After a subdued Q1, cotton mills are likely to recover in terms of their profit margin in Q3 of the current year with increased availability of fibre from the new harvest season, which starts in October.
The profit margins of most spinning mills remained under pressure in the April-June quarter 2017. This was followed by weak global sentiment, which hampered India's cotton yarn exports and subdued demand from local markets due to traders' destocking ahead of GST (goods and services tax) implementation effective July 1.
"The level of global cotton production in CY18 is estimated to exceed consumption, after two consecutive years of shortfall. The resultant surplus, therefore, will create a downward bias in prices, which besides easing pressure on margins of the spinners, is likely to bring down their working capital requirements. This bodes well for the domestic cotton spinning industry.
"Improved supply of cotton fibre is expected to provide some respite to the domestic spinners during H2 FY2018," said Jayanta Roy, Senior Vice-President and Group Head, Corporate Sector Ratings, Icra.
Although the weather conditions have been largely favourable, erratic rainfall in Southern and Central India, flooding in some regions of North Gujarat (the largest cotton producing state in the country) and pest problems in some areas, may impact the average yield for the season.
Accordingly, the yields are expected to be lower vis-a-vis the yield of 531 kg per ha reported in the previous season. Even with a yield of around 505 kg per ha, at a level close to the past three years’ average, the cotton crop output is expected to grow by 5 per cent to around 36 million bales (170 kgs each) in CY2018.
Meanwhile, a decline in yarn realisations has affected margins of spinners in recent weeks and is likely to reflect in their second-quarter performance.
"However, with further correction in cotton prices expected with the commencement of harvest season in October, the spinners’ profitability will improve during the second half of the current financial year," said an analyst.
Cotton stocks in China continue to be higher than historical averages. As per the estimates, it will take about two-three years more for excess stocks to reach historical average levels and revival of imports by China. Nevertheless, with this year’s cotton auctions, a recovery in yarn demand from China is likely to help the Indian yarn exporters in H2FY18. Further, Indian yarn exporters are trying to diversify their markets to increase their sales volumes.
The cotton spinning sector in India has witnessed challenges on multiple fronts over the past few quarters. While exports continue to fall due to weak demand from one of the key markets (China), domestic demand also slowed down in Q1FY18 amid focus on inventory clearance prior to GST implementation, which affected offtake and hence production volumes. Q1FY18 was the fourth consecutive quarter wherein companies reported an annual decline in volumes.
Besides the demand-side pressures, the challenges have been further accentuated by consistently firm cotton fibre prices resulting in subdued margins, as well as the strengthening of the Indian currency vis-a-vis currencies of the competing nations, thereby affecting realisations. As a result, Q1FY18 was the weakest first quarter for the domestic spinners during the past six years in terms of profitability.