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Textile: Macro triggers - Views on News from Equitymaster
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Textile: Macro triggers
Dec 13, 2006

Textile stocks have largely been very sporadic participants in the market rally over the past six months. This was primarily because of two factors. One, most players in the sector are in an investment mode thereby incurring high capex, depreciation and interest costs. Second, the high dependence on exports subjected the companies to foreign exchange volatility. The shift to the benign post-quota regime was also not without hiccups, with other low cost manufacturing nations trying to cannibalise some market share. Nevertheless, what enthuses us about the sector is the fact that while the current phase is a temporary phenomenon in the sector, the valuations accorded to some of the best players in the sector does not seem to be factoring in the potential upsides here from. Sustained high growth in exports, focus on enriching product mix, growth in domestic demand for branded apparel, strength across the textile value chain and India’s role as an alternative supplier to China positions the country very favourably on the fundamental barometer. Favorable reforms (government proposing to extend the TUF* tenure) and significant capex becoming operational suggest improved earnings visibility.

Enriching the export mix
From traditionally being low value yarn and fabric exporter, India is fast emerging as an exporter with a higher mix of value added products (apparels, garments and home textiles). The increasing share of value added products (53% of 1HFY07 exports) is indicative of the fact that while overseas buyers seem more confident of sourcing their requirements from the domestic players, even the realisations are expected to be less volatile going forward.

Value addition – A differentiating factor
Focus on higher value addition and thrust on enriching product mix is India's attempt to differentiate itself from regional peers such as China and Pakistan. India's higher price realisations have reasonably compensated for the relatively lower market share of exports to the US as compared to China. Further, once the higher capacities get commissioned, we believe that Indian companies would be in a position to garner better margins and healthier profitability in the future.

Bridging the demand supply mismatch The sector has undertaken large-scale capacity expansion over the last couple of months (Post dismantling of quotas) that are now becoming operational in phases. While this would lead to nearly doubling of capacities, it should also provide the sector with high operating leverage and improved earnings growth visibility. The expanded capacity would help meet bulk orders from the overseas buyers.

FDI to strengthen the outsourcing story
FDI in single brand retailing is set to pave the path for entry of global giants into India’s domestic retail markets and should induce them to incrementally source from the domestic exporters. 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 Indian vendors. This in turn could spell the outsourcing opportunity for India as has been witnessed earlier in the Indian auto component sector with global automotive giants having entered the sector.

Indian government continues to respond favorably to industry requests
The Indian textile industry, which employs more than 35 m people and is the second-largest employment generator after the agriculture sector. The government recognising the sector's potential to spur economic growth, generate employment opportunities and drive exports, continues to respond favorably to industry requests to boost growth prospects, encourage further investment and enhance the global competitiveness of the textile sector. Some specific measures that are expected to prove benign to the sector going forward are:

  • The government plan to extend the 5% interest subsidy via Technology Upgradation Fund (TUF) scheme, which was previously slated to expire in March 2007.

  • Fast progress on relaxing labor laws to improve sector productivity. With textile SEZs offering flexible labor laws, we think a national rollout is not far.

  • Establishment of Integrated Textile Parks for scaling manufacturing capabilities in India. Nine parks have already received permission by the Textile Ministry; the target is for 25.

While these triggers certainly call for a revised outlook for the textile sector, concerns about possible slowdown in exports to the developed markets (due to slower economic growth) and pressure on realisations due to surplus capacities cap the expected returns.

*Textile companies have been offered term loans from banks at 5% to 6% subsidised interest rates under the Technology Upgradation Fund (TUF) scheme to enhance and modernise their capacities. The same was originally due to expire in March 2007.

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