Spinning mills that were facing a problem during the first half of FY17 due to rising prices of cotton are soon set to see a U-turn in their fortunes. In the last two months, news of good monsoon, higher acreage under cotton cultivation and better output expected for the 2017-18 season are harbingers of stable, if not higher profitability.
From April to November 2016, cotton prices (Sankar-6 variety) soared from Rs90 per kg to around Rs140 per kg. Lower crop and tight inventory levels fuelled prices in the domestic market. Meanwhile, news of Chinaâ€™s lower stock inventory led to hope that Chinaâ€™s cotton imports will resume again. This too supported the high cotton prices. Spinning mills therefore bore the brunt of the high prices impacting operating margins during the last two quarters.
A sample of 13 large spinning mills from rating agency Icra reflects these trendsÂ (see chart). Profitability was squeezed, as a result, of the twin problems of flat revenue growth and high input costs. The average operating margin after peaking at 15.4% in the September 2016 quarter, dropped to 12.8% in the December quarter and further to 11% in the March 2017 quarter.
But softer cotton prices in the last two months bring hope for mills. Will it sustain? Industry experts forecast a 10% increase in acreage in the 2017-18 season after a similar decline in the previous season. Also, international prices are unlikely to firm up given the robust harvest in United States of America and also Australia. Domestic prices being linked to global indicators, they should therefore stay soft in the coming months.
The key, however, is for yarn demand to increase. Indiaâ€™s total yarn production declined to a five-year low in FY2017. The demand from mills was weak during 2016 primarily due to a steep decline in cotton yarn exports (due to weak Chinese imports), which comprises a third of the countryâ€™s output. Although exports have revived in the last few months, analysts believe that it is insufficient to offset the steep decline earlier.
Mills are also hopeful of higher off take by domestic fabric weavers given the festive season ahead and the pent-up demand following a near freeze in off take due to demonetisation and the uncertainty linked to the new goods and services tax (GST).
Meanwhile, there is not much hope for mills in terms of realization on sales as yarn prices are expected to be range bound given moderate utilization levels and soft input (cotton) prices. Icra forecasts profitability of spinners to remain range-bound at a modest level sustained during the past three years.
Meanwhile, although the 5% GST is a welcome step for the cotton textile industry, issues and costs related to compliance may lead to disruption in the supply chain for some more quarters, given the small and medium scale nature of spinners and weavers. A true picture on operating performance would be seen only from the second half of FY2018.