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Friday, March 29, 2024

Fall in credit profile in Denim sector

According to a recently published report, the denim industry is expected to face a downfall. The denim industry represents less than 10% of the textile market. The industry is likely to face deterioration in credit profile in the absence of improvements in realizations in FY18. Said in the report is that the market’s  operating margins could fall to 10-11 per cent in FY18 due to cost inflation amid surplus capacity in denim standard products with low cotton content.

Ind-Ra has also estimated prices to moderate in 2HFY18, highlighted in the report ‘Stable Input Prices, Fiscal Incentives to Support Textile and Cotton in FY18’. However, the denim surplus situation and inventory losses are likely to pressurize margins.Moreover, the man-made industry demands a level playing field for the taxation of cotton, which is exempt from indirect taxation. If cotton is brought under the Goods and Services Tax (GST) then cotton fabrics including denim sector’s profitability may come under pressure in the transitory period.

The agencies denim peer set average EBITDA margins deteriorated in 9MFY17 to 12.6% from FY16’s 13.2 per cent. The fall in margins is on account of players’ inability to completely pass on the increase in cotton prices, on the back of high competitive pressure, similar to the situation in FY14. Also, the Raw cotton prices have increased by 32.8% YoY in March 2017 and Ind-Ra expects it to remain elevated until 1HFY18. For Denim manufacturers’ cotton forms more than 35-40% of the total raw material requirement. The agency notes that for many of the basic denim fabric manufacturers catering to domestic consumption average realizations remained steady, despite higher cotton prices in 9MFY17.

However, some of them have been able to increase realizations for 4QFY17 partly passing the cost inflation with a lag. Denim garments players are likely to perform better than fabric players, as the retail margins may sustain as fabric prices remain under pressure.

Ind-Ra expects the denim sector to post robust volume growth of over 10-15% in line with the past trend along with rising disposable incomes a rapid growth of the retail sector, westernization trend, young population demographics, and versatility of denim as a fabric. However, Ind-Ra views that the capacity addition is growing at a faster rate. Moreover, the existing capacities will face competition from new-age cost-efficient plants.

Overall, the credit profile for most players has come under pressure also due to the stretched working capital cycle and debt-led capacity expansion in the backdrop of operating margin pressure. Aggregate peer set net leverage (Net Debt/EBITDA) increased to 4.59x in 1HFY17 compared to 2.83x in FY16. The working capital cycle has got stretched to 61 days in 1HFY17compared to 54 days in FY16, on account of the high credit period and inventory holding for the new capacity ramp-up. Increased competition in the international arena and higher receivable days will impact the exports profitability. Companies with strong liquidity, low leverage, and short working capital cycle are better placed to face the challenging times.

 

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