Operating profitability¹ of cotton yarn spinners is set to improve 100 basis points (bps) to 11-12% in fiscal 2024, despite an expected 10-12% on-year fall in revenue stemming from lower realisations and muted exports. Yet operating profitability will remain below the pre-pandemic 5-year average of 12-13%.

The rise in operating profitability in fiscal 2024 would follow a sharp ~600-700 bps fall estimated for fiscal 2023 (in line with earlier forecast) to 10.5-11% — on a high base of fiscal 2022, when decadal-high spreads had spooled up profitability.

Credit profiles of cotton yarn spinners are seen stable following deleveraged balance sheets due to low capex in the past few fiscals, super-normal cash generation in fiscal 2022, and likely improvement in operating profitability in fiscal 2024, a Crisil Ratings analysis of 101 cotton yarn spinners accounting for ~35% of the industry’s revenues, shows.

Says Gautam Shahi, Director, Crisil Ratings, “Cotton prices in India will average 15-20% lower (on-year) in fiscal 2024 because of higher production in the ongoing cotton season. This has led to a sharp correction in prices since November 2022. Yarn prices are also commensurately lower. That, along with only a marginal growth in export demand, will keep cotton prices in check next fiscal. Additionally, it would ensure spreads² between raw cotton and yarn prices stay healthy at Rs 85-95 per kg (chart 1 in annexure), and support improvement in the operating margins of yarn spinners by 100 bps, to 11-12%, next fiscal.”

In addition to healthy spreads, expected improvement in capacity utilisation, supported by improving domestic and exports volumes in fiscal 2023, will bolster operating profitability of yarn spinners in fiscal 2024. Prices of cotton, the largest cost head for spinners, had begun rising in February-March 2022 and soared to all-time highs by May-June 2022, sharply impacting the operating profitability of spinners in fiscal 2023.

Domestic yarn demand (75% of total yarn demand) remains steady with 4-5% volume growth expected in fiscal 2024, supported by stable domestic readymade garments (key end-user) demand.

A slowdown in the global readymade garment market and its impact on cotton yarn demand could curtail export orders (comprising 25% of total yarn demand). However, Indian exports will continue to benefit from the US ban on material coming from the Xinjiang region of China, and supply-chain derisking by global customers. Cotton yarn export volume is expected to grow at 3-5% next fiscal, after halving in fiscal 2023.

Says Sehul Bhatt, Associate Director, Crisil MI&A Research, “The fall in domestic raw cotton prices below international prices (chart 2 in annexure) also augurs well for domestic yarn spinners because it improves their competitive advantage. Expected improvement in operating performance will increase capex incurred by cotton yarn spinners by ~45% to Rs 2,100-2,200 crore in fiscal 2024, versus Rs 1,500 crore average in the past three fiscals.”

Despite the spending, credit profiles of cotton yarn spinners will remain stable aided by improvement in profitability in fiscal 2024, lower leverage, and strengthened balance sheets. Gearing will improve to 0.5 time in fiscal 2024, lowest in the past 5 fiscals, compared with 0.6 time estimated for fiscal 2023.

Interest coverage ratio of the sample set is set to improve to 4.8-5.2 times in fiscal 2024, up from less than 3.7 times estimated for fiscal 2023.

The lifting of the ban on Xinjiang cotton and any adverse movement in domestic cotton prices in the coming months will bear watching.

¹ Operating profitability= earnings before interest, tax, depreciation and amortisation
² Spreads refer to the difference between the prices of raw cotton (average of domestic and international cotton prices) and domestic cotton yarn