Operating profits of cotton spinners will double next fiscal as revenue spurts 20-25% on higher sales to Asian buyers and appreciation in cotton yarn prices, a study of 102 of them (including 95 rated by CRISIL), which account for 40% of the industry, shows. Consequently, the credit outlook for cotton spinners, which was negative in the first half of this fiscal, will turn positive next fiscal, as accruals improve and inventory reduces.

With global demand for knitted garments and home textiles recovering faster than expected due to extended stay-at-home period, and sharper focus on health and hygiene, exports of yarn to China, Bangladesh and Vietnam (which account for over half of India’s exports) rose 22%, 39% and 51%, respectively, on-year in April-December 2020 (see chart 1 in annexure). What has also helped is the US move to ban use of Xinjiang cotton, which has cranked up Indian yarn exports.

Supplementing exports is the expectation of revival in domestic demand next fiscal owing to recovery in discretionary spending by consumers. Consequently, overall revenues of cotton spinners, which is set to decline 14-16% this fiscal, should rebound next fiscal.

Spreads¹ (difference between cotton and yarn prices), too, have improved as a rebound in global demand lifted prices of yarn higher than cotton (up ~20% over April-December 2020, compared with 13% for cotton). Spreads had narrowed to Rs 80-85 per kg in June-August from as wide as Rs 103 in May, and clawed back to Rs 90-95 in September-December (see chart 2 in annexure). The trend should continue next fiscal, given improving demand.

Says Gautam Shahi, Director, CRISIL Ratings, “Capacity utilisation of spinners has also risen from 70-80% in the second quarter this fiscal to ~90% in the third, and is likely to remain high next fiscal, too, which supports revenue. That, and widening cotton and yarn spreads would mean operating margins of spinners would increase 200-250 bps on-year to ~11% next fiscal, and operating profits would almost double.”

With demand rising, inventory should decline to typical levels of 2-3 months by the end of this fiscal, from around 4 months a year ago. That would reduce dependence on short-term borrowings.

Says Kiran Kavala, Associate Director, CRISIL Ratings, “The credit outlook for cotton spinners is positive as improving cash accrual and lower working capital debt will burnish debt protection metrics next fiscal. This is significant, considering credit ratio (ratio of number of rating upgrades to rating downgrades) for CRISIL-rated cotton spinners had deteriorated to 0.31 (April 2020 - February 2021), after hovering over 1 time in the past three fiscals. We expect the credit ratio to improve next fiscal driven by improvement in debt protection metrics such as interest coverage² and net cash accrual to total debt of cotton spinners estimated to double to over 4 times and 0.25 time, respectively, next fiscal from an estimated ~2 times and 0.12 time, respectively, this fiscal.”

Higher exports and yarn realisation have helped spinners recover a chunk of the losses incurred in the first quarter of this fiscal. That said, China’s stance on cotton yarn imports and the sustenance of higher spreads remain the monitorables.

¹ Refers to spread between domestic price of Shankar–6 (S-6) variety of cotton and domestic price of 40s count yarn. As cotton is the main raw material for manufacturing yarn, the spread directly impacts profitability.
² Adjusted earnings before interest, tax, depreciation and amortisation divided by total finance costs