International cotton prices are likely to head lower for the rest of the year. A report by Bloomberg early this week said that cotton futures slumped 29% in the last 12 months as stocks kept piling up. Two forces—higher supplies from the US, which is the worldΆs largest exporter of cotton, and lower Chinese demand—are pulling down cotton prices.
The good news for end-users of cotton in India is that low international prices will keep domestic cotton prices in check. The last six months saw highly volatile prices because of poor closing stock for the 2011-12 season, which was down to half the normal 5.5 million bales. Further, earlier estimates of shortfall in rain and lower cotton crop for the ensuing season led to a speculative pull-back in domestic cotton prices, which had fallen from the mid-2011 price of Rs.61,500 per candy to Rs.35,000. A candy is equal to 355.6 kg of cotton.
However, in the last three months, higher estimates of global and domestic cotton production brought down domestic prices by around 11% to Rs.34,500 per candy (Shanker-6 variety). Industry sources now expect prices to be range-bound between Rs.33,000 and Rs.35,000 per candy over the next few quarters. Global prices will have a tempering effect on domestic prices, too.
The stable raw material price is a big relief for domestic yarn mills. Volatility hits yarn millsΆ profitability because of their inability to plan the timely purchase of raw cotton. For example, profit at both the operating and net level of most yarn mills was adversely affected for two quarters prior to the one that ended March 2012, as they were carrying cotton purchased at higher price points. The industry estimates that volatility in cotton prices led to an increase of Rs.5,500 crore by way of working capital needs for the spinning sector.
Volatile cotton prices are mirrored in the share prices of domestic yarn mills. According to Bharat Chhoda, analyst at ICICI Securities Ltd, “mills are learning to battle the challenges of cotton price volatility by holding inventory for lower periods of around three to four months instead of longer durations. This will save interest costs as working capital needs reduce”.
One grey area for the near term is demand for yarn. High inflation and lower domestic savings had seen a dip in demand for garments, which in turn affects yarn offtake adversely. AnalystsΆ believe, however, that the Indian consumption story will pick up as soon as interest rates cool off.
Hence, with the biggest worry—cotton—expected to be stable, yarn mills should make higher profits going forward. Already, the June quarter performance for large mills such as Vardhman Textiles Ltd, Ambika Cotton Mills Ltd and KPR Mill Ltd have improved when compared with the preceding quarter. Any growth in yarn sales will, therefore, translate into better shareholder returns, given the stable outlook for cotton prices in the medium term.
