Profitability of textile companies to improve from H2FY12

Decline in input costs and moderate demand growth will help improve the profitability of cotton yarn and man-made fibre (MMF) manufacturers to improve over the next few quarters, after facing severe profitability pressures which led to significant erosion in their market capitalisation in first half of the current financial year.

In the past one year, cotton yarn and MMF players have registered a negative return of 48 per cent and 37 per cent, respectively, compared to negative 20 per cent return for S&P CNX NIFTY.

However, according to CRISIL Research, the current valuation of these manufacturers discounts the current negative sentiments around the sector and offers good scope for upside. Further, stocks of ready-made garment (RMG) companies seem to be fairly priced in spite of being at historical highs, as they offer relatively high and stable returns among the textile companies during the present uncertain times.

The stocks of branded RMG companies have out-performed the S&P CNX NIFTY significantly and posted 25 per cent return on a one-year basis.

The slow-down in demand in both domestic and export markets and the anticipation of a spurt in global cotton production resulted in sharp correction in cotton and yarn prices during H1FY12.

This resulted in cotton yarn players reporting significant losses in H1FY12 as they were carrying high cost cotton inventory from the last season. The sharp drop in cotton yarn prices also enhanced its price competitiveness vis-a-vis polyester (a substitute for cotton) limiting the flexibility of MMF players to pass on the hike in the costs of their inputs, which are derivatives of crude oil.