under pressure with lower input prices.

A study of synthetic and blended yarn spinners shows average revenue of growth of about 1.3 per cent YoY for 1H16, while an expansion in average EBITDA margin by 115bp to 12.1 per cent . The interest cover also expanded to 3x in 1H16 from 2.6x in 1H15.

Slowdown in synthetic textiles: Capacity utilisation in the polyester filament yarn segment was low at 55 per cent in FY15, was 50.7 per cent in 1H16 (annualised) and is likely to remain so in FY17. Exports of Indian manmade textiles grew 8.1 per cent YoY during April-November 2015 to $3.39 billion. Of this, synthetic yarn growth was flat, fabrics grew by 9.2 per cent and made ups grew sharply by 21 per cent.

Globally, there is a higher adoption of synthetic textiles, but in India the growth has been slow as the government policy is skewed towards natural fibres. Synthetic fibres are subject to 12 per cent excise duty whereas cotton and its downstream products are subject to zero excise duty. Cotton being an agri-commodity, the prices are subject to minimum support prices, whereas there is no protection for polyester fibre prices. There is a lower capacity utilisation rate in synthetic textiles than cotton textiles, as demand is lower. Although the adoption of synthetic and blended garments is picking up which will drive the consumption in the medium term, central and state taxation at fibre level are key challenges for synthetic textile manufacturers.

Polarised operating performance: The value-added textile segment continues to witness stable demand despite the macroeconomic data not seeming to be encouraging. The large textile companies focused on scale, value addition and product diversification therefore continue to report sound operating performance. However, smaller units struggle with issues such as non-compliance with pollution norms leading to frequent shutdowns, labour attrition, lack of modernisation and thus lower competitiveness and margins.

Lower benefit under ATUFS, lower greenfield capex expectation: In a significant departure, ATUFS stipulates only a capital subsidy instead of the interest cum capital subsidy prevalent under the earlier version of TUFS.

A capital subsidy of 10-15 per cent will replace the capital (0-15 per cent) cum interest subsidy (2-6 per cent), which could be a setback for processors and weavers who avail both capital and interest subsidy.

The garmenting segment will receive a higher subsidy than other segments, while the overall quantum of subsidy appears to have reduced. Also, the government has preferred to channelise the benefits of the scheme towards small to mid-sized enterprises instead of large companies by capping the subsidy amount. This scheme is also positive for the existing projects which were awaiting the release of subsidy under the earlier versions.

However, the capital subsidy would be provided upfront as against the interest subsidy which is accrued over the tenor of the loan. Hence, the net present value of interest reimbursement for future years would need to be compared to the upfront capital subsidy amount to assess the real benefit under the new scheme.

According to the amended scheme, the subsidy amount is capped, which was not the case earlier.

The capping of the subsidy implies that larger projects will largely be self-reliant, while small and medium enterprises will be provided greater support. This is a setback for the large-sized projects as it will reduce the subsidy benefit substantially for fresh capex by larger players. While capping will help distribute the subsidy among a larger number of players, there is a possibility of break-up of larger projects into different entities to avail benefit under the scheme.

Impact of global trade agreements: India is likely to lose competitive advantage against peers such as Vietnam, which have gained duty-free access to Europe, while Indian exporters have to pay a duty of 9.6 per cent.

In the longer term, the passage of trans-pacific partnership (TPP) could also weaken competitive positioning as peers such as Vietnam could gain zero duty access to 12 TPP countries including the US, Canada and Japan, whereas Indian companies exports would be subject to 15-50 per cent duty.

Partial protection for Indian textile exporters would come from the adherence to the ?yarn-forward? rule in the pact. Textile and garments produced from fabric made by a TPP nation will qualify for duty-free status.

Lack of sufficient capacities of yarn/fabric may however constrain member countries. This could also trigger Indian and Chinese textile companies to set up backward integration facilities in TPP countries such as Vietnam.

The build-up of capacities may happen gradually and in the short-term the market share of Indian exporters is likely to decline.

A double whammy for India will be the case when these countries set up their own backward integration facilities for yarn and fabric, which will hurt India?s exports of yarn and fabric to these countries, and bring down India?s share in textile exports.

Among Asian peers Vietnam would be a key beneficiary of TPP, while India, China, and Bangladesh would be negatively impacted. Vietnam is the second-largest garment exporter in the world with garment exports worth $24 billion in 2014, and would thus be able to increase its textiles export market share strongly to TPP countries by being able to sell at zero duty. However, India has an edge in value-added garmenting over China and other Asian peers, which should remain partly insulated due to the lack of readily available similar capabilities in TPP countries. China which houses 40 per cent of the global apparel capacity ($165 billion exports) is not a part of TPP, which is a breather for India. Also, among TPP countries, Vietnam is the only key manufacturer of garments, hence the capacity to serve the entire demand will be limited.

The TPP agreement concluded in October 2015 is a US-led trade agreement between 12 countries comprising the US, Australia, Canada, Japan, Malaysia, Mexico, Peru, Vietnam, Chile, Brunei, Singapore and New Zealand. The objective of the agreement is to promote the domestic industry and gain duty-free access to member nations. Garmenting is already a competitive business, with low entry barriers, rising wage rates and frequent fluctuations in input prices.

Sluggish exports: The textile demand has slowed from China while the US and Europe are doing better. There are imbalances in the market rather than recessionary pressures, revolving around the changing duty levies and import-export policies of various countries, and forex fluctuations impacting currency competitiveness. India is gaining prominence in the value-added segment (hand embroidered, embellished) although the pricing power has not changed and remains under pressure of large retailers. Garments generate lower EBITDA margin than fabrics and yarn but higher asset turnover.

Absence of free trade agreements with key export destinations ? the US, Europe and Canada are impediments to the growth of apparel exports.

Growth is likely to remain largely volume-led while realisations will continue to exhibit commodity and competitive pricing pressure.

For April-November 2015, excluding raw cotton the textile exports declined 2 per cent YoY to $23.5 billion. However in rupee terms, the textile exports grew 4 per cent YoY due to rupee depreciation vs. USD (April-November 2015 INR/USD: 64.4; April-November: 60.5).

Of this pie, apparel exports accounted for 47 per cent of total textile exports, and have been growing at a faster rate of 2 per cent in USD terms and 8 per cent in INR terms. This was despite the sharp depreciation in the value of euro (Europe accounts for 40 per cent of India?s textile exports) and lower realisations as exporters passed on the decline in raw material prices to customers.

Credit profile remains stable

Indian textile companies are focusing on internal efficiencies and value-added offerings to drive margin growth. The working capital borrowings are likely to reduce with the lower inventory holding period, which would also bring down the inventory carrying costs and risks. Most of the larger groups such as Vardhman Textiles Limited, Sutlej Textiles and Industries Limited (IND AA-/Stable), RSWM Limited (IND A??) have completed their capex cycle over FY12-FY15 and no large greenfield expansion is anticipated in FY17. However, some companies could go for forward or backward integration to protect their margins.

Working capital prudence has taken over speculative inventory gains on cotton and hedging of commodity and forex risks is taking priority for most exporters. However, margin pressure could perpetuate for smaller players which buy from the open market or in smaller quantities and keep forex positions unhedged.

In addition to the central government schemes, various state governments have announced new textile policies in recent years, to encourage industry.

2015 Review

FY15 was a year of normalisation for textile companies, from FY14 which was exceptionally good in terms of high Chinese demand. Revenues of the top 10 cotton spinners grew 7 per cent YoY, a reflection of higher volumes, as realisations lowered from FY14 whereas the EBITDA fell 12.6 per cent YoY.

Average EBITDA margins for cotton yarn spinners also corrected to 15.7 per cent in FY15 from 18.8 per cent in FY14 and average cash flow from operations increased to Rs 2.7 billion from Rs 2 billion. Total debt for the top cotton yarn spinners reduced in FY15 to Rs 75 billion from Rs 85 billion in FY14, a reflection of working capital optimisation and lower capex. However, financial leverage for the top 10 spinners increased to 3.1x in FY15 from 2.7 times in FY14.

For synthetic and blended yarn manufacturers (top six listed players), the revenue growth was lower at 2 per cent YoY in FY15, EBITDA declined by 7 per cent, and average EBITDA margins declined to 12.2 per cent from 13.6 per cent in FY14. The debt was flat at Rs 38 billion, and average leverage slightly increased to 3.6 times in FY15 from 3.3 times in FY14.

For large listed fabrics/garment players FY15, revenues grew 12 per cent YoY, whereas EBITDA grew 11.8 per cent YoY, hence EBITDA margins were stable at 14.9 per cent, a reflection of higher value addition, branding benefit and pricing power. Average cash flow from operations increased 30.7 per cent YoY to Rs 5 billion in FY15. Financial leverage remained stable at 3.4 times in FY15.

QUICK BYTES

• Lower input prices drive margin expansion
• Slower capex cycle supports credit metrics
• Overcapacity and inventory losses in polyester
• Uncertainty from China policy and production strategy

Global economic conditions signal slowdown

Thanks to the growth of new markets in developed countries and increasing international trade the global textile industry continues to grow, generating sales of approximately $750 billion during 2015, a growth of over 5 per cent for the year. By 2019 the value of the global textile industry is expected to reach values of $910 billion, although weakening global economic conditions may slow down this growth. The textile industry is highly dependent on economic factors such as global economic growth and currency variations. Factors influencing the production line, such as energy costs and wages, also have an impact on costs. The uncertainty about global growth forecasts will provide some challenges ahead, according to a World Textile Outlook 2016, published by World Textile Information Network Ltd. Some of the factors which will impact the growth of textile industry globally are: energy costs, wages, and environ regulations.

Fibres

Global cotton prices remained stable for most of the year. After China scrapped its controversial stockpiling programme, global cotton prices stayed within a tight range during 2015. The Cotlook A Index, which gauges the world?s cotton market, barely changed last year, having reached its lowest level on 26 January (65.3 cents per pound) and highest on July 1 (74.8 cents per pound).

The Indian cotton spot rate remained flat, despite support from the government, while prices in Pakistan were firm due to tight supply. Vietnam has emerged as a spotlight of world cotton trading, with the nation?s cotton yarn sector booming, boosted by robust demand from China. Historically low man-made fibre (MMF) values in China: The plunging oil price dragged down MMF values to an historic low in China, which contributes at least 40 per cent of global production. Viscose producers enjoyed hefty profits between March and November, while their quotations soared 3,350 Yuan, or 30 per cent, to 14,600 Yuan per tonne.

Fabrics

Fabric prices have increased significantly due to quality improvements of dyeing materials. Cotton fabric sales encountered head winds, as more and more garment manufacturers switched to cheaper MMF fabrics. Although raw material costs slumped in 2015, China fabric prices still increased, indicating that consumers had to pay more for the surging costs of dyeing processes, as mills use more quality dyeing materials to reduce potential environmental hazards. Global exports of knitted fabric grew by 3 per cent in 2014. The global value of knitted and crocheted fabrics exported in 2014 was $33.7 billion, a marginal increase from 2013. Global exports in this sector were worth $238.4 billion.