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Profitability of textile companies to come back in H2
Dec '11
CRISIL Research expects profitability of cotton yarn and man-made fibre (MMF) players to improve over the next few quarters on account of decline in input costs and moderate demand growth. During H1FY12, these players witnessed severe profitability pressures which led to significant erosion in their market capitalisation.

In the past one year, cotton yarn and MMF players have registered a negative return of 48% and 37%, respectively, compared to negative 20% return for S&P CNX NIFTY.

However, CRISIL Research believes that the current valuation of these players discounts the current negative sentiments around the sector and offers good scope for upside.

Further, stocks of ready-made garment (RMG) companies seem to be fairly priced in spite of being at historical highs, as they offer relatively high and stable returns among the textile companies during the present uncertain times. The stocks of branded RMG companies have out-performed the S&P CNX NIFTY significantly and posted 25% return on a one-year basis.

The slow-down in demand in both domestic and export markets and the anticipation of a spurt in global cotton production resulted in sharp correction in cotton and yarn prices during H1FY12. This resulted in cotton yarn players reporting significant losses in H1FY12 as they were carrying high cost cotton inventory from the last season.

The sharp drop in cotton yarn prices also enhanced its price competitiveness vis-a-vis polyester (a substitute for cotton) limiting the flexibility of MMF players to pass on the hike in the costs of their inputs, which are derivatives of crude oil. According to Mr Ajay Srinivasan, Head – Industry Research, “Like in the past, we expect easing commodity prices to support moderate demand growth in FY13 and help EBITDA margins of players across the value chain to improve by 100-300 bps y-o-y.”

Valuations of cotton yarn companies and MMF players are nearing their FY09 historical lows with a one-year forward price-to-book value (P/Bv) average multiple of 0.4x and 0.5x, respectively. On the other hand, branded apparel manufacturers are trading at historical highs of one year forward P/Bv multiples of 4.7-5x, against an average of 2.9x from April 2007 to April 2011.

According to Mr Tarun Bhatia, Director – Capital Markets, “With profitability outlook for FY13 improving, valuations of cotton yarn and MMF players are expected to offer substantial upside potential for investors. RMG stocks though fundamentally strong appear to be fairly priced.”

CRISIL Research has seven textile stocks under coverage – Nahar Spinning Mills and Maharaja Shree Umaid Mills in the cotton yarn segment, JBF Industries, Sangam (India), Alok Industries and Shri Lakshmi Cotsyn in the MMF segment, Kewal Kiran in the RMG space. Of these, most companies have a valuation grade of 5/5, indicating that these stocks have a strong upside (more than 25%).

CRISIL Research

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