ICRA: Domestic Cotton Spinners In A Bind As Weak Export Demand, Uncompetitive Cotton Prices Weigh On Performance
The performance of domestic cotton spinners is likely to weaken in FY2020, following a brief recovery in FY2019, as they are grappling with the twin challenges of weak export demand and uncompetitive cotton prices. As per an ICRA report, de-growth in volumes due to lower export demand and a sharper decline in realisations vis-a-vis cotton prices because of higher minimum support price (MSP)-led floor price for cotton are expected to result in a decline in turnover and an estimated 100-150 bps compression in operating profitability of domestic cotton spinners during the year FY2020.
Commenting on this, Mr. Jayanta Roy, Senior Vice-President and Group Head, Corporate Sector Ratings, ICRA, said, “Based on the emerging trends, we have revised the credit outlook on the Indian cotton spinning industry to 'Negative,' as the profitability and debt coverage metrics are expected to moderate from the current levels. The impact is likely to be more pronounced for leveraged companies, that have undertaken a sizeable debt-funded capital expansion in the recent years and have higher repayments scheduled in the near term.”
Having said that, it ought to be noted that a large proportion of spinners have not undertaken capacity expansions in the recent years, given the unencouraging demand trends during this period, coupled with the discontinuance of subsidy benefits under the Government of India’s Technology Upgradation Fund Scheme (TUFS) for the spinning segment. This has resulted in a consistent decline in term borrowings for such companies in recent years with scheduled debt repayments, due to which the impact on their debt coverage metrics and liquidity could be lower, despite industry pressures.
With India exporting roughly one-third of its cotton yarn production every year, trends in export demand play a crucial role in determining the overall performance of the domestic spinning sector. India’s cotton yarn export quantity declined by 33% Y-o-Y in Q1 FY2020 (41% in May and June 2019) and stood at a seven-year low of 59 million kg in June 2019. As a result, multiple textile associations across the country have reported stock pile-ups and production cuts by spinning mills in recent months. Whereas markets other than China, which has been the largest cotton yarn market for India, had supported the demand during FY2017 and FY2018 when exports to China fell, the pressure is more broad-based now. As compared to a 50% Y-o-Y decline in cotton yarn exports to China during Q1 FY2020, exports to other markets too declined by ~20%.
“The pressure is primarily originating from higher cotton prices in the domestic market, which has made Indian yarn manufacturers uncompetitive in the international markets. As a result, the near-term outlook on Indian cotton yarn exports is quite weak at present”, Mr. Roy added.
Weakened competitiveness of domestic spinners is corroborated by the fact that India’s cotton yarn exports to China declined in Q1 FY2020, even though China’s cotton yarn import volumes remained range bound. In contrast to the domestic trend, wherein cotton fibre prices firmed up during the quarter ended June 2019 owing to a shortage of cotton availability, international cotton prices corrected at a sharp pace. This was driven by a higher-than-average global cotton stock-to-use ratio, as lower consumption arrested the pace of decline in the global cotton stocks, and healthy crop expectations for CYg2020 (refers to global cotton year ending July 2020). As a result, the spread between the Indian and the international cotton prices, which typically remains at ~5-7%, with international cotton mostly trading at a premium, reversed and domestic cotton remained ~7-9% more expensive vis-a-vis international cotton in June and July 2019 (average premium of ~2% in quarter ended June 2019). While domestic cotton prices also started correcting in July 2019, the extent of correction has been limited vis-a-vis international cotton prices.
Besides uncompetitive cotton prices, other factors which have been affecting cotton yarn exports from India include a duty-free access provided by China to Pakistan from July 2019 onwards, continued competitive pressures from nations such as Vietnam, and higher cotton fibre imports by China, which is keeping its cotton availability comfortable and cotton fibre prices competitive. In addition, imposition of tariffs by the US on garment exports from China is affecting China’s apparel exports, in turn slowing down the demand for cotton yarn.
The impact on profitability of domestic cotton spinners is expected to be seen in H1 FY2020, particularly during Q2, as yarn realisations started correcting from July 2019 onwards after remaining firm during Q1 FY2020. Cotton yarn realisations (for 30s carded yarn) averaged at Rs. 212/ kg in July 2019, vis-a-vis Rs. 225/ kg in Q1FY2019 and Rs. 220/ kg in the previous 12 months. As a result of a sharper fall in realisations vis-a-vis cotton prices, the spot as well as rolling (adjusted for cotton stock holding) contribution margins have fallen to Rs. 88/ kg and Rs. 84/ kg in July 2019, vis-a-vis Rs. 94/ kg and Rs. 96/ kg in FY2019. With expectations of a better crop in CYi2020 (Indian Cotton Year ending September 2020), cotton fibre prices are likely to correct to a level lower than the average prices observed during the harvest season ended March 2019. Accordingly, companies that stocked sizeable volumes of cotton at a higher cost vis-a-vis the prevailing cotton price levels, may witness a higher decline in contribution margins at the prevailing yarn realisations.
Improvement, going forward, will remain contingent on developments in the international market, including global cotton output during CYg2020, China’s policies on cotton stocking and imports, and the US-China trade war. These factors will determine the relative competitiveness of domestic spinners in the international markets and hence export demand. Having said that, ICRA expects the overall annual performance in FY2020 to be weaker than FY2019 despite a possible recovery during the second half.