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Low cost cotton inventory saves the day

About the stock: Indo Count is one of India’s largest home textile manufacturer and exporters with an extensive product range spanning across bed sheets, quilts and bed linen. It has a presence in top nine out of 10 top big box retailers in the US.

* Indo Count is an integrated bedding solution provider, boasting capacity of 90 million meters per annum of dyeing/processing and cutting /sewing

* It exports to nearly 54 countries with US being the prime market (~75% of revenues and commanding ~20%+ market share in bed sheets)

Q1FY23: Indo Count (ICL) reported a resilient performance in Q1FY23 with gross margins (low cost inventory) saving the day. It has completed acquisition of the home textile business of GHCL, which is reflected in the current quarter’s revenue.

* Overall volumes for the quarter were at 19.1 million metre (up 6% YoY). Excluding GHCL volumes, we expect volumes to have declined 22% YoY

* We believe the company has utilised most of its low cost cotton inventory, which has resulted in Indio Count reporting abnormally higher gross margins of 62% (vs. average 51-54%)

* The significant delta in gross margins (up 730 bps YoY) more than negated the negative impact of higher operating cost due to integration with GHCL and negative operating leverage (employee & other expenses as percentage to sales rose 346 bps YoY, 511 bps, respectively). Hence, EBITDA margin decline was restricted to 120 bps at 17.3% (up 270 bps QoQ)

What should investors do: The stock price has witnessed a steep correction in the last six months (~40%). India’s market share loss in US bed sheets (from 61% to 53%), all-time high cotton prices, softening of US demand (lower housing sales) are some of the main factors weighing on the stock performance. Inventory days have spiked significantly while higher capex has also led debt to bloat to | 1300 crore (D/E: 0.8x). While Q2FY23 is expected to remain challenging, the company expects a gradual recovery from Q3 onwards (but volumes lower than previous year).

* We maintain HOLD rating on the stock

Target Price and Valuation: We value ICL at | 150 i.e. 7x FY24E EPS

Key triggers for future price performance:

* FTAs with UK/Europe to improve Indian textiles global competiveness

* With the latest acquisition of GHCL, it would be able to add a whole new avenue of customer base that is untapped, thereby leading to gain in global market share. ICL plans to cross sell its value added categories (fashion, institutional and utility categories) to the existing clientele of GHCL

* Focus on increasing share of B2C and D2C segment through its branded portfolio (owned and licenced). This would aid margins, going forward

Alternate Stock Idea: Apart from ICL, in our textile coverage we like KPR Mill.

* KPR Mills is among select vertically integrated textile players in India that has displayed consistent operating margins with strong return ratios

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