The operating margins of domestic cotton yarn spinners are likely to shrink 100-150 basis points (bps) in financial year 2020 mainly because of lower cotton output, rising cotton prices, and moderating demand.

This will reverse the recovery seen in the previous fiscal year.

But this will faintly impact the credit profiles of spinners, given the continuation of three major spurs of FY 2019 — modest capex intensity, prudent working capital management, and strengthened balance sheets.

India’s cotton production is expected drop by over 5% in cotton season 2019 (the CS is usually from October 1, 2018, to September 30, 2019) due to low water availability and inadequate south-west monsoon in key cotton producing states and higher incidences of pest attacks.

Lower production is expected to shrink India’s cotton stock to a two-year low of 1.2 months by the end of CS 2019, leading to firming up of domestic cotton prices to Rs 128-Rs 140 per kg this fiscal year — a rise of 7-8% over previous financial year.

Meanwhile, global cotton prices are expected to remain steady at Rs 128-134 per kg as the lower production in India, the US and Australia will be offset by higher production in China and Brazil. This would narrow the gap between domestic and global cotton prices, said CRISIL on Tuesday.

Demand for cotton yarn is found to be turning south due to moderation in domestic as well as exports demand. CRISIL estimates the overall cotton yarn demand (volume terms) to grow at a slower pace of 4.5% in fiscal year 2020 as compared with 5.6% in the previous financial year.

The slowdown will be mainly driven by tepid growth in domestic demand (comprising three-fourths of overall demand) at 2.9-3% in fiscal 2020.

Growth in exports is also expected to be slower at 9-10% in FY2020, compared with 13.5% in FY2019, amid trade tensions between the US and China, and commissioning of yarn capacities in Vietnam, which enjoys preferential access to Chinese markets. “This is not good news for Indian spinners,” said Hetal Gandhi, director, CRISIL Research. “Higher cotton costs and moderate demand outlook mean they may not be able to get commensurate increase in yarn prices, which would reduce their operating margins by 100-150 bps in this fiscal year,” he added.

CRISIL rates 309 cotton spinners. Considering lower profitability, debt/Ebitda (earnings before interest, tax, depreciation and amortisation) of CRISIL’s portfolio is expected to be 3.5-4 times in FY2020, compared with 3.5 times in FY2019 and 4.6 times in FY2018. “The credit profiles of spinners are not expected to be impacted materially, as capital spending is likely to remain moderate given current capacity utilisation levels of 75-80%,” said Gautam Shahi, director of CRISIL Ratings. “Spinners are also expected to continue managing their working capital prudently,” he added.

Besides, strengthening of balance sheets owing to healthy demand and softer cotton prices, and moderate capex in FY2019 will help spinners absorb impact of lower operating profits in the current fiscal. However, small cotton spinners (spindles less than 20,000) with leveraged balance sheets could face some challenges because of higher cotton prices, the ratings agency noted.

Published On : 08-05-2019

Source : Financial Express