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Temporary Omicron-led demand disruptions aside, cotton spinners in a sweet spot with decadal high profits; Outlook positive: ICRA

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24 January 2022, New Delhi: Indian cotton spinners are riding high on strong demand and realisations and have reported multi-year high operating profits in the past four quarters, even as cotton fibre prices increased parallelly. Besides recovery in domestic demand, robust growth in export demand has also supported volumes. ICRA Ratings expects its sample of large/ mid-scale spinning companies to report a robust double-digit growth in revenues and all-time high profits in FY2022, with ~400-600 bps improvement in operating margins. While the growth is primarily being led by all-time high realisations which have sustained for much of the year, volumes are also estimated to be better than the pre-Covid levels.

Elaborating on this, Mr. Jayanta Roy, Senior Vice President & Group Head, Corporate Sector Ratings, ICRA, said, “Companies which had higher stocks of lower cost cotton from the previous season benefitted more in terms of profitability in H1 FY2022. This apart, inclusion of all cotton yarn exports under Remission of Duties and Taxes on Exported Products (RoDTEP) scheme from January 2021 onwards (as notified in August 2021) has also supported margins as well as price competitiveness of domestic spinners in international markets.”

The slight decline in December 2021 aside, cotton yarn prices remained on a rising trend in the current fiscal, touching all-time highs in recent months. In 9M FY2022, Indian cotton yarn prices averaged ~36% higher than FY2021. Even though cotton prices also increased during 9M FY2022 (averaging ~42% higher than FY2021), continued increase in realisations led average spot contribution margins for 9M FY2022 to decadal highs.

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On the exports front, following a 5% growth in FY2021 despite the pandemic impact, India’s cotton yarn exports surged ~47% Y-o-Y in H1 FY2022 led by ~130% Y-o-Y increase in exports to Bangladesh. ICRA expects Indian cotton yarn exports to be at all-time highs in FY2022, breaching the previous high recorded in FY2014.

Commenting on this, Ms. Nidhi Marwaha, Vice President & Sector Head, Corporate Sector Ratings, ICRA, said, Besides competitive Indian cotton and cotton yarn prices in the international markets, concerns raised by large buying regions, including the US and the EU, on Xinjiang cotton and healthy growth in Bangladesh’s apparel exports are driving export demand. While China remained the largest export market for Indian cotton yarn till FY2021 despite a moderation in its share in recent years, Bangladesh has overtaken China this year, accounting for ~40% share in H1 FY2022. ICRA Ratings expect this demand to sustain for the next 9-12 months at least.”

Even as risk of subsequent pandemic waves remains, ICRA expects domestic spinners to sustain healthy volumes in FY2023 as well, amid a shift in preference away from Xinjiang cotton and competitive domestic cotton prices. However, prices are expected to taper as cotton yarn realisations remain unsustainable at current levels, which may affect demand. This, in turn, would result in some moderation in performance in FY2023 from FY2022 levels, with turnover likely to correct by ~10-15%, though remaining higher than the pre-pandemic levels. While operating margins are also expected to decline from exceptionally high levels estimated for FY2022, these are likely to remain ~100-200 bps higher than the past three-year average.

“Despite moderation from FY2022 levels due to a possible decline in realisations, ICRA expects spinners’ business performance to remain healthy and better than the pre-Covid levels in terms of scale as well as profitability in FY2023. Considering this, the outlook for the sector is Positive”, added Ms. Marwaha.

Improved capacity utilisation and greater financial flexibility have led to pick up in capex activity in the cotton spinning segment in recent months, in line with ICRA’s expectations. This follows muted capex activity in recent years. Several spinners, particularly mid-scale and large-scale players, have already announced their capital expenditure plans. In addition to capacity enhancements, plans include capex towards de-bottlenecking, as well as margin-accretive/ efficiency improvement projects such as machinery upgradation and renewable power capacity additions. However, despite an expectation of enhanced debt-funded capex, ICRA expects spinners’ capitalisation and coverage metrics in FY2023 to remain better than the levels reported in recent years, supported by improvements in revenues and profits.

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