Covid-19 pandemic delays recovery prospects for domestic spinners: ICRA
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New Delhi, May 7, 2020: The Covid-19 pandemic is hitting the domestic cotton spinning sector hard, with performance in FY2021 likely to be at multi-year lows. As per an ICRA note, amid severe demand disruptions, pressure on realisations as well as contribution margins, the operating income of cotton spinners is expected to decline by ~15-20% on a YoY basis, while the operating margins are estimated to correct by ~200-400 bps for the full year FY2021, compared to the FY2020E levels.
Mr. Jayanta Roy, Senior Vice-President and Group Head, Corporate Sector Ratings, ICRA, said: “Though performance pressures are expected across the spectrum, highly leveraged entities in lower rating categories would remain more vulnerable over the next few quarters, with heightened challenges of increased working capital requirements and diminishing order book position. In comparison, we expect the impact to be lower on credit profiles of companies with an established customer base, low term debt obligations and companies which have stocked lower cotton fibre at high prices.”
Demand for the downstream products viz. fabrics, apparels and home textiles, has been sluggish beginning March 2020, amid the lockdown across nations. Being vulnerable to consumer sentiments and discretionary spending, downstream segments are likely to witness severe demand-side pressures over the next two quarters as well, even after the initial lockdown is lifted. Yarn, being an intermediate product, is likely to face a ripple effect of the contraction in demand in the downstream segments.
According to Mr. Roy: “With inventory pile-ups at the downstream levels as well as expectations of a gradual pick-up in demand for apparels and home textiles, the pick-up in demand for yarn is also likely to be only gradual and spread over several months. With domestic as well as a majority of India’s major cotton yarn export markets being under lockdown at present, the outlook on yarn demand remains bleak.”
ICRA expects India’s cotton yarn exports to fall by ~18-20% to nearly a decade-low level of ~750 million kg in FY2021, closer to the level of exports last seen in FY2012, following an estimated 25% decline in FY2020, as domestic cotton yarn remained uncompetitive in global markets during much of the previous year. The situation is likely to worsen, given the supply glut situation, which is currently evolving in China. As the lockdown in China was lifted from the beginning of April 2020 onwards, spinners there have been scaling up operations even as demand from the downstream segments remains subdued amid weak domestic consumption demand as well as lack of demand in the export markets. As a result, there are reports of inventory pile-ups in China. Besides affecting direct demand from China, as it generally consumes ~8-10% of India’s cotton yarn production, the supply glut in China is likely to result in an increase in competition for India’s cotton yarn in other overseas markets as well.
This apart, weak demand outlook for India’s apparels and home textile exports is expected to affect yarn consumption by the downstream companies engaged in exports.
This comes at a time when the Indian spinning sector was just starting to come out of a challenging FY2020 that saw severe demand-side pressures and unfavourable movements in raw material prices and yarn realisations. There had been a visible weakening in credit profile of domestic spinners in FY2020, corroborated by a credit ratio (upgrade to downgrade) of ~0.35 times during the year. With rapid and widening impact of the Covid-19 pandemic and no meaningful recovery in sight, at least in H1 FY2021, ICRA is maintaining the Negative outlook on the cotton spinning sector, assigned in August 2019.
“With expectations of a slow paced and elongated recovery post the initial lockdowns, we expect severe pressures on the performance of the domestic spinning companies in FY2021, and a loss of business to the tune of US$2.5-3 billion in FY2021,” Mr. Roy added.
As the Covid-19 led lockdowns started from March 25, 2020 onwards, the cotton spinners were mostly through with their raw material stocking for FY2021, with their working capital borrowings peaking. As a result, while spinners continue to incur carrying costs for the inventory stocked, cash inflows are expected to start with a lag after the lockdowns are lifted, which are expected to keep their liquidity profiles stretched, particularly for companies with sizeable stocks. Further, cotton prices have already seen a steep correction after the end of the harvest season in March 2020. As per ICRA estimates, while the cost of cotton inventory (for Shanker-6 variety) held by the spinners at the end of March-2020 averaged at ~Rs 110/Kg, the cotton prices declined by ~5% to ~Rs 104/Kg in April 20. This, together with an expected correction in yarn realisations is likely to result in a significant contraction in profitability of the domestic cotton spinners in FY2021.