By admin       2018-07-03

The surge witnessed in domestic cotton prices in the recent months (from ~Rs115/kg in March-April 2018 to ~Rs134/kg in June 2018 for Shankar 6 variety) augurs well for the profitability of the domestic spinning sector in the near term. As a result, the trend of recovery in profitability, which started in Q4FY18 after two consecutive weak quarters, is expected to gain momentum during H1FY19. Jayanta Roy, Senior Vice-President and Group Head, Corporate Sector Ratings, ICRA Ltd, said, The improvement is expected to be stronger for well-stocked spinners, which were able to build up low-cost cotton reserves in the month of December 2017 when domestic prices had dipped temporarily, bringing down their overall weighted average raw material costs. As per ICRA, international cotton prices witnessed a sharp surge and reached four-year high levels during the six-month period ended May 2018. This was the result of an evolving cotton scenario in China as well as speculative buying in the backdrop of anticipated tightening of global cotton demand-supply situation. While the prices have stabilized in the last week of June 2018 after surging further by ~5-6% in the first few weeks of June 2018, these continue to be ~10% higher yoy. In comparison, Indian cotton prices increased at a much slower pace during Jan-May18 amid adequate stocking by the spinners during the harvest period, which resulted in a widening of the spread between the Indian and international cotton prices to ~18% vis-a-vis a normal spread of ~2-5%. This, together with rupee depreciation, made Indian products competitive, resulting in a sharp growth of more than 50% yoy in India’s cotton yarn exports between March and May 2018. This, in turn, supported a sharper rise in yarn realizations vis-a-vis cotton prices, resulting in an expansion in contribution margins of domestic spinners. The trend is corroborated by a ~25% yoy increase in spinners’ real contribution margins during the recent months. Following a spurt in exports of Indian cotton yarn between March and May 2018, an increase in Indian cotton prices was witnessed starting mid-May 2018, which narrowed the spread between domestic and international cotton prices to ~6-8% in the last week of June 2018. With price differential correcting, ICRA expects the recent spurt in exports of Indian cotton and yarn to be arrested and growth to moderate from Q2FY19 onwards, Roy added. Besides the arbitrage opportunity getting bridged, competitive pressures from Vietnam, and China’s focus on improving the cotton availability situation are expected to moderate the export demand for India’s cotton yarn. Nevertheless, expectations of firm cotton prices and revival of domestic demand, which remains volatile and weak, is likely to lend support to the yarn prices. Although higher cotton prices are expected to result in increased working capital requirements and, hence, interest costs of cotton-based spinners during FY2019, interest coverage indicators are expected to remain comfortable aided by a further improvement in profitability. Earlier in Q4FY18, the aggregate interest cover for ICRA’s sample had improved to 3.9x from 3.1x and 3.6x in Q2FY18 and Q3FY18m, respectively, despite the seasonal increase in interest outgo due to higher cotton stocking in Q4.

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