Revenues of cotton spinners are set to decline 30-35% in the current fiscal, a six year low, because of tepid domestic and export demand following the Covid-19 pandemic. This along with inventory losses and lower profitability is expected to result in moderation in credit quality of cotton spinners this fiscal, a study of 150 Crisil rated firms shows.

Domestic demand for cotton yarn, which accounts for over 70% of overall demand, has been impacted because of slack in end-user segments such as readymade garments (RMG) and home textiles.

Cotton yarn exports, too, have been materially affected because of fewer orders from China and Bangladesh, which account for over half of India’s exports. Revenue from exports had already wound back by a third last fiscal, with China increasing procurement from other countries, predominantly Vietnam.

The decline in yarn offtake since Covid-19 afflictions began in February 2020 has meant the current fiscal began with higher inventories of 4-4.5 months compared with 3-3.5 months on average in the past two fiscals. With demand likely to revive only from the second half of this fiscal, inventories will remain high in the first half.

Says Hetal Gandhi, Director, Crisil Research, “Cotton spinners are facing a double whammy of sharp erosion in revenue and inventory losses. Revenues of the domestic industry, which had fallen last fiscal, is set to slip again and touch a six-year low. Additionally, inventory losses loom because cotton prices have declined 10-15% on a sequential basis in the first quarter of the current fiscal.”

With yarn prices falling more than cotton prices, cotton-yarn spread is seen narrowing down to Rs 75-80 per kg this fiscal versus Rs 80-85 per kg last fiscal, which will contract operating margins by 350-400 bps.

Further, the working capital cycle has got elongated because of a stretch in receivables following steep business pressure on key end-users such as RMG makers (refer to Crisil’s press release titled, ‘Slack demand to crimp garment maker revenues by 25-30%’, dated July 30, 2020). Consequently, spinners have been depending more on bank borrowings, leading to high utilisation of working capital limits.

Net-net, we expect credit outlook for cotton spinners to remain negative this fiscal.

Says Krishna Ambadasu, Associate Director, Crisil Ratings, “Already the credit ratio¹ for Crisil rated cotton spinners has deteriorated between April-July 2020, after hovering around 1 time in the previous three fiscals. Tepid business performance and consequent, low cash flows from operations is aggravating liquidity pressures, in the first half of the current fiscal. Interest coverage ratio² for Crisil rated players is expected to slide to below 1.6 times this fiscal versus 2.7 times last fiscal.”

Most firms are managing the situation by availing of moratorium on debt servicing, additional Covid-19 related bank lines, and government measures such as the relief package to micro, small and medium enterprises. Additionally, one-time restructuring of loans announced by RBI will be a viable option amidst tightness in accruals to repayments in current fiscal.”

That said, the benefit of continuing soft cotton prices and liquidation of high-cost inventories from the past fiscal should help cotton spinners perform better in the second half of the current fiscal, provided demand limps back.

¹ Ratio of upgrades to downgrades
² Adjusted earnings before interest, tax, depreciation and amortisation divided by total finance costs