Spinners' financial risk profiles weak historically
CRISIL expects the business risk profiles of cotton yarn spinners rated by it to improve over the medium term, backed by robust cash flows resulting from healthy demand and profitability. Their financial risk profiles will, however, deteriorate because of expected debt-funded capacity expansions.
Hence, improvement in their credit risk profiles may be gradual, supported by healthy demand, offset to an extent by debt-funded capital expenditure (capex). Players that fund capex prudently, and maintain healthy financial metrics, are more likely to have their ratings upgraded in the next 12 to 18 months.
CRISIL's view is based on a study of 156 spinners rated by it, which collectively represent about 30 per cent of the cotton yarn industry in terms of revenues (based on average realisations of yarn). The demand for cotton yarn, estimated at 3073 million kilograms in 2009-10 (refers to financial year, April 1 to March 31), registered a compound annual growth rate of 6 per cent between 2004-05 and 2009-10; demand had declined in 2008-09, when the global recession resulted in exports reducing by about 4 per cent.
The domestic market, nevertheless, remained stable during 2008-09, and helped limit the overall fall in demand to around 2 per cent. In the medium term, CRISIL expects growth in domestic demand to remain favourable and the global offtake to be steady, helping CRISIL-rated yarn manufacturers report overall growth of 9 to 10 per cent per annum.
Says Mr. Gurpreet Chhatwal, Director, CRISIL Ratings, ”High operating rates, low costs of carry-forward inventory, and unprecedented recovery in demand augmented the operating profitability of players in 2009-10; the average operating margins of CRISIL-rated spinners improved to about 16 per cent in 2009-10, a 300-basis-point (100 basis points equal 1 percentage point) increase, over the previous year's levels.” The improvement in margins has exceeded their historic levels by 700 basis points for some players. Adds Mr. Chhatwal, “The operating margins of players may, however, moderate to 14 to 15 per cent over the medium term, because of rising raw material costs, buyers' resistance to hikes in the prices of cotton yarn, and the Government of India's (GoI's) recent quantitative embargo on yarn exports.”
The spinners' financial risk profiles have been weak historically, as indicated by their high leverage, although their interest coverage ratios have remained moderate; players' undertook debt-funded expansions in the past decade, taking advantage of GoI's push to modernise and enhance competitiveness of the textile sector under the Technology Upgradation Fund Scheme. Spinners' gearing and interest coverage ratios averaged 2.7 times and 2.4 times, respectively, over the five years ended 2009-10. Emerging from a recessionary trend in 2008-09, players' financial risk profiles have recovered since the second quarter of 2009-10, supported by buoyant demand and higher operating margins, resulting in healthy cash flows and improved capital structure.