India Ratings’ outlook for cotton textiles remains negative to stable for 2013 on account of subdued demand, although margins are expected to benefit from softening raw material prices. The outlook for synthetic textiles remains negative for 2013 due to reversal of substitution demand and oversupply in domestic partially oriented yarn, pressurizing selling prices and margins of synthetic textile companies.
Stable Cotton Prices: Muted international demand of cotton and surplus production are likely to keep cotton prices stable and range-bound during 2013. India Ratings expects cotton yarn manufacturers to benefit from slow but steady pick-up in domestic demand, the likely higher demand of cotton yarn from China and improving margins on account of low cotton prices and firm cotton yarn prices.
Stability in cotton prices will enable spinning mills to better plan the inventory buying. However, spinners in Southern India and Gujarat continue to underutilize capacity due to power shortage or incur high cost of self-generated power.
Exports Demand Sluggish: India Ratings expects garment exporters’ revenues to remain subdued on the back of the persistent economic slowdown in key export destinations of US and Europe and continuous deterioration in India’s competitiveness in apparel exports.
However, to offset the impact, Indian exporters are diversifying into other geographies. Selling prices are likely to remain lower depending on companies’ bargaining power which is very low for small exporters or for low value added products (such as Rangoli International ‘IND BB+’).
Existing Ratings Factor Risks: Around 88% of India Ratings-rated cotton textile companies have a Stable Outlook despite the industry outlook being negative to stable. This is because the agency has already factored into the ratings the weak credit quality marked by higher instances of near-full utilization of working capital limits and negative operating cash flows. The same is true for 73% India Ratings-rated cotton textile companies with sub-investment grade ratings.
Liquidity Concerns in Small Companies: Timing/efficiency of cotton buying, receivables and inventory management would continue to be key liquidity determinants in 2013. In 2012, India Ratings took negative rating actions on companies that overused their working-capital limits and/or delayed debt servicing due to liquidity stress. Leverage indicators are weak, yet better than 2008-2009 slowdown, when companies were in midst of capex cycle and high on debt.
What Could Change the Outlook?
Continued Stability: A stable outlook on cotton and synthetic textiles would require favorable policy environment, improvements in demand-supply position, continued stability in input costs and consequent improvement in margins/liquidity. It is unlikely that the sector’s outlook will turn positive until fundamental issues such as power shortage, lack of technology and modern machinery and demand slowdown are resolved. However, foreign direct investment (FDI) in retail is an opportunity that would unleash demand in the long run and offset any slowdown in exports.
Input Price, Inventory Risks: The cotton outlook could be revised to negative if input costs turn volatile, which could intensify inventory price risks, cash flows and liquidity. Given the sector’s high debt dependence for operational as well as capex needs, any volatility in EBITDA could lead to huge swings in leverage.
Key Issues
Demand Slowdown Persists
Garment exporters continue to face order slowdown with order sizes becoming smaller from existing clients in US and EU coupled with selling price pressure. To combat this, companies are venturing into newer markets such as Africa, Russia, Korea, Japan and Eastern EU. Demand is weakened further by tough competition from Asian peers such as China, Bangladesh and Vietnam who are lower cost manufacturers of apparel and also enjoy more favorable duty structure on exports.
Domestically, weak consumer sentiment, high inflation and low wage growth have been dampening textiles and apparel sales. Discounts will be offered to encourage sales, but will keep margins under pressure. Different Segments, Different Outlooks Cotton yarn spinners’ outlook is stable as they are better positioned in terms of pick-up in demand with upcoming orders from China and lower cotton prices comforting their margins.
Companies such as Sharmanji Yarns (‘IND BB+’/Stable) are better positioned to weather cyclicality with flexibility to switch between cotton and synthetic yarn manufacturing. Production of cotton yarn increased by 13.9% yoy over April-November 2012. Synthetic yarn spinners have a negative outlook as lower demand and rising cost of inputs are squeezing their margins. Production of man-made filament yarn decreased by 0.2% yoy over April-November 2012 whereas production of blended and 100% non-cotton yarn grew at 0.1% yoy in the same period.
Fabric players’ outlook is negative to stable as fabric companies’ margins are on slower revival as labor, power and fuel costs are edging higher (around 15%-20% of total costs) offsetting input price decrease. Domestic cotton apparel makers are on cautiously stable outlook due to a fall in raw material prices and modest demand growth. Cotton apparel exporters are on a negative to stable outlook while synthetic textile exporters have a negative outlook. Exports of synthetic textiles decreased by 12.4% yoy over April-October 2012.
Input Price Risks
India Ratings expects cotton and cotton yarn prices to remain stable in 2013. As per The Cotton Corporation of India Ltd., cotton production in the current season (October 2012 to March 2013) is estimated at 35 million bales (1 bale=170 kg) while domestic consumption is expected at 27 million, leaving 7 million surplus. However, cotton prices have remained volatile in the last two years and any unexpected volatility could adversely impact textile companies.
After trending upwards over June-August 2012, raw cotton prices declined in September 2012 due to higher–than-expected domestic arrivals of cotton and higher imports of cotton by spinning mills, in anticipation of a lower harvest. Cotton yarn prices rose in H2FY12 on higher demand from spinners and greater exports to China.
Fabric processing and garmenting are highly labor-intensive, and labor costs in India are rising. Therefore, setting up units or outsourcing work to third-parties in low-cost Indian regions or low-labor-cost countries such as Bangladesh could be instrumental in protecting margins.
Power is an important cost component, particularly for spinning mills and fabric units that are more mechanized than garment units. Besides the element of cost, uninterrupted power supply is also important. Companies with captive power generation facilities are viewed favorably as they are self-sustained and more cost effective.
Margins indication is more varied and dependent on company-specific strategies (backward integration, production diversification) to mitigate the margin weakness. High interest costs continue to impact net profitability and interest coverage.
Elongated Working Capital Cycles
Working capital requirements of companies which are backward integrating (Shahi Exports Private Limited; ‘IND A-’/Stable) are expected to increase. Another trend for exporters was increase in inventory days on account of samples for new product lines (Eastman Exporters Global Clothing Private Limited; ‘IND A-’/Stable; FY12: 132 days, FY11: 91 days). Surya Processors Private Limited (‘IND BB-’/Positive) also continued to illustrate lengthy receivables and inventory period.
Tight Liquidity Position
Around 19% of total outstanding India Ratings-rated textile companies are rated in the ‘IND D’ category, mainly on account of liquidity constraints, resulting in debt servicing delays and defaults. Companies are facing liquidity concerns due to delays in bank line enhancements and highly working capital intensive operations. Median interest coverage for textile companies rated in the ‘IND B’ category is less than 2x indicating low cushion against any volatility in earnings.
Debt Restructuring Scheme Ineffective
The INR350bn textile debt recast plan approved by the Reserve Bank of India (RBI) in 2012 has failed to gain traction as most of the stressed textile companies had already availed restructuring during the 2008-2009 slowdown, and the second round of restructuring would render their loans as non-performing assets (NPA). The NPA tag would deprive them of benefits under The Technology Up gradation Fund Scheme (TUFS) and push up their borrowing costs.
Therefore, the scheme largely remained unutilized and textile companies opted for high-cost bank borrowings to maintain liquidity. The Indian banking system exposure to the textile sector was estimated at INR1, 000bn as on 31 March 2012. Considering weak credit quality and rising proportion of the textile sector in non-performing assets, banks are cautious and stricter in lending norms to this sector.
More Policy Measures Required
Credit profiles of companies going for large debt-funded capex will remain subdued in 2013 given the input price risks and high borrowing costs. Completed capex resulting in scale benefits would lead to margin expansion. More policy measures are required to revive liquidity and growth in the backdrop of challenging textile industry operating environment since 2008.
To boost investments in the spinning segment, the Gujarat Government in September 2012 came up with The Gujarat Textile Policy (GTP) targeting installation of 2.5m spindles worth INR70bn over the next five years. RBI also extended the 2% interest subvention for exporters till 2014, which will aid liquidity.
An additional 2% incentive is provided by the government for entities registering higher yoy exports. Other measures in the pipeline such as talks with Europe for zero import duty on Indian imports into EU could provide level playing field with countries such as Bangladesh in the long run.
The government has allocated INR115.7bn for the TUFS scheme in the Twelfth Five Year Plan period (2012-2017). This is likely to encourage investments in the sector, especially in the areas of modernization, spinning and processing capabilities as well as for entering new markets/products.
2012 Review
Stabile Margins: 2012 was marked by stability and restoration of operating margins for textile players across the value chain led by steady cotton prices, and the consequent positive impact on liquidity. Margins have been stable-to-improving, led by a better product mix, commanding higher margins in the case of Eastman Exports Global Clothing Private Limited (‘IND A-’/Stable).
Flat Revenues: Demand remained sluggish across the value chain in 2012. For apparel exporters, order sizes reduced, hence volumes fell. However, rupee realizations increased partially due to rupee depreciation against the USD and Euro which resulted in moderate Low Capex: Investment activity slowed down across the textile value chain in 2012 due to uncertain demand and volatile raw material prices which led to tying up of funds in inventories.
Mid-Year Outlook Revision: The Outlook for synthetic textile companies was revised to negative from stable in August 2012 as crude-based raw material prices have increased on account of rupee depreciation (for further details, please refer 2012 Mid-Year Outlook: Indian Textiles report, dated 2 August 2012,). Lower cotton prices and sluggish demand have reduced the substitution demand of synthetic fibers/textiles.
Rating Actions: In 2012, India Ratings affirmed 20 textile companies, downgraded seven, upgraded two, and revised the Outlooks of two companies to Negative from Stable and of one company to Positive from Stable. Gayatri Suiting’s, a manufacturer of synthetic fiber and textiles, was downgraded to ‘IND D’ from ‘IND BB-’ on account of term loan defaults due to its stretched liquidity.
The Outlook on Navnitlal Private Limited was revised to Negative from Stable, led by weakened interest coverage and deteriorating credit metrics due to raw material price volatility and slowing demand. Rupa & Company was upgraded from ‘IND A-’ to ‘IND A’, driven by improvement in financial profile emanating from a superior product mix.
