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Several near term headwinds loom over textile sector

The textile value chain has recently been marred by various challenges such as: a) all-time high cotton prices (up 2x YoY) b) increasing freight expenses and delay in order delivery owing to port congestion for global retail chains c) inability/reluctance of US retailers to absorb higher prices owing to recent spike in inflation impacting consumer sentiments, d) inventory pile up for large global retailers. Indian home textile players witnessed a decline in market share in the US. Also, India’s apparel export data in May 2022 has seen a receding trajectory. US is one of the key textile markets for India accounting for 50% of home textile exports and 28% of apparel exports. Hence, reduced purchasing power in key export markets would negatively impact order book of Indian exporters. Textile stocks witnessed a significant rally in the past two years. However, we believe current headwinds could in the near term outweigh long term structural story (expected free trade agreements with Europe/UK, PLI scheme, China+1).

Higher cotton prices subdue demand

Owing to a decline in cotton production (~8% YoY) domestic cotton prices have risen ~90% YoY to | 272/kg. Correspondingly yarn prices, which were already trading at higher levels, inched up further by ~38% YoY to an all-time high of | 385/kg in May-June 2022. Yarn players who had recorded one of their best EBITDA margins in FY22 are now reeling under pressure as yarn spreads have shrunk from an all-time high of | 110/kg to | 40/kg (exhibit: 2). This is expected to negatively impact margins for yarn players in H1FY23 as cotton prices are expected to remain elevated owing to supply deficit till start of the next cotton season which begins from October 2022. While domestic demand for yarn remains stable, volume for yarn exports has been impacted (exhibit: 3). Majority of RMG exporters were able to pass the increased input cost initially as demand was healthy post lockdown relaxations. However, increased inflation has led to slackening of demand and reluctance from global retailers to accept further price hikes can negatively impact the volume growth of Indian RMG players going ahead.

Bulging inventory may slow order book momentum in near term

The recent event/news flow suggested that major US retailers (like GAP, Target and Walmart) were grappling with excess inventory issues owing to lower-than-expected demand and delayed deliveries due to port congestion resulting in seasonal and occasion specific products remaining unsold (exhibit: 7). Global retailers have significantly trimmed down their profit projections sighting RM inflation and removal/reduction of stimulus. US is a major revenue contributor for companies in our coverage universe (Gokaldas: 85%, Indo Count: 75%, Faze Three: 60%, KPR Mill: 25%). While our conversation with RMG players have indicated no major slowdown in orders yet, we do believe there could be challenges, which could result in slackening of tempo of order flows to sourcing partners of global retailers in the immediate ensuing quarters. Ramp up of demand in key geographies (US, UK, Europe) in holiday season in Q4CY22 stays the most critical aspect to be monitored

Cautious outlook; players with strong b/s to weather storm

Textile companies in our coverage universe had demonstrated strong performance in FY22 with our top picks KPR and Gokaldas Exports (GEL) reporting their historical high RoCE of 27% and 20%, respectively, while maintaining a comfortable liquidity position (D/E= KPR: 0.4x, GEL: 0.1x). We expect companies with better balance sheets to weather the challenging scenario. The textile sector has good long term potential but we advise a cautious stance on the sector currently owing to near term headwinds. Hence, we downgrade the stocks from BUY to HOLD (Exhibit: 12).

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