Revenue of the Indian viscose staple yarn (VSY) industry is set to grow 10-12% on-year to an all-time high of over $2.5 billion this fiscal on continued strong demand - similar pace to last fiscal.

Even as yarn prices decline, though at a lower rate than raw material prices, overall profitability is likely to improve 200-300 basis points (bps).

Strong balance sheets and improved cash flows will support the credit risk profiles of manufacturers, despite substantial debt-funded capital expenditure (capex).

A CRISIL Ratings analysis of VSY companies, accounting for over a fourth of the industry by revenue, indicates as much.

VSY is an attractive alternative to cotton yarn because of its lower prices and comparable features. It logged a compound annual growth rate of 13% over the last three fiscals, higher than 5% for cotton yarn.

During this period, VSY prices were relatively stable, ranging between Rs 200 and Rs 250 per kg. In contrast, cotton yarn prices ranged between Rs 200 and Rs 380 per kg. The removal of anti-dumping duty on imports of viscose staple fibre (VSF) in fiscal 2022 also helped steady VSY prices.

Subsequently, VSY’s share of the spinning industry volume increased to over 10% last fiscal from under 7% in fiscal 2020.

Says Himank Sharma, Director, CRISIL Ratings Ltd, “Viscose spinners’ volume is expected to grow 15% on-year this fiscal, supported by sustained domestic demand and a revival in export demand during the second half. Overall, segmental growth will be in low double digits.”

With VSY makers’ revenue improving and spreads between VSY and VSF expanding to Rs 55-58 per kg (chart 1 in annexure), operating margin is likely to improve to 11-12%.

Higher viscose yarn imports from China and weaker global demand impacted spreads last fiscal, causing margin to shrink 800-900 bps. Margin is projected to recover this fiscal as prices of major raw materials (wood pulp and chemicals) moderate, nearing steady-state levels of 12-13%.

VSY makers have increased capacity by 50% in the past three fiscals. They are expected to add another ~15% capacity this fiscal with an outlay of ~Rs 600 crore, likely to be funded by a 1:1 debt-to-equity ratio.

Says Jayashree Nandakumar, Director, CRISIL Ratings Ltd, “The capital-intensive nature of the VSY segment has resulted in players regularly contracting debt for capacity expansion. However, strong balance sheets have ensured credit risk profiles of players remain comfortable despite continuous capex.”

Gearing is expected to improve to ~0.85 time as on March 31, 2024, from ~1.0 time as on March 31, 2023, while the interest coverage ratio is likely to improve to ~6 times this fiscal, from 4.5 times last fiscal, on the back of higher profitability.

Any adverse impact of levy of anti-dumping duty on VSF, leading to higher input cost for viscose spinners or lower domestic demand, along with a further slowdown in global demand, will bear watching.