The business risk profiles of cotton yarn spinners are likely to improve in the medium term, backed by robust cash flows resulting from healthy demand and profitability. However, their financial risk profiles will deteriorate because of expected debt-funded capacity expansions, according to a study by Crisil.
Hence, the improvement in their credit risk profiles may be gradual, supported by healthy demand and offset to an extent by debt-funded capital expenditure (capex). The study said players, who funded capex prudently and maintained healthy financial metrics, were more likely to have their ratings upgraded in the next 12 to 18 months.
Crisil’s view is based on a study of 156 spinners rated by it, which collectively represent about 30 per cent of the cotton yarn industry in terms of revenues (based on average realisations of yarn).
The demand for cotton yarn, estimated at 3,073 million kilograms in 2009-10, has been growing at a compounded annual growth rate of six per cent since 2004-05. The demand, however, declined in 2008-09 when the global recession resulted in exports reducing by about four per cent. But the domestic market remained stable and helped limit the overall fall in demand to around two per cent.
In the medium term, Crisil expects the growth in domestic demand to remain favourable and the global offtake to be steady, helping Crisil-rated yarn manufacturers report overall growth of 9 to 10 per cent per annum.
“High operating rates, low costs of carry-forward inventory and unprecedented recovery in demand augmented the operating profitability of players in 2009-10; the average operating margins of Crisil-rated spinners improved to about 16 per cent in 2009-10, a 300-basis-point (100 basis points equal one percentage point) increase over the previous year’s levels,” said Gurpreet Chhatwal, director, Crisil Ratings.
Also Read
For some players, the improvement in margins has exceeded their historic levels by 700 basis points. “The operating margins of players may, however, moderate to 14 to 15 per cent over the medium term because of rising raw material costs, buyers’ resistance to hikes in the prices of cotton yarn, and the government’s recent quantitative embargo on yarn exports,” Chhatwal said.
The spinners’ financial risk profiles have been weak historically, as indicated by their high leverage, although their interest coverage ratios have remained moderate. They undertook debt-funded expansions in the past decade, taking advantage of the government’s push to modernise and enhance competitiveness of the textile sector under the Technology Upgradation Fund Scheme.
Spinners’ gearing and interest coverage ratios averaged 2.7 times and 2.4 times, respectively, over the five years ended 2009-10. Emerging from a recessionary trend in 2008-09, players’ financial risk profiles have recovered since the second quarter of 2009-10, supported by buoyant demand and higher operating margins, resulting in healthy cash flows and improved capital structure.
“Yarn manufacturers are likely to resume capacity expansion from 2011-12 to meet the increasing demand: the fact that players have been operating at more than 90 per cent of capacity from 2009-10 implies that fresh additions to capacity will be necessary if they are to meet the expected demand,” said R Vasudevan, head, Crisil Ratings.
Debt funding of capex will result in deterioration of players’ capital structure. Strong operating cash flows underpinned by healthy demand and robust margins will support spinners’ financial risk profiles, and players who fund capex with a prudent debt-equity mix are likely to have their ratings upgraded in the next 12 to 18 months, according to Vasudevan.