Denim industry operating margins decline to 10% amid overcapacity

Operating margins of the denim industry fell from 13 per cent in 2015-16 to around 10 per cent in FY18. This is on the back of continued overcapacity in fabric and mismatch between denim fabric and garment capacity additions.

India Ratings and Research (Ind-Ra) anticipates the domestic denim sector will continue to face margin pressures during FY19, with 15-20 per cent of capacity not utilised. 

Led by Nandan Denim, Arvind, KG Denim, Jindal Worldwide and Aarvee Denim, India is a leading denim fabric manufacturer in the world, with a capacity of about 1,500 million metres per annum (mmpa). The competition is set to intensify, with several players having undertaken capacity additions of another 100-150 mmpa by FY19. 

However, this is not being met with similar rise in garmenting capacity, according to Ind-Ra. “Long-term demand potential for the segment remains intact due to denim’s versatile fashion appeal among the young populace, rising disposable income and untapped semi-urban pockets. However, Ind-Ra expects denim fabric capacity additions to outpace garmenting capacity additions over the short term,” the report stated. 

“Ind-Ra expects the present downturn to be relatively prolonged, partly on account of the regulatory disruptions the industry underwent in FY17–FY18. Ind-Ra expects  operating margins to remain in the range of 10-11 per cent in FY18-19.”  

Factors that could ease the situation include softening of cotton prices due to rise in sowing, coupled with capacity absorption to some extent by export.

According to Ind-Ra, with farmers switching from soybean to cotton, the 2017-18 season has seen about 19 per cent rise in the natural fibre. The higher production could soften cotton prices during FY19 and help curtail margin contraction for denim fabric manufacturers.

“Exporters will also see some impact on margins because of reduced duty drawback, notwithstanding the increase in availability of input tax credit. Further, any adverse outcome of the ongoing dispute with the US Trade Representative at the World Trade Organization with regard to India’s export promotion schemes could have a material impact on exporters’ margins,” Ind-Ra stated. 

While part of the denim fabric surplus will get absorbed in global markets, India’s denim manufacturers majorly depend on the domestic market, with export below 20 per cent of total production. In FY17, denim fabric export stood at 142 million metres (FY16 saw 132 mm), against import of 9 mm (FY16 saw 10 mm).