After quite a few years of facing a glut in the domestic market due to excess capacity, the Indian denim industry may finally see the demand-supply gap narrowing. In addition, with mass consumption demand also expected improve even as denim players go for more premium products, gross margins in the industry are also expected to improve by 3-4 per cent this year.
"There was a mismatch in demand and supply. But in the last couple of years, due to demonetisation and Goods and Services Tax (GST), the denim market has seen a slowdown and the overcapacity is getting adjusted. Also, no new capacities or fresh investments are likely to come up. Hence, the excessive capacity that got accumulated over the years is now getting utilised gradually," says Sharad Jaipuria, CMD, Ginni International told Business Standard.
Denim, mostly fabric, capacity in India had suddenly shot up a few years ago and now stands at roughly 1,700-1,800 million metres a year. However, with annual exports being hardly 200-250 million metres, the rest of the capacity was earmarked for the domestic market, creating a glut. This had led to shrinking margins for even some of the top denim makers.
However, Jaipuria, who is also the president of Denim Manufacturers' Association, believes that with no new investment in sight and capacity rationalising, gross margins could improve by 3-4 per cent this year.
Reiterating Jaipuria's views is a recent report by India Ratings and Research (Fitch Group) as part of its FY20 outlook for textile sector’s denim industry which states that the denim manufacturers may expect operating margins to improve marginally.
The rating agency too expects minimal new greenfield investments in the sector as sub-optimal utilisation levels will not entice any players to start investing before FY'22 given that the current capex will require two to three years to stabilise.
However, while the sector’s operating margins is expected to improve moderately to 10-11 per cent in FY20, inflation in cotton prices could offset the benefits of operating leverage and modest increase in fiscal incentives.
"We believe denim sector margins are on the cusp of gradual improvement owing to focus on premium products and vertical integration. The agency expects return of wholesale and consumer demand for basic denim in domestic market and exports for value-added denim to gradually improve capacity utilisation. While the basic denim overcapacity will persist in FY2020-FY2022, the improved demand outlook will underpin benefits from operating leverage and enable transmission of raw material cost inflation to an extent," says Mahaveer Shankarlal, Associate Director – Corporate Ratings, India Ratings and Research (Fitch Group).
On one hand, India Ratings and Research (Fitch Group) expects the credit profile of denim fabric manufacturers to marginally improve in FY20 amid recovery in operating margin, aided by reduction in operating leverage and higher mix of value-added products. However, on the other, it estimates revision of remission of state levies and states’ incentive schemes will underpin margin recovery in FY20.