The looming overcapacity problem in spinning
Recently many spinning companies in textile industry have announced capacity expansion as they have earned decent profits. But can the expansion turn into nightmare for some companies?
Estimated time to read - 5 minutes
What spinning companies do?
They process cotton to convert raw cotton into thread
How the cotton price increase affect spinning company?
The spinning companies need to buy raw material during harvest season & store it for 3-9 months until the next crop comes in the market.
This paragraph summarizes the cotton price movement -
“From Rs. 53 - 60 per kg in 2020, the cotton price jumped to an average price of Rs. 77 per kg the next year. The price further soared to Rs. 100 -113 in the initial half of 2022. But recently prices have corrected to Rs. 90'/kg.” (Keep this price decline in mind )
The cotton prices started increasing during 2021 due to crop shortage & Xinjiang (China) cotton ban from 53/kg to 77/kg. As the raw cotton prices started increasing by the time So the prices started increasing during 2021 due to crop shortage & Xinjiang (China) cotton ban. (further to around 100/kg). The spinning companies which had lower cost inventory hiked prices of their yarns in line with cotton price increase & ended up with higher profit margins. So the companies started expanding based on expanded profit margins or have announced expansion plans.
Listed companies expanding capacity -
Filatex India - 1000-1200 cr capex (Enterprise value - 2627 cr)
Nitin Spinners - 955 cr capex (Enterprise value - 1890 cr)
Sutlej Textile - 900 cr capex (Enterprise value - 2034 cr)
Vardhman textile - 1400 cr capex (Enterprise value - 10813 cr)
Sportking India - 175 cr capex (Enterprise value - 1811 cr)
Companies are expanding as they have earned peak profits as the EBITDA margins have expanded from 11% to 25%. Everything seems alright?
Read the commentary by a listed company read below -
Analyst question - Secondly if we see now our volume is coming in the range of 25000 to 28000 tonnes and your utilization is also 94% I guess last you have put up the capacity in terms of spindles was in 2017 is there any now plans to increase the capacity or would you like to remain at the same levels?
Management reply - The point is that yes we may think of but then at the moment we do not have any plan to increase immediately because if you look at even the deliveries of spinning machines are ranging between two years to three years, so which we expect that would come down in about six months’ time because once this settles down so their deliveries they will be started quoting in the range of two years by next six to eight months. I think at that point of time we would think of that if we can look at the capacity increase; however, we need to improve our own efficiencies; we would like to get better there, so we will improve our margin till such time.
But now what has changed in past 6 months?
The cotton prices now have started to decline back to 90/kg (as stated above) & are expected to further fall back or moderate. So now the spinners have to sell their higher cost cotton at reduced prices which will suppress margins & might also lead to bankruptcy of players with weak balance sheet. Also, the simultaneous expansion leading to overcapacity is also a threat.
My take on the issue -
The spinning industry benefited from cotton price increases which helped them double their EBITDA margins. But many buyers of cotton yarn reduced purchase by either mixing polyester or shutting down capacity. But the price of cotton has started tapering off peak which is expected to affect spinners negatively. If a company with high level of debt currently is expanding capacity with further debt the company might be headed for trouble.
So the capex announcement of spinners might not help much & if cotton price reduce to pre covid levels I expect few companies to go under the water.
What’s your take let me know.
I might be wrong & the above companies are not a buy/ sell/ hold recommendation. The above article is just my personal view.