As the lockdown in China was lifted from the beginning of April 2020 onwards, spinners there have been scaling up operations.
The Covid-19 pandemic is hitting the domestic cotton spinning sector hard, with performance in FY21 likely to be at multi-year lows. Amid severe demand disruptions, pressure on realisations as well as contribution margins, the operating income of cotton spinners is expected to decline 15-20% on a year-on-year basis, while the operating margins are estimated to correct by 200-400 bps for the full year FY21, compared to the FY20E levels, said an Icra note on Thursday.
This comes at a time when the Indian spinning sector was just starting to come out of a challenging FY20 that saw severe demand-side pressures and unfavourable movements in raw material prices and yarn realisations. There had been a visible weakening in credit profile of domestic spinners in FY20, corroborated by a credit ratio (upgrade to downgrade) of 0.35 times during the year. With widening impact of the pandemic and no meaningful recovery in sight, at least in H1 FY21, Icra is maintaining the negative outlook on the cotton spinning sector, assigned in August 2019.
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This apart, weak demand outlook for India’s apparels and home textile exports is expected to affect yarn consumption by the downstream companies engaged in exports. “With expectations of a slow paced and elongated recovery post the initial lockdowns, we expect severe pressures on the performance of the domestic spinning companies in FY21, and a loss of business to the tune of $2.5-3 billion in FY21,” said Jayanta Roy, senior vice-president and group head, corporate sector ratings, Icra.
Demand for the downstream products such as fabrics, apparels and home textiles, has been sluggish beginning March 2020, amid the lockdown across nations. Being vulnerable to consumer sentiments and discretionary spending, downstream segments are likely to witness severe demand-side pressures over the next two quarters as well, even after the initial lockdown is lifted. Yarn, being an intermediate product, is likely to face a ripple effect of the contraction in demand in the downstream segments.
Icra expects India’s cotton yarn exports to fall 18-20% to nearly a decade-low level of 750 million kg in FY21, closer to the level of exports last seen in FY12, following an estimated 25% decline in FY20, as domestic cotton yarn remained uncompetitive in global markets during much of the previous year. The situation is likely to worsen, given the supply glut situation, which is currently evolving in China.
As the lockdown in China was lifted from the beginning of April 2020 onwards, spinners there have been scaling up operations even as demand from the downstream segments remains subdued amid weak domestic consumption demand as well as lack of demand in the export markets. As a result, there are reports of inventory pile-ups in China. Besides affecting direct demand from China, as it generally consumes 8-10% of India’s cotton yarn production, the supply glut in China is likely to result in an increase in competition for India’s cotton yarn in other overseas markets as well.
“Though performance pressures are expected across the spectrum, highly leveraged entities in lower rating categories would remain more vulnerable over the next few quarters, with heightened challenges of increased working capital requirements and diminishing order book position. In comparison, we expect the impact to be lower on credit profiles of companies with an established customer base, low term debt obligations and companies which have stocked lower cotton fibre at high prices,” Roy said.