Apr 13, 2007|
Textile: Offering value?
At a time when companies across sectors and sectors across industrial and service categories have generated much investor interest, causing their stock prices to multiply several times, the textile sector seems to be unduly derelict.
High volatility in near-term earnings due to hiccups in production ramp up, margin pressure due to higher overhead on newly commissioned expansion and the adverse impact of mark-to-market provisions due to forex fluctuations have been the bone of contention. Consequently, the sector's relative price to earnings multiple to the Sensex is down to FY02 levels, which was when the industry had a very high degree of uncertainty, with several players under the BIFR. While the concerns about near term earnings visibility are not unfounded, we believe that such an approach would be very myopic and investors need to look beyond the 'next few quarters' to gauge the prospects of the sector. The modest long-term earnings growth visibility, operating leverage likely to kick in on newly commissioned expansion and improving capital efficiency make a strong case for upward re-rating for the sector.
What went wrong?
Slower offtake post quota: The Indian textile industry was expected to be one of the frontrunners in a quota-free regime with export growth sustaining at high levels and Indian companies gaining market share over their global peers. Also, the changing product mix in favor of higher value-added products and thrust on value addition was expected to differentiate the Indian product offerings, thus contributing towards higher price realisations and better margins. However, the changes in fashion trends and oversupply led to excess inventory with the global retailers, leading to lower offtakes from their offshoring bases in India. To add to it, the pricing pressures dampened hopes of better realisations.
Low cost substitution: One of the key reasons attributable to the severe volume pressure witnessed by the industry in FY07 is the substitution by lower cost producers as the 'preferred sourcing base'. The requisitions from Bangladesh, which were earlier serviced mainly by the larger players in India, is being replaced by local capacities that are coming up. Also, Pakistan and Turkey have now become preferred sourcing bases over India with their logistical advantage due to geographical proximity to Europe.
High operating costs: Most Indian textile companies had a substantial cotton inventory at the beginning of the previous season and the cover kept the cotton prices favourable for the companies until the early part of this fiscal. However, with cotton prices firming up over the past couple of months, the average cost of cotton consumed during 9mFY07 has escalated. Also, to reduce power costs, most company installed captive power capacities based on natural gas. However, due to insufficiency of the feed (natural gas), the companies had to continue accessing the relatively expensive grid power, leading to higher power costs. Textile being a labour intensive industry, the higher labour costs, in an effort to stem the attrition at the middle and junior levels, has also adversely impacted the companies' operating margins.
Foreign exchange losses: The steady appreciation of the rupee against the dollar put the companies' forex hedging strategies at bay and bore deeper holes in the already dented bottomlines.
Value unlocking proposition...
With a significant portion of the sector's large-scale capacity expansions now becoming operational in phases, operating leverage is expected to start filtering in, thus considerably easing the cost pressures going forward. The rising income levels translating into rise in domestic demand for branded apparels and the growing penetration of malls are additional triggers, in our view.
Entry of the global textile giants via FDI route into Indian retail markets would lead them to source more domestically. This would provide the industry with an opportunity to work with global retailers on quality standards and delivery schedules, and give retailers comfort about the manufacturing and designing capabilities of the Indian vendors. This in turn is expected to boost the outsourcing opportunity for India as has been already witnessed this in the Indian auto component sector with global automotive giants having entered the sector.
Another encouraging fact is that the Indian government continues to respond favorably to industry requests and has been more generous with regard to subsidies of late. However, the impending infrastructure bottlenecks and labour reforms still leave a lot to be desired.
While most textile companies offer distinct value propositions, investors would do well by identifying their investment targets based on time-tested parameters.
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