A sharp fall in both domestic and exports demand because of the Covid-19 pandemic, lower profitability, and elongation of working capital cycle are expected to impair the credit profiles of readymade garment (RMG) makers this fiscal.

The impact will be felt more by exporters owing to higher revenue de-growth and stretched receivables, an analysis of over 180 CRISIL-rated RMG manufacturers (representing revenue of around Rs 40,000 crore) shows.

The prolonged lockdown and lower discretionary spending are expected to reduce the revenue of RMG makers by 25-30% this fiscal. For exporters, the fall will be more because of tepid discretionary spending in the US and European Union (accounting for ~60% of India’s RMG exports).

Says Gautam Shahi, Director, CRISIL Ratings, “Over the past five fiscals, revenue growth of RMG makers was supported by domestic demand even as exports were muted. This fiscal, with domestic demand also falling significantly, revenues are expected to be materially impacted. Consequently, their operating margins are expected to contract 250-300 basis points (bps) to 7-7.5% for the sample set, despite softer cotton prices, and cost-reduction initiatives.”

Further, their working capital cycle has elongated because of higher inventory and stretched receivables. Last fiscal ended with 20-25% higher inventory as the Covid-19 pandemic took hold and lockdowns began in late March. With demand depressed in the first half of this fiscal, inventories will remain high. Adding to the woes of exporters will be weakening credit profiles of some large global brick & mortal retailers, which will stretch receivables.

Says Kiran Kavala, Associate Director, CRISIL Ratings, “A sharp fall in profits means RMG makers will not have sufficient cash accruals to meet repayment obligations in the first half of this fiscal. But they are expected to utilise the cushion available in their working capital facilities, and will be helped by the moratorium on loan repayments, the government relief package to micro, small and medium enterprises, and the Covid-19 emergency credit lines.”

Cash flows are likely to improve in the second half of this fiscal due to pick-up in demand from the third quarter as the festive season begins in India and fall/winter season begins in the export markets. That would put RMG makers in a better place to service debt obligations. But given the material impact of weak business performance in the first half, the ratios of net cash accrual to loan repayments, and interest coverage will still be significantly weaker at 1.4-1.7 times and well below 3 times expected this fiscal, compared with 2.4 times and 4 times, respectively, in fiscal 2020.

Given the milieu, depreciation of the rupee against the dollar and the euro, and increase in incentive structure for exporters – which can help moderate the fall in profitability – will be the key monitorables.