INDIA: Increasing cotton prices could trip margins at spinning mills

Expectations of higher minimum support price and increased demand from China are expected to impact cotton prices, already under pressure from reduced production

Low cotton prices over the last year had given a leg-up to profitability of Indo Count Industries, Nahar Spinning Mills and Vardhman Textiles that may feel the heat of rising cotton prices in the quarters ahead.

A surge in cotton prices spells bad news for spinning mills. Stable prices until January had lifted profit margins for mills in fiscal year 2018 (FY18), bringing relief as margins had been falling earlier.

The trouble started after the ministry of agriculture estimated that cotton crop sowing in the kharif season until May is 14% lower than a year ago. In line with this, rating agency Icra Ltd has forecast a 7-8% decline in cotton acreage to 11.4 million hectares in calendar year 2019 (CY19).

Even the seasonal estimate of 35 million bales for CY19 is lower than last year’s output. Severe pest attacks on cotton crop last season may have led to losses that forced farmers to shift out of cotton this season.

Be that as it may, speculation on lower output has driven up domestic prices (Sankar-6 variety) by 15% since January. With elections round the bend, analysts expect higher minimum support price for cotton. Icra estimates a minimum floor price of Rs 115-120 per kg, way higher than about Rs 95 per kg about two years ago.

Meanwhile, the domestic uptrend is also supported by strong international prices due to a revival in demand from China. The country’s cotton imports were low for two years as it wanted to exhaust its buffer stocks. Moreover, global cotton output too may fall short of consumption and take stocks to a seven-year low. That is another factor that can keep cotton prices up.

All these factors point to cotton prices ruling firm for a while. Even the Southern India Mills Association’s view that speculation on lower output is keeping prices elevated has not softened prices yet.

If prices rule high in the months ahead, spinning mills’ profitability will slip, albeit with a lag. However, analysts expect a mixed set of results in the second half of FY19. Larger integrated mills that are also financially stable, such as Indo Count Industries Ltd, Nahar Spinning Mills Ltd and Vardhman Textiles Ltd, possess sufficient low-cost cotton stock. Their margins are less likely to be weighed down by rising cotton prices. Also, if yarn prices move up then that will allow them to absorb the increase in cotton prices.