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The shift from yarn to real estate - Views on News from Equitymaster
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  • Dec 9, 2010

    The shift from yarn to real estate

    Mumbai has emerged as one of the most expensive and sought after destinations for realty development in Asia. The reason for the same obviously stems from the city's role in housing India's financial infrastructure. If one traces back into history, the role was assumed by the city over a period of time. Once known for its textile mills, the city has lost its roots with yarn manufacturing over the decades. So much so that the largest players in this business have now taken upon themselves to make the move from yarn to real estate.

    Companies like Raymond and Arvind Mills have been the pioneers of branded apparel in the country. In fact they are also the biggest exporters to global apparel manufacturers and retailers. The inherent cost advantage that India enjoys has helped the businesses for decades. Being the second largest producer of cotton has also come to the players' aid in the past. But the post recession period has not really brought any meaningful recovery to their fortunes. Being largely export oriented, the Indian players' pricing power remains restricted to the growth in demand from the West. Despite higher domestic consumption, margins continue to lean on the Western trends.

    Meanwhile higher input costs have also played spoilsport. With most of Indian cotton getting exported, international prices for the commodity have gone through the roof thereby impacting cost of raw materials. Companies like Arvind and Raymond attempted to curb rise in power costs with captive capacities. However they were constrained by issues like lack of gas supply for power plants.

    Further, foreign currency dealings have had the biggest impact on the wafer thin margins of these companies. Little pricing power and high input costs were already taking a toll. In addition, the forex losses led the company's financial health into oblivion. Important to mention here that these companies have also accumulated excessive debt. Thanks to the lure of borrowing at subsidized rates. The only item that could bring some 'positivity' to their cash flows was something 'extraordinary'! And that is what the players finally tapped.

    Most of the textile players owned large parcels of land in and around Mumbai. Raymond and Arvind, for instance, own land in Thane and Ahmedabad (Gujarat) respectively. Since real estate has come to be a more lucrative business than textile, the promoters leaned towards the former. Arvind chose to partially sell its land and cut down losses in denim manufacturing. Raymond on the other hand took up realty development as its latest business interest. Players like Alok who were quaint and profitable manufacturers of home textile also tried their hand at it. This was despite having no previous experience in real estate.

    Thus the real estate bug seems to have bitten the once yarn manufacturers really hard. For the time being, it may seem benign to them as well to their investors. For those who are selling land are able to cut down textile losses. Those are not selling are able to over value their land banks and seek premium valuations. While the textile businesses still offer very little visibility, realty is claimed to be the game changer. We are not so sure. The valuations of the realty stakes could erode dramatically in the event of a bubble burst in the sector. Further, both textile and real estate businesses have the tendency to lean towards high leverage. Hence a combination of the two could be a futile one for investors.



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