Chennai: After a brief but sharp upturn, the cotton yarn industry is facing a challenging environment yet again. This time, due to the steep fall in cotton prices since April this year along with rising interest rates. Recent crash in cotton prices right after the end of peak supplies has questioned the practice of procuring raw material in bulk quantities during the season. Due to this, the operating profit margin of spinners is expected to decline this fiscal year.
As per analysis, the spinners may find it difficult to recover their cost, as the yarn would be produced utilising high priced cotton procured during October 2010 and March 2011. It is believed that the pressure on operating profit margins will be the highest in Q2, FY12, when most mills are likely to consume the highest priced cotton, said Icra in a study.
Due to the sharp drop in yarn prices since April, in sync with the falling cotton prices, the spread between yarn and raw material has almost halved in a short span of less than twelve months on account of consumption of high-cost inventory procured in the period from October 2010 to March 2011. Considering that the average price of cotton from October 2010 to March 2011 was R123/kg4, the spread declined from a high of R109/kg in December 2010 to R24/kg in July 2011 given the average price of R147/kg for 30s carded knitting cotton yarn.
The raw material cost of the yarn to be produced during Q2 and Q3 could be in the range of R137-145/kg, assuming an average yield of 85% to 90% for carded yarn. Hence, the prevailing market price may not be sufficient to recover the cost of production.
Icra expects no improvement in the situation until November/December 2011, as the mills may take that long to consume their current stock of cotton. Subsequently, fresh purchases of cotton are likely to be made at more reasonable rates upon arrival of fresh cotton in the market.
It is expected that the demand too to improve in the domestic market with the onset of festival season in H2, 2011-12 and in the export markets as well in order to fill the gradually depleting pipeline inventory. Moreover, the recent decision by government to reinstate the DEPB benefits on export of cotton yarn and cotton with retrospective effect from April 1, 2011 and October 1, 2010, respectively; and removal of quantitative cap on cotton exports, may arrest the downward pressure and help stabilise the prices of cotton and cotton yarn, the Icra study said.
According to the study, during 2010-11, cotton prices more than doubled to Rs 1,761 per kg in April 2011 from Rs 74 per kg in March 2010 on the back of a combination of robust demand and constrained supply because of unfavourable climatic conditions in main producing countries like China, Pakistan and the US. The spinning companies were able to pass on the soaring cotton prices to their customers on the back of strong demand for cotton yarn in domestic as well as international markets. Rising yarn prices coupled with utilisation of low-cost inventory procured from October 2009 to March 2010 enabled spinning mills to post an increase in their average operating profit margin to 17.5%2 in 2010-11 from 14.5% in 2009-10.
The buoyancy in profitability was, however, deflated in Q4 of 2010-11 due to the ban on export of cotton yarn which lasted from January 15, 2011 until March 31, 2011. This burdened the spinning companies with surplus yarn inventory. The pile-up in inventory towards the end of March/April 2011 was also due to subdued demand in the domestic market following closure of dyeing units in Tirupur, which is a leading hub for hosiery exports and levy of 10% excise duty on branded garments. Unsold stock squeezed the liquidity of spinners which in turn affected cotton purchases by mills and had a further cascading effect on cotton prices. The cotton prices started tumbling and are currently down by almost 50% from the peak of April 2011.