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Textile: A sense of deja vu? - Views on News from Equitymaster

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Textile: A sense of deja vu?

Jul 7, 2006

The bear carnage witnessed on the bourses over the last couple of months took a toll on all sectors alike - be it old or new economy stocks. Textile stocks have been witness to such market wrath more than once. In the previous interest rate hike-economic slowdown cycle (from late 1990s to early 2000s), it was this sector that was the worst affected, with most players being subject to the BIFR (Board of Industrial and Financial Reconstruction). The textile story, which had picked up momentum after the dismantling of the quota regime in January 2005, now however, seems to have failed to lure the investors. Stocks from the apparel as well as home textile segments alike (even market leaders) were under the hammer and have grossly under performed the benchmark BSE-Sensex over the past couple of months.

Several knots to untie...
We explored the possible causes for the investor apathy towards the sector and came up with several of them.

Demand slowdown: Although the domestic demand for textile remains robust, the same is not true for the branded garment segment. Therefore, manufacturers largely rely on the overseas markets for vending their products. Of this, the US and the EU consume nearly 90% of the exports. To put things into perspective, Raymond derived nearly 55% of its revenues from exports in FY06, despite having well-established brands and a well-penetrated domestic distribution system. For home textile companies like Welspun, the domestic market being dominated by unorganised players, nearly 90% of the produce is exported. However, with the US and the EU economies now showing signs of slowdown, the same will inevitably have an impact on the incremental demand.

Exchange rate risks: Given the volatility of the rupee against foreign currencies (especially against the US dollar), the exposure to the overseas markets renders the textile companies to significant foreign exchange risks. Although most textile companies have some hedging mechanisms (example, forward bookings) in place, an unexpected movement in the rupee can obliterate such efforts.

Hardening interest rates: Rise is interest rates at a time when most textile companies are heavily leveraged due to the ensuing or ongoing capex plans is bound to pressurise their interest coverage ratios. In fact, this is the time that will test whether the companies have taken cognizance of the lessons learnt during the previous interest rate cycle. Nevertheless, companies that have already taken advantage of the TUF (Technology Upgradation Fund - to expire in March 2007) to fund their capex are, however, better off than their peers.

Global towel capacities (MMT)
Country Existing Expansion plans Total
China 150,000 20,000 170,000
India 100,000 30,000 130,000
Brazil 100,000 10,000 110,000
Pakistan 75,000 15,000 90,000
USA 110,000 (60,000) 50,000
Total 535,000 15,000 550,000
Overcapacity: Companies in the apparel and home textile segments alike have huge capacities coming up in the near term. However, the underutilisation of these capacities, led by flagging demand, may deny any operating leverage, thus forcing them to compromise on their operating margins.

Competition against global leaders: With foreign brands being allowed to make a foray into to India through the FDI route (FDI in single brand retailing) it calls for competitiveness on the part of the Indian players. Be it through the joint venture route or otherwise, companies that have so far been taking the advantage of in-licensing the established brands, now need to focus on building their own.

What to expect?
While the demand for branded textiles is here to stay, intensifying competition and oversupply may step up pressure on the pricing front. Also, rational utilisation of capacity and operating efficiency will determine the way forward. It will thus be prudent on the part of investors to restrict their exposure to players that have the pricing power (market leadership) coupled with a competitive edge.


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