The current article aims to highlight the key features of the business model of textile companies. After reading the current article, an investor would know what makes any textile company a strong or a weak player. She would understand the features of fundamentally strong textile companies and how to find them.
Textile companies cover entities across the whole supply chain, which includes growing the fibre, spinning it into yarn, preparation of the plain cloth (fabric) and then manufacturing and sale of garments (apparel). Therefore, whenever an investor comes across any textile company, then she should, first, assess which segment of the textile value/supply chain, it belongs to.
Classification of textile companies
As discussed above, the textile sector is divided into different segments starting from growing the fibre to the selling of readymade garments. Before analysing any textile company, an investor needs to ascertain the role the company plays in this value chain because companies in different sections of the textile sector face different business challenges.
1) Fibre growers/manufacturers:
Textile fibre is mainly divided into natural fibre and man-made fibre. Natural fibre mainly consists of cotton; however, there are other kinds of natural fibre also like hemp fibre, stinging nestled fibre, coffee ground fibre, pineapple fabric piñatex, banana fibre, lotus fibre etc. Nevertheless in the natural fibre category, cotton is the most widely used fibre in the world.
Textile industry risk analysis by VIS Credit Rating Company Limited, Pakistan, January 2022 (click here), page 2:
The risk of substitution for cotton fibre is extremely low, as there is a natural lack of an alternative raw material for the manufacture of textile products. However, internationally developments have been made for more sustainable innovations in the industry, that also provide alternatives to cotton fiber, e.g., Hemp fiber, stinging nestled fiber, coffee ground fiber, pineapple fabric piñatex, banana fiber and lotus fiber.
Manmade fibre is of two types: synthetic and cellulosic. Synthetic fibres are primarily produced from petrochemicals and therefore are derivatives of crude oil. They mainly constitute polyester staple fibre (PSF), acrylic staple fibre (ASF) and nylon staple fibre (NSF). Cellulosic fibre is made from cellulose (wood) and mainly constitutes viscose staple fibre (VSF). Among the manmade fibres, polyester forms the major (about 80%) portion.
Rating Methodology for Manmade Yarn Manufacturing, CARE, December 2020 (click here), page 1:
Manmade fibres (MMF) can be broadly categorised under two heads- Synthetic and Cellulosic. Under the Synthetic fibre segment, there are three types of major fibres- polyester staple fibre (PSF), acrylic staple fibre (ASF) and nylon staple fibre (NSF); whereas under Cellulosic, viscose staple fibre (VSF) constitutes the major proportion…Polyester segment accounts for more than 80% of the total MMF industry.
Further, natural and manmade fibres are mixed (blended) in different proportions to give unique properties to the yarn and the cloth to be manufactured from it.
In India, cotton constitutes about 70% of yarn while the remaining comprises primarily manmade fibre. This is in sharp contrast to global yarn production, in which manmade fibre comprises 65%.
Rating methodology – textiles (spinning) by ICRA, March 2022 (click here), page 3:
Manmade fibre accounts for ~65% share in the world’s fibre consumption… In contrast, cotton yarn accounts for nearly 70% of the total spun yarn production in India.
Such a sharp difference in the pattern of yarn consumption in India vis-à-vis the world is primarily due to govt. policies. Manmade fibre in India attracts higher taxes than cotton, which has pushed the textile industry toward cotton. As a result, cotton is the most available fibre in the Indian market.
Rating methodology – textiles (spinning) by ICRA, March 2022, page 3:
Due to abundant availability of cotton fibre and relatively higher indirect taxes on the manmade one which impact export competitiveness, the Indian spinning industry is largely skewed towards the cotton spinning and cotton yarn accounts for ~70% of the total spun yarn production in the country
Cotton is an agricultural product, whose production depends on numerous factors like minimum support price (MSP) by govt., the weather, demand-supply in India as well as the international market etc. Cotton is mainly available in the market during its harvest season (October-March) every year. Growing cotton is covered under the agricultural sector instead of the textile sector.
Manmade fibres are primarily crude oil derivatives and their raw material are produced by refineries. Their prices are dependent on crude oil prices and their demand-supply situation in the Indian and international markets. Their raw material is covered under the petrochemical industry instead of the textile industry.
Therefore, the scope of the textile industry begins with the first step where natural or manmade fibre is converted into thread i.e. yarn.
2) Spinning – yarn/thread makers:
Spinning involves making thread/yarn from fibre. Spinning mills buy cotton from farmers/manmade fibre from refineries and convert it into thread. Depending upon the requirement of customers, spinning mills get specialized in making cotton yarn, manmade yarn or blended (mixed) yarn.
3) Knitting – fabric/cloth makers:
Fabric makers (knitters, weavers) buy yarn from spinning mills and convert it into cloth. Fabric makers mainly sell the cloth to garment manufacturers as a B2B sale who in turn, make readymade garments for selling in the market. However, some fabric manufacturers sell their cloth directly to customers (B2C) by creating their own brands and sales channel (e.g. Raymond) that meet the need of people who do not buy readymade clothes and instead like to get them stitched from tailors.
4) Garmenting – apparel manufacturing and retailing:
The garments/apparel sector constitutes the final stage in the textile value chain where the cloth prepared by knitters/weavers is converted into garments and sold to customers. It includes two segments: apparel manufacturing which makes the clothes and apparel retailing which sells the clothes in the shops. Some players do exclusive apparel manufacturing or apparel retailing; however, some players do both, manufacturing as well as retailing.
An investor would appreciate that companies in each part of the textile value chain: spinning, knitting and garmenting face different business challenges and therefore, it is essential for an investor to assess at what stage of the textile value chain a company operates before she does its detailed analysis.
Further advised reading: How to analyse New Companies in Unknown Industries?
Now, let us understand the key characteristics of textile companies and understand how each business factor affects textile companies in different segments of the value chain.
Key characteristics of business model of textile companies
1) Commodity nature of products:
In the value chain of the textile industry, spinning and knitting lead to commodity products.
In the case of spinning, the characteristics of the yarn are specified by the fabric maker in terms of the type of fibre, count number, blend ratio etc. Once these specifications are finalized then the yarn produced by one spinning mill is not very different from the yarn produced by another spinning mill. Therefore, most of the yarn produced in the industry is commodity yarn and the fabric maker can source the yarn from any supplier who is willing to offer it at acceptable terms.
Rating methodology – textiles (spinning) by ICRA, March 2022 (click here), page 3:
The Indian spinning industry is highly fragmented…given the commoditized nature of the product with limited product differentiation
Nevertheless, many spinners try to differentiate themselves by producing premium quality yarn (i.e. of higher counts) and by producing value-added yarn like compact yarn, slub yarn, mélange yarn etc.
Rating methodology – textiles (spinning) by ICRA, March 2022, page 3:
However, companies manufacturing value-added yarn such as compact yarn, slub yarn, mélange yarn etc. can command premium pricing and differentiate the products to some extent.
CRISIL Ratings’ criteria for the cotton textiles industry, February 2021 (click here), page 11:
A key factor distinguishing players in the commodity yarn market is their count range…yarn realisations in the finer counts are generally less elastic than cotton prices, and are substantially higher than those in coarser counts.
CRISIL Ratings takes a positive note of value addition in products, including twisted yarn, dyed yarn, gassed and mercerised yarn, and compact and melange yarn, as these fetch better realisations,
Similarly, the fabric segment is also dominated by commodity products. Once a manufacturer provides the specification for the fibre in terms of quality of yarn, colour etc., then there is not much difference in the fabric produced by one fabric manufacturer and another.
Rating methodology for entities in the textile industry – fabric making, ICRA, April 2020 (click here), page 2:
High level of fragmentation and commoditised nature of product results in high competitive intensity
Nevertheless, a few players are able to differentiate themselves by way of making fabric of premium quality with respect to specifications like grams per square meter (GSM), picks per inch etc. and by producing fabric that needs less processing before manufacturing garments.
CRISIL Ratings’ criteria for the cotton textiles industry, February 2021, page 11:
The fabric that needs least processing before it can be used in garmenting will have the least price elasticity. This is applicable for woven and knitted fabrics.
A few fabric producers create a brand for their products by selling them directly to customers (B2C) unlike sales to garment manufacturers (B2B). By creating a brand in the B2C segment (e.g. Raymond Ltd), these fabric players are able to differentiate their products and in turn, earn a better profit.
Rating methodology for entities in the textile industry – fabric making, ICRA, April 2020, page 4:
In addition to being sold to garment manufacturers, fabric is sold directly to customers who prefer customised stitching over ready-made garments. Thus, entities focusing on the B2C model, which are able to establish their brand…they have higher profit margins compared to entities which are mostly present in the unbranded commoditised segment.
Therefore, an investor would appreciate that in spinning and knitting (fabric making) segments, most of the textile industry produces commoditised, and non-differentiable products. Once the characteristics like type of fibre, blending, counts etc. are finalised after that the product of one manufacturer is not very different from the product of another.
Nevertheless, a few spinning mills and a few fabric producers are able to differentiate their products and earn a high-profit margin.
In the case of the garment-making (apparel) segment, the products are not commoditised. This is because, in the garment segment, an apparel manufacturer can differentiate its products by its design abilities.
CRISIL Ratings’ criteria for the cotton textiles industry, February 2021, pages 11-12:
Garmenting is the final stage of manufacturing in the textile industry. This segment is generally not commoditised
Rating Methodology for Entities in the Textile Industry – Apparels, ICRA, April 2020 (click here), page 1:
differentiation can be achieved based on design capabilities
Design abilities form the basis of branding in the direct B2C apparel segment. The garments/apparel segment has many brands both Indian and international at almost every price point offering different choices to customers. Branded apparel is able to earn a higher price than commoditised unbranded garments.
Further advised reading: How to do Business Analysis of a Company
2) Competitive intensity and pricing power:
The textile industry as a whole is highly fragmented with many small players dominating each of the segments of the textile value chain i.e. spinning, fabric-making and apparel. One of the major reasons for such composition of the textile industry is govt. policies that promote small-scale industries in the textile sector, which is driven by the large employment generation in the textile sector.
Other major reasons for the highly fragmented nature of the textile industry are very low entry barriers because the technology, raw material and labour are easily available.
Rating methodology for textiles sector by India Ratings, August 2020 (click here), page 2:
The industry is highly fragmented due to low-entry barriers and easy availability of raw material and labour, leading to a large unorganised sector participant and only a few large players.
An investor would appreciate that when an industry is fragmented with many small players producing primarily commodity goods, then it would have very high competition, which in turn would impact the pricing power of the players. As a result, the majority of players in the textile industry do not have pricing power over their customers.
Rating Methodology for Cotton Textile Manufacturing, CARE, November 2020 (click here), page 1:
The entire cotton textile value chain is highly fragmented in nature having both small and large players operating, thereby making the industry highly competitive.
In the spinning segment, an investor would note that even though India has the world’s second-largest (20%) spindle capacity at 50 million spindles; however, still the average size of a spinning unit in the country is only about 30,000 spindles. As per ICRA, the industry is so fragmented that the largest spinning player has only 3% of the industry’s capacity.
Rating methodology – textiles (spinning) by ICRA, March 2022, pages 1 & 3:
India has the second largest spinning capacity in the world after China, with more than 50 million spindles, equivalent to ~20% of the global spun yarn capacity.
Overall, the Indian spinning industry is highly fragmented, with the largest player in the industry accounting for less than 3% of the overall installed capacity of the country. As per ICRA’s estimates, installed capacities in the Indian spinning sector average at ~30,000 spindles per unit
The manmade fibre mills segment is no different from cotton spinning mills. The manmade fibre spinning mills segment is also fragmented.
Rating Methodology for Manmade Yarn Manufacturing, CARE, December 2020, page 1:
The manmade yarn industry is relatively fragmented compared to the MMF industry, with both small and large spinners operating in the segment.
An investor would appreciate that a large number of small spinning mills that produce primarily commoditised products would have intense competition among themselves and very low pricing power over their customers. This is because the customer can easily replace yarn from one spinning mill with another mill.
Rating methodology – textiles (spinning) by ICRA, March 2022, page 3:
The Indian spinning industry is highly fragmented…Moreover, given the commoditized nature of the product with limited product differentiation, the competitive intensity is high with minimal pricing power.
The fabric segment of the Indian textile industry is no different from the spinning segment in terms of fragmentation of supply capacity. One of the reasons for the presence of a largely unorganized sector in fabric manufacturing is the active promotion of small-scale industry by the govt. using incentivising policies.
Rating methodology for entities in the textile industry – fabric making, ICRA, April 2020, page 1:
Indian fabric industry is highly fragmented, dominated by a large number of small-scale units in the unorganised sector due to the Government’s earlier policy of promoting the small-scale sector through tax and fiscal incentives and favourable labour policies.
As a result, in the fabric-making segment, about 85% of the industry capacity is in the unorganized sector.
Rating methodology for entities in the textile industry – fabric making, ICRA, April 2020, page 2:
The domestic fabric manufacturing industry is fragmented with ~85% of the fabric production concentrated in the small-scale units in the unorganized sector. The share of large mills which comprises integrated composite mills is only ~3-4% in the total domestic fabric production (with balance accounted by the handloom sector).
An investor would appreciate that a fragmented industry with a large number of unorganized players producing commoditised and non-differentiable products would have a very high competitive intensity and a very low pricing power over their customers.
Rating methodology for entities in the textile industry – fabric making, ICRA, April 2020, page 2:
High level of fragmentation and commoditised nature of product results in high competitive intensity and limited pricing power.
As discussed above, only a few players in the entire fabric-making industry who produce premium fabric and those who have created their own brands in the B2C segment are able to enjoy some pricing power.
Rating methodology for entities in the textile industry – fabric making, ICRA, April 2020, page 2:
However, players in the branded and premium fabric segment, enjoy some pricing flexibility and thereby better margins.
The garment/apparel segment of the textile industry was reserved only for small-scale units by the Govt. of India in the past. As a result, this segment is also highly fragmented in terms of market share owned by different suppliers.
Rating Methodology for Entities in the Textile Industry – Apparels, ICRA, April 2020, page 1:
Indian apparel manufacturing industry is highly fragmented and is characterised by a large number of small-scale units. This in turn is attributable to the Government’s earlier policy of reserving the sector for the small-scale units, which had a specified cap on investments in plant and machinery (the sector was fully de-reserved from CY2005).
The unorganized sector dominates the Indian apparel manufacturing as well as retailing segment due to the easy availability of raw material (fabric), low cost of production, and active govt. support for small-scale industries in the sector.
This has led to a very high level of competition in the sector even though its products are not commodities and many brands are present in the market. Nevertheless, the majority of the players do not have pricing power.
Rating Methodology for Entities in the Textile Industry – Apparels, ICRA, April 2020, page 3:
As the apparel manufacturing and retailing sectors are fragmented and unorganized, the competitive intensity is high and the pricing ability is restricted to large retailers and strong apparel brands, besides niche boutique/ designer stores. While given the low cost of production and sufficient availability of raw material, a large chunk of domestic apparel requirement is met from domestic manufacturing, apparel imports have also grown
An investor would note that only some of the established apparel brands have some pricing power. Nevertheless, most brands have to follow the market in terms of sales and match the discounts to their competitors.
The Indian branded apparel retail industry is intensely competitive, with the presence of several large domestic and international brands, as well as smaller, regional brands.
Rating Methodology for Entities in the Textile Industry – Apparels, ICRA, April 2020, page 1:
This is because even the branded apparel sector is highly competitive in India with many domestic and international brands competing
An investor may note the example of Monte Carlo Fashions Ltd, which highlighted to its investors that each brand; whether Indian or international, whether strong or weak, has to adjust to the market and cannot survive without discounts.
Conference call of Monte Carlo Fashions Ltd, May 2018, page 5:
Sandeep Jain: Sir I think in today’s scenario, we see all the leading brands not only Indian brands but the international brands also, no brand can survive without discounts so when it is end of season discount sale every brand be it a strong brand or a weak brand has to adjust to the market conditions.
An investor may read out a detailed analysis of Monte Carlo Fashions Ltd in the following article: Analysis: Monte Carlo Fashions Ltd
Therefore, from the above discussion, an investor would appreciate that almost the entire textile value chain including spinning mills, fabric makers and apparel manufacturers and retailers, is highly fragmented where many small players providing non-differentiable products and services compete with each other. As a result, most of the players do not have any pricing power.
The credit rating agency, ICRA stated that out of the hundreds of textile players analysed by it, the average net profit margin (NPM) of spinning mills is about 1% whereas the NPM of fabric and apparel players is about 3%.
Rating methodology – textiles (spinning) by ICRA, January 2018 (click here), page 5:
For the spinning mills rated by ICRA, the average OPBDITA margins have averaged ~12-13% with net profit margins of ~1% over the past five years.
Rating methodology for entities in the textile industry – fabric making, ICRA, March 2018 (click here), page 5:
For the ~100 fabric entities rated by ICRA during the past five years, the average OPBDITA margins have remained at ~11% with net profit margins of ~3%.
Rating Methodology for Entities in the Textile Industry – Apparels, ICRA, March 2018 (click here), page 3:
For more than 100 apparel manufacturers/exporters rated by ICRA, the OPBDITA margins have averaged ~9% with net profit margins of ~3% over the past five years.
Therefore, an investor would appreciate that the pricing power of the textile players is low resulting in very nominal profit margins. Only a few players are able to differentiate their products in a predominantly commoditised marketplace and able to earn a high-profit margin in the textile sector.
Further advised reading: How to do Financial Analysis of a Company
3) Impact of changing raw material prices:
While an investor analyses various companies in the textile value chain, then she realizes that the raw material costs whether it is cotton or manmade fibre or the fabric or garments form the largest portion of its operating costs.
Rating Methodology for Cotton Textile Manufacturing, CARE, November 2020, page 1:
Raw material cost constitutes the largest portion of the total operational cost in the entire cotton textile value chain.
Raw cotton constitutes about 60% of the operating costs of a spinning mill.
CRISIL Ratings’ criteria for the cotton textiles industry, May 2013 (click here), page 3:
Raw cotton, the primary input for spinning units, constitutes about 60 per cent of the units’ cost of production
As per the credit rating agency, ICRA, for the fabric manufacturers, yarn costs are about 60% of their operating costs.
Rating methodology for entities in the textile industry – fabric making, ICRA, April 2020, page 5:
The fabric industry is raw material intensive with yarn cost accounting for nearly 60% of the total operating costs
While analysing the apparel manufacturers, an investor notices that it is even more raw-material intensive and the fabric costs consume about 60% of its revenue.
Rating Methodology for Entities in the Textile Industry – Apparels, ICRA, April 2020, page 7:
apparel manufacturing industry is raw material and labour intensive with the fabric (raw material) cost accounting for ~60% of the total revenues
Therefore, an investor would notice that almost the entire textile value chain is very raw material intensive and any factor impacting the prices or availability of its raw material would have a significant on the textile players.
Out of all the textile players, cotton spinning mills are most sensitive to raw material price and availability changes. This is because; first, cotton is primarily available in the harvesting season (Oct. to March) and the cotton-spinning mills have to stock cotton appropriately looking at their order book and expectations of availability and prices of cotton during the non-harvest season. Therefore, the cotton-spinning mills end up having a high level of inventory stocking during the harvest season.
Rating Methodology for Cotton Textile Manufacturing, CARE, November 2020, page 11:
Procurement of cotton by spinning mills start from October every year (with the start of cotton harvesting) and continues till February – March. Spinning mills usually procure cotton fibre stock during the harvesting season to ensure optimisation of operations during the non-harvesting season.
Second, cotton prices are very volatile and depend upon good or bad weather, the minimum support price (MSP) declared by the govt., demand and availability of cotton fibre in the Indian as well as the international market because fibre is a globally-traded commodity and domestic and international cotton prices move together with a lag, expectations of next season’s crop as well as the prices of manmade fibre, which also act as a substitute etc.
Rating Methodology for Cotton Textile Manufacturing, CARE, November 2020, pages 1-2:
Prices of cotton fibre are highly volatile…Cotton, being an agricultural commodity, its availability and price are dependent on the vagaries of nature, international demand and supply, expectation of crop during the on-going season and also in the next season, Minimum Support Price (MSP) fixed by the Government, time of procurement, prices of polyester fibre/yarn and also by the distance of the cotton spinning unit from the major cotton fibre sourcing centre.
Rating Methodology for Cotton Textile Manufacturing, CARE, May 2013, page 3:
parity between domestic and international prices. Both prices move in tandem, albeit with a brief time lag.
Third, as discussed earlier, cotton spinning mills have very low pricing power over their customers because the spinning segment is highly fragmented and produces mainly commodity products. Therefore, the ability of the spinning mills to pass on increases in the input costs is very low.
Rating Methodology for Cotton Textile Manufacturing, CARE, November 2020, page 5:
Fragmented and competitive nature of the industry and competition with the manmade yarn fibre/ yarn (where prices are governed by crude oil prices) limits the ability of cotton spinning companies to completely pass on any major increase in the prices of raw cotton to their customers and can hence affect their profitability margins.
The low pricing power of spinning mills and their inability to pass on the increased costs to their customers was visible during FY2020 when the cotton prices increased substantially without a proportionate increase in yarn prices. As a result, the profit margins of most of the spinning mills declined in FY2020.
Spinning mills producing yarn from manmade fibre are comparatively less exposed to inventory risk as they do not have to stock inventory for the non-harvesting season like cotton-spinning mills. This is because manmade fibre is available around the year. Nevertheless, manmade fibre spinning mills are exposed to fluctuating raw material prices because the prices of manmade fibre are linked to crude oil prices, which are very volatile.
Rating Methodology for Manmade Yarn Manufacturing, CARE, December 2020, page 3:
Manmade yarn manufacturers do not face seasonality risk like their cotton counterparts. Despite that, inventory management plays a crucial role owing to the linkage of the raw material with crude oil prices, etc… Owing to the competitive nature of the industry, any adverse inventory fluctuation can have an impact on the overall financial risk profile of a company.
Rating Methodology for Manmade Yarn Manufacturing, CARE, December 2020, page 2:
Being derivatives of crude oil, PSF prices are inherently volatile in nature, making the margins of the spinners susceptible to adverse fluctuations in the fibre prices.
Another factor that puts manmade-fibre (MMF) spinning mills in an adverse situation is that the MMF production in India is highly concentrated because MMF producers are very large corporates like Reliance group, Aditya Birla group etc. whereas the MMF spinning mills are very small fragmented units. As a result, the MMF spinning mills do not have any bargaining power against large MMF suppliers.
Rating Methodology for Manmade Yarn Manufacturing, CARE, December 2019 (click here), page 2:
The MMF capacity in India is highly organised with Reliance Industries, Indo Rama Synthetics, Bombay Dyeing, and Grasim holding nearly 95% of the total capacity. The manmade yarn industry, on the other hand, is relatively fragmented compared to the MMF industry
Such composition of the MMF industry puts the manmade-fibre yarn producers in a very disadvantaged position and the increasing cost of their raw material becomes a factor that can push them out of business as well.
In a series of orders against Grasim Industries Ltd, which is the only producer of viscose stable fibre (VSF) in India and has more than 85% market share, the Competition Commission of India (CCI) found that the company was involved in unfair business practices (read here: CCI order March 2020, CCI order August 2021).
CCI found that Grasim (opposite party 2, OP-2) was arbitrarily charging a higher price to those customers who bought a higher quantity of VSF. It was also charging a higher price to those mills that were selling VSF yarn in the domestic market and a cheaper price to mills that were exporting VSF yarn in the export market.
on many occasions, a buyer who purchases a larger quantity of VSF has to pay a higher price as compared to another buyer who sources a lesser quantity from OP-2.
OP-2 and its pricing policy failed to reasonably justify the reasons for higher net prices recovered from domestic spinners as compared to other segments.
CCI also found that Grasim was keeping a tight check on the VSF utilization by the spinning mills by forcing them to share their production data with Grasim in order to block any attempt by its VSF customers to sell the VSF in the market by trading or exporting it.
The act of OP-2, with respect to seeking from its customers’ details of VSF bought and used for production of VSF yarn in the garb of offering discounts as a condition for sale of VSF can be interpreted as not only preventing the resale of VSF by its customers in India but also preventing the export of VSF by its customers as a competitor to OP-2 in the export market. By seeking the details of production and sale from its customer, OP-2, has been controlling the entire market in its favour.
In one of the cases, CCI found that Grasim had charged such high prices to a VSF spinner that it had to shut down its VSF spinning business because it could not compete with other VSF spinners whom Grasim was selling VSF at a cheaper price.
withdrawing/providing no discounts/credit notes to a VSF spinner and at the same time selling VSF at discounted prices/adjusting through credit notes to other domestic spinners who are all competitors in the downstream domestic VSF yarn market. Owing to the said conduct, Informant No. 2 had to cease production of VSF yarn/blended VSF yarn.
Due to these anti-competitive practices, CCI put a penalty of ₹301.61 cr on Grasim Industries Ltd and ordered it to stop abusing its dominant position on VSF spinners.
Therefore, an investor would appreciate that the relatively low bargaining power of MMF spinners against MMF producers puts them in a seriously disadvantaged position.
While analysing fabric and garment manufacturers, an investor would notice that even though, raw material prices are a significant cost for them, still, the volatility of their raw material prices i.e. yarn cost for fabric manufacturers and fabric cost for apparel manufacturers does not have a very high impact on them. This is because they manufacture goods only after getting confirmed orders and they price their products by factoring in the current ongoing prices of raw materials (yarn or fabric).
Rating Methodology for Cotton Textile Manufacturing, CARE, November 2020, page 3:
For fabric and garment manufacturers, the susceptibility of margins to fluctuations in the raw material prices remains low as the manufacturing is generally order backed where prices are fixed as per the prevailing market price of the raw material. Companies manufacturing against confirmed orders, fixing the prices taking into account the prevailing raw material prices, and maintaining raw material inventory position commensurate to their order book positions, are insulated from the fluctuations in raw material prices.
An investor may read out a detailed analysis of Montel Carlo Fashions Ltd, in which we observe that the company has always been able to pass on the increase in its raw material costs by way of increasing the prices of its garments to its customers.
Conference call, August 2021, page 3:
Sandeep Jain:…As far as your question about the high cotton prices are concerned yes there have been increase in the cotton prices but fortunately, we have been able to pass all the cost increase to our garments
Further advised reading: Analysis: Monte Carlo Fashions Ltd
Moreover, fabric and apparel manufacturers benefit from the year-round availability of their raw materials i.e. yarn and fabric, unlike raw cotton. Therefore, they do not have to stock a high raw material inventory like cotton-spinning mills, which reduces their susceptibility to fluctuations in their raw material prices.
Rating methodology for entities in the textile industry – fabric making, ICRA, April 2020, page 5:
The susceptibility of a fabric-maker’s profitability to fluctuations in raw material prices is generally low because of the limited yarn stocking by the units, as yarn is readily available throughout the year.
Therefore, an investor would appreciate that due to high raw material costs, low pricing power, and intense competition between fragmented-industry players, companies in the textile industry are exposed to a significant risk of fluctuations in raw material prices. The risk is highest in the case of spinning mills. However, the fabric and apparel manufacturers are able to mitigate raw material price risk by manufacturing goods only against confirmed orders where prices are quoted after factoring in ongoing raw material prices.
Nevertheless, if fabric and apparel manufacturers accept long-period fixed price orders then they may also get exposed to a higher raw-material price fluctuation risk.
Rating methodology for entities in the textile industry – fabric making, ICRA, April 2020, page 5:
Nevertheless, the vulnerability to raw material price fluctuations increases if the entity accepts long-term fixed price orders.
4) Cost competitiveness, economies of scale:
From the above discussion, an investor would remember that almost all the segments of the textile industry are highly fragmented and dominated by small players. Therefore, all the players face intense price-based competition. An investor would appreciate that in such a situation, the players with the lowest cost of production gain major competitive advantages.
As most of the products made by the textile value chain are non-differentiable commodities in nature, except garment-manufacturing; therefore, customers can easily switch from products of one manufacturer to another. In such a market, the lowest cost producers determine the market price and other players have to match the prices (price-takers) irrespective of their cost structure.
Rating methodology for textiles sector by India Ratings, August 2020, page 8:
Cost position is an important factor in differentiating between companies as domestic producers are the price takers for finished goods and profitability will be highly dependent on the cost position.
In the textile segment, the raw material cost is the largest cost component, which is not under the control of the players. As a result, the main method for the players to reduce their costs is operating leverage i.e. economies of scale in which companies increase their manufacturing capacities. As a result, the fixed costs get spread over a larger volume of production and the per-unit cost of production declines.
Rating Methodology for Cotton Textile Manufacturing, CARE, September 2018 (click here), page 4:
The cotton spinning industry is characterized by cyclicality, fragmentation and high capital intensity. Raw material cost forms a major component of cost and players operate at very low margins. Economies of scale and level of integration are the key to profitable operations.
As a result, small players in the textile value chain are at a competitive disadvantage and are highly vulnerable during economic downturns.
Rating methodology for textiles sector by India Ratings, August 2020, page 2:
large players are likely to have more stable market and customer bases, whereas small players would be more vulnerable to competition and raw material price volatility even when the demand is stable.
In the spinning segment, it is essential to have a large spindle capacity. If a mill has a smaller spindle capacity than the industry average of 28,000 spindles, then the mill would find it difficult to be cost-efficient and would be at a competitive disadvantage.
Rating methodology – textiles (spinning) by ICRA, September 2015 (click here), page 1:
During the last 15 years, the average size of the spinning unit in India has increased from ~24000 spindles to ~28000 spindles. Companies below this average unit size may find it difficult to have a competitive cost structure in the commoditized yarn market, unless the capacity is recently added, as it will have a better level of modernization.
Similarly, in the fabric-making segment as well, having a lower cost structure by way of economies of scale is essential because of high competition in the commoditised market.
Rating methodology for entities in the textile industry – fabric making, ICRA, April 2020, page 2:
Given the intense competition and limited product differentiation, larger capacities in fabric manufacturing offer benefits of economies of scale, thereby resulting in a better cost structure.
In the apparel manufacturing and retailing section as well, the cost efficiencies developed by a large size are essential to support profit margins.
Rating Methodology for Entities in the Textile Industry – Apparels, ICRA, April 2020, page 3:
a large revenue base leads to economies of scale in terms of cost efficiencies in procurement and administrative functions, thereby supporting the margins of the retailer
Moreover, as a garment manufacturer grows big, then it is able to sell directly to big brands and gain large orders offering higher profit margins, which brings strength to its business model.
Rating Methodology for Cotton Textile Manufacturing, CARE, November 2020, page 4:
For the garment manufacturers, apart from cost advantage, large capacities allow the mills to deal directly with the large domestic or international end-customers rather than selling the products through dealers/ distributors.
Moreover, an investor would appreciate that established international brands take a long time to approve vendors due to a focus on maintaining consistency in the quality of their products. As a result, a long approval process by international brands becomes an entry barrier for new entrants. As a result, a textile company having economies of scale and catering directly to big brands seems to have many competitive advantages.
Rating methodology for textiles sector by India Ratings, August 2020, page 6:
companies supplying to international brands require a long lead time for new vendor approval, thereby creating an entry barrier for new players.
Therefore, an investor would appreciate that in the entire textile value chain whether it is spinning, fabric or apparel manufacturing, due to intense competition and almost non-differentiable products, companies have to focus on lowering their cost of production and large capacities with economies of scale help a lot to achieve it. Smaller players are at a competitive disadvantage even during times when demand is stable.
Rating methodology for textiles sector by India Ratings, August 2020, page 2:
large players are likely to have more stable market and customer bases, whereas small players would be more vulnerable to competition and raw material price volatility even when the demand is stable.
Further advised reading: Credit Rating Reports: A Complete Guide for Stock Investors
5) Capital-intensive nature of operations:
The textile industry is a capital-intensive sector, which needs large capital both for installing plants & machinery as well as for managing working capital due to the raw-material-intensive nature of the business.
Rating Methodology for Cotton Textile Manufacturing, CARE, November 2020, page 6:
Owing to the capital intensive nature of business, companies having operations in the industry typically have high reliance on external debt to fund their fixed capital expenditure and working capital requirements.
Out of all the segments of the textile value chain, spinning is the most capital-intensive; both from the perspective of fixed capital (manufacturing plant) as well as working capital (inventory and receivables).
CRISIL Ratings’ criteria for the cotton textiles industry, February 2021, page 11:
The cotton yarn spinning industry is highly capital intensive, faces acute cyclicality, has extremely fragmented capacities, and is intensely competitive on account of the commoditised nature of the product.
Rating methodology – textiles (spinning) by ICRA, March 2022, page 10:
Given the fixed capital as well as working capital-intensive nature of the spinning business, the funding requirements are typically high in the spinning sector.
As per the estimates by the credit rating agency, ICRA, a spinning plant with an industry-average size of about 25,000 spindles needs about ₹90-100 cr for installation and produces a revenue of about ₹90-110 cr indicating a fixed asset turnover ratio of 1, which is low in comparison to other manufacturing industries.
Rating methodology – textiles (spinning) by ICRA, March 2022, page 4:
Spinning is a highly capital-intensive industry requiring significant investments in plant and machinery. A typical spinning plant with ~25,000 spindles involves a capital outlay of ~Rs. 90 to 100 crore – depending on land cost, degree of automation and nature of expansion, i.e. greenfield or brownfield. A spinning unit of this scale has the potential to generate revenues of ~Rs. 90 to 110 crore, depending on the fibre usage and yarn count being produced by the mill.
Further advised reading: Asset Turnover Ratio: A Complete Guide for Investors
An investor would remember from the above discussion that in India, almost 70% of the yarn spinning units use cotton. Cotton is an agricultural commodity, which is harvested from October to March. Spinning mills have to buy most of their cotton during the early part of this harvesting season because the best cotton is available only during the start of the season.
CRISIL Ratings’ criteria for the cotton textiles industry, February 2021, page 12:
While cotton arrivals are spread over a six-month period from October to March, quality cotton is usually available in the first few months.
Moreover, during the non-harvesting months, April to September, the availability of cotton is lower and additionally, the cotton prices start reflecting the expectations of the cotton crop in the next harvesting season. Therefore, the quality, availability and price of cotton become uncertain during the non-harvesting season.
Rating methodology – textiles (spinning) by ICRA, March 2022, page 6:
volatility in cotton fibre prices after the harvest season can be driven by the estimates of crop production in the next season
As a result, cotton companies prefer to stock cotton during the harvesting season as per their order estimates. In fact, spinning companies, which can procure a large amount of cotton are at an advantage as they can maintain the quality of their yarn
Rating Methodology for Cotton Textile Manufacturing, CARE, November 2020, page 2:
The companies which are capable of procuring large quantities of similar quality cotton fibre are looked at favourably as it enables them to maintain uniformity in the quality of yarn manufactured.
The practice of buying a large amount of cotton during the harvesting season leads to a large requirement of inventory by spinning mills, which makes their operations working capital intensive. In addition, it also puts them at risk of inventory losses if the prices of cotton decline later on.
Rating Methodology for Cotton Textile Manufacturing, CARE, November 2020, page 3:
Spinning mills usually procure cotton fibre stock during the harvesting season to ensure optimisation of operations during the non-harvesting season. This, however, exposes the players to adverse fluctuations in the raw material prices. Any significant decline in the prices of the fibre, especially for the entities having excess inventory on their books, can lead to inventory losses.
In fact, in the past during FY2012, cotton prices did decline sharply and most of the spinning mills faced inventory losses. As a result, the cotton mills started cutting down on their inventory levels and reduced it to about 2-3 months of inventory FY2017 onwards from earlier levels of about 6 months of inventory.
CRISIL Ratings’ criteria for the cotton textiles industry, February 2018 (click here), page 5:
After the inventory losses incurred in fiscal 2012, cotton spinners are cautious on stocking cotton for long periods. Thus, most have shifted to a leaner inventory cycle of 2-3 months in fiscal 2017, as against the earlier norm of 6 months.
In comparison, the working capital intensity of spinning mills based on manmade fibre is lower than cotton-spinning mills because manmade fibre is available around the year without any seasonality. As a result, manmade fibre-spinning mills do not need to do excess stockings. On average, manmade fibre spinning mills maintain an inventory of 1 month as compared to an inventory of 3 months for cotton-spinning mills.
Rating methodology – textiles (spinning) by ICRA, March 2022, page 6:
fiscal year-end inventory levels average close to ~three months for cotton-based spinners and typically stand at ~1 month (at year-ends) for mills based on manmade fibre.
Further advised reading: Inventory Turnover Ratio: A Complete Guide
Therefore, an investor would notice that the spinning mills segment is highly capital intensive both from the perspective of fixed capital as well as working capital.
When an investor looks at the fabric-making segment, then she notices that fabric manufacturing is also capital intensive and needs significant investment in plant and machinery as well as working capital.
Rating methodology for entities in the textile industry – fabric making, ICRA, April 2020, page 7:
Given the fixed capital as well as working capital-intensive nature of the fabric-making business, funding requirements are typically high in the sector.
As per ICRA, a fabric-making unit of about 100 looms needs an investment of about ₹70-90 cr and produces a revenue of about ₹100-150 cr indicating an asset turnover of about 1.5 to 1.7, which is low considering other manufacturing industries.
Rating methodology for entities in the textile industry – fabric making, ICRA, April 2020, page 1:
Fabric manufacturing is somewhat capital intensive and requires significant investment in plant and machinery. A typical modern fabric-manufacturing (weaving) unit with ~100 looms will have a capital cost of ~Rs. 70 crore to ~Rs. 90 crore, depending on the nature of expansion, i.e. greenfield or brownfield. The high fixed capital intensity is also reflected in the operating income/gross block, which typically remains at ~1.5-1.7 times for fabric manufacturers. In addition, fabric manufacturing operations are working capital intensive.
A fabric-making business is working capital intensive because it needs to maintain an inventory of about 2.5-3 months and additionally receivables of about 1.5-2 months are stuck with customers at any point in time indicating a significant requirement of money for working capital.
Rating methodology for entities in the textile industry – fabric making, ICRA, April 2020, page 6:
Typically, the inventory holding period for fabric-manufacturing entities averages ~2.5-3 months
receivables position and the turnover period, which typically remains ~1.5 to 2 months for fabric-making entities
On the contrary, when an investor analyses the apparel segment, then she notices that both apparel manufacturing, as well as apparel retailing, are not capital intensive. In fact, they are labour-intensive operations that need a significant number of people and a large amount of raw materials to manufacture and sell clothes.
CRISIL Ratings’ criteria for the cotton textiles industry, February 2021, page 11:
Garment manufacturing, on the other hand, is not as capital intensive as yarn spinning;
Rating Methodology for Entities in the Textile Industry – Apparels, ICRA, April 2020, page 7:
apparel manufacturing industry is raw material and labour intensive with the fabric (raw material) cost accounting for ~60% of the total revenues and manpower cost accounting for ~8~9% of the total revenues.
Therefore, an investor would appreciate that even though the apparel business is not fixed capital intensive (manufacturing plants); still, it is highly working capital intensive because apparel manufacturers, as well as retailers, need to keep a large amount of inventory.
Rating Methodology for Entities in the Textile Industry – Apparels, ICRA, April 2020, page 5:
The apparel industry is working capital intensive, primarily on account of the high inventory levels.
An apparel manufacturer needs to keep a large amount of inventory as it has a long manufacturing cycle. Apart from the usual need of keeping the required amount of fabric for uninterrupted operations and work-in-progress, the apparel units need to keep a large stock of garments of different designs, colours, and sizes (SKUs: stock keeping units) in their warehouses so that they may supply to the retail shops as and when needed. This makes apparel manufacturing an inventory-intensive business.
Rating Methodology for Entities in the Textile Industry – Apparels, ICRA, April 2020, page 5:
The inventory levels for the entities involved in apparel manufacturing are on account of the long manufacturing cycle, which involves multiple processing stages, starting from order-backed fabric stocking, processing and stitching to finished apparels in transit to port/customers or awaiting shipment, pending the completion of the entire lot size.
Apparel retailers have to keep a large amount of stock with different designs in the shop and in the store to meet changing customer expectations.
Rating Methodology for Entities in the Textile Industry – Apparels, ICRA, April 2020, page 5:
For an apparel retailer, the inventory is because of the requirement to stock apparels for multiple designs, colours and sizes in the stores, which typically averages ~three to four months of store sales, stock apparels in warehouses to ensure good fill rates in the stores and inventory on account of season leftovers.
The inventory requirements of the apparel company increase further in case, it has both manufacturing and retailing divisions instead of only manufacturing or retailing.
Rating Methodology for Entities in the Textile Industry – Apparels, ICRA, April 2020, page 5:
For an apparel retailer having in-house apparel manufacturing, the inventory levels are even higher and thus pose higher working capital requirements compared to entities which are involved in only manufacturing/ retailing.
An apparel manufacturer/retailer usually keeps an inventory of about 100 days and in addition has receivables outstanding of about 65 days of sales, which makes their business working-capital intensive.
Rating Methodology for Entities in the Textile Industry – Apparels, ICRA, March 2018, pages 5 & 7:
On an average, for the last five years, for more than 100 apparel entities (manufacturers and apparel retailers) rated by ICRA, the overall inventory levels have remained close to ~100 days.
receivables position, which on an average has remained at ~65 days for more than 100 entities rated by ICRA
Further advised reading: Receivable Days: A Complete Guide
Apparel companies follow different business models to sell their garments to end customers i.e. multi-brand outlets (MBO), and exclusive brand outlets (EBO) that can either be company-owned or franchise-owned. Each of these models has different fixed and working capital requirements.
From a fixed-capital perspective, company-owned EBOs are the most expensive because the company has to spend all the money on owning/leasing the shop, its interiors, staff and utilities. However, in the case of franchise-owned EBOs and MBOs, the company does not need to spend these costs and the store owners make these spendings. Nevertheless, an investor needs to note that franchise-owned EBOs may demand a minimum guaranteed return on their investment, which nullifies a lot of the gains from savings in capital expenditure.
Rating Methodology for Entities in the Textile Industry – Apparels, ICRA, March 2018, page 3:
In contrast to the owned-EBO distribution model, entities retailing through MBOs and franchisee-managed EBOs require limited fixed capital investments, in-store interiors and fixtures besides limited fixed overheads such as rentals, employee salaries, electricity charges etc. They are accordingly able to withstand downturns better, scale up easily during demand upturns and also command higher returns on investment. However, if the franchisee-managed EBOs have an arrangement of minimum guaranteed returns, the said benefits get offset to a large extent.
From the working-capital perspective, the company-owned EBOs are most capital-intensive because the garments until sold to the end customers remain an inventory of the company. On the contrary, in the case of MBOs and franchise-owned EBOs, the company sells the garments to the shop under the sale-or-return (SOR) or outright sale model, which reduces its obligations for unsold inventory significantly.
Rating Methodology for Entities in the Textile Industry – Apparels, ICRA, April 2020, page 6:
When the apparels are retailed through entity-managed EBOs, the apparel inventory remains with the entity till it is sold to the final customers. However, in case of retailing through distribution partners, i.e. MBOs and franchisee-managed EBOs, the entity enters into either/or mix of the sale or return (SOR) model or an outright sale model with their distribution partners.
In the sale or return (SOR) model, all the unsold inventory at the end of the season is taken back by the company. However, in the outright sale model, the company’s risk of unsold inventory is eliminated as there is no provision for the return of unsold garments to the company. However, in such situations, the shops ask for a longer credit period to compensate for the higher inventory risk undertaken by them.
Rating Methodology for Entities in the Textile Industry – Apparels, ICRA, April 2020, page 6:
In some cases under the SOR model, the sale is recognised when the entity transfers the inventory to the channel partner, and the unsold inventory with the channel partners at the end of the season is taken back by the entity and is reflected as sales returns.
In the outright sale model, the apparels once sold to the channel partners are not taken back. High proportion of sales on an outright sale basis keeps the inventory levels under control as there are no unexpected returns at the end of the season; however, the outright sale model is analysed for the pace of debtor collection, as sometimes, the entities tend to extend a longer credit period, if the sales at the end of channel partner are slow.
Nevertheless, an investor would appreciate that the garment designs become out of fashion very soon and therefore, it is difficult to sell garments from the previous season. As a result, the unsold garments lose their value fast. Therefore, inventory management is very critical for apparel manufacturers and retailers.
Rating Methodology for Entities in the Textile Industry – Apparels, ICRA, April 2020, page 5:
Given the fast-changing fashion trends, apparels can face fast obsolescence and witness a sharp decline in their realisable value, if not sold within the marketing season they were manufactured for. Accordingly, inventory management is most critical for the profitability of an apparel retailer.
Further advised reading: Operating Performance Analysis: A Simple & Complete Guide
Companies need to run aggressive end-of-season sales to get rid of unsold inventory, many times at steep discounts. Therefore, at times, even under the outright sale model, the shops may request the company to share discounts as the monetary loss due to discount sales and unsold inventory can be huge.
Rating Methodology for Entities in the Textile Industry – Apparels, ICRA, April 2020, page 6:
ICRA also notes that in the case of the outright sale model, large unsold inventories at the MBOs/franchise managed the EBOs can impact the future sales of the entity and thus the policy on inventory liquidation through discount sharing with channel partners is also compared with other players.
Therefore, an investor would appreciate that in the textile value chain, the spinning segment is the most fixed-capital intensive, and fabric making is somewhat fixed-capital intensive. However, garment manufacturing is not much fixed-capital intensive instead it is a more labour-intensive business.
From a working capital perspective, both spinning and fabric-making are working capital intensive; however, garment manufacturing and retailing are much more working capital intensive in comparison. In addition, the risk of inventory obsolescence is also highest in the garment/apparel business.
An investor would also appreciate that the textile industry needs regular modernization of plants & machinery to keep them efficient. Modernization itself adds to the capital-intensive nature of textile mills.
CRISIL Ratings’ criteria for the cotton textiles industry, February 2021, page 13:
Modernising a textile unit is fairly capital intensive, and in general, the industry has lagged behind other cotton exporting nations in this respect; only a few financially strong companies resort to continuous modernisation.
Another factor that makes textile companies capital-intensive is their high power requirements. Spinning mills are the most power-intensive segment of the textile value chain. For a spinning mill, power costs are about 10% of revenue.
Rating Methodology for Cotton Textile Manufacturing, CARE, September 2018, page 2:
Power cost also forms a fair component of cost (about 10% of sales)
Many times, to ensure an uninterrupted and good power supply, textile companies install captive power plants, which increases the capital intensiveness of their business.
Rating Methodology for Cotton Textile Manufacturing, CARE, November 2020, page 2:
captive generation have an assured and uninterrupted supply of power. However, the same increases their capex requirement.
In order to reduce their power requirements, textile companies go for the modernization of plants as technologically new plants are power-efficient. However, as discussed above modernization of plants is also a capital-intensive activity.
Moreover, an investor would also appreciate that textile operations, especially garment manufacturing, are labour-intensive. As per CRISIL, labour cost forms about 6% to 14% of operating costs for textile companies.
CRISIL Ratings’ criteria for the cotton textiles industry, May 2013, page 3:
labour costs vary from 6 per cent to 14 per cent among CRISIL-rated companies
Labour-intensive operations expose textile companies to problems like strikes, labour unrest etc., which force companies to have multiple manufacturing plants so that labour problems at one plant may not affect the tight delivery schedules of customers.
Rating Methodology for Entities in the Textile Industry – Apparels, ICRA, April 2020, page 3:
However, given the labour intensity of the sector, large units can also face challenges related to manpower issues, such as strikes, labour unrests etc.
In order to reduce the dependence on labour, usually, textile companies go for the modernization of plants because the new machines with better technology are more automated and reduce the dependence on labour.
Rating Methodology for Cotton Textile Manufacturing, CARE, November 2020, page 3:
mills having higher level of modernisation, have lesser reliance on labour and are viewed favourably
However, as discussed above, the modernization of textile units is a capital-intensive exercise.
Therefore, an investor would appreciate that installing, running, maintaining and modernising textile units is a capital-intensive activity. As a result, it may seem that only deep-pocketed entities would be able to enter this sector. However, an investor would also note that the textile sector is one of the largest employers in India, second only to agriculture. Therefore, governments, both centre and state, support the creation, maintenance and modernisation of textile mills via their policy and fiscal incentives.
Rating Methodology for Cotton Textile Manufacturing, CARE, September 2018, page 5:
Government of India provides various fiscal incentives [Amended Technology Upgradation Fund Scheme (TUFFS), Scheme for Integrated Textile Parks (SITP), Rebate of State and Central Taxes and Levies (RoSCTL), etc.] to companies operating in the textile value chain. These incentives constitute a major portion of the profitability margins of the companies and are looked at closely. In addition to that, in order to promote investment, certain State governments also provide fiscal incentives in the form of capital or interest subsidy to players setting up new textile units or undertaking modernisation at their existing units.
In fact, despite being a capital-intensive sector, due to the support received from the govt. in the form of fiscal incentives and subsidies, textile companies routinely go for modernization and capacity expansions.
Rating methodology for entities in the textile industry – fabric making, ICRA, April 2020, page 9:
Being capital intensive and given the availability of various fiscal incentives for capital investments, capacity expansion has been a regular feature for industry participants.
In the apparel manufacturing segment, companies get significant incentives from govt. like subsidies to expand capacities.
Rating Methodology for Entities in the Textile Industry – Apparels, ICRA, April 2020, page 8:
apparel manufacturers continue to have access to capital subsidies for eligible benchmarked machinery at a higher rate of 15% (with a cap of Rs. 30 crore) under TUFS, vis-à-vis 10% under the earlier scheme.
Therefore, an investor would appreciate that despite being a capital-intensive sector, even the small-scale textile players have added and modernised capacities because the govt. has supported them by way of various incentives and subsidies.
Going ahead, an investor should always keep in mind the capital-intensive nature of the textile business and the role of govt. incentives whenever she analyses any textile company. Any reduction in the govt. incentives may impact the financial position of the companies and their ability to do capital expenditure.
6) Cyclicity and seasonality in the textile industry:
An investor would appreciate that the demand in the textile sector is linked to the macroeconomic conditions in the country. This is because the purchase of fabric/garments is linked to consumer confidence, spending power and discretion. As a result, the demand for textile products undergoes cyclical changes in line with the general economic cycles (boom and bust phases).
Rating methodology for entities in the textile industry – fabric making, ICRA, April 2020, page 2:
performance of fabric-making entities is closely linked to macro-economic conditions, consumer confidence and spending patterns, considering the discretionary nature of the end use products, from a demand perspective.
Rating Methodology for Entities in the Textile Industry – Apparels, ICRA, April 2020, page 2:
Performance of apparel entities is closely linked to macro-economic conditions, consumer confidence and spending patterns, particularly considering the discretionary nature of their products.
As per credit rating agency, Standard and Poor’s (S&P), the apparel industry faces both price and volume cyclicity. As per S&P, the price-cyclicity is more in the non-branded apparel segment and lesser in the premium branded apparel segment.
Key credit factors for the branded nondurables industry, July 2015 (click here), pages 2 and 3:
For apparel companies, price points may be higher, especially for luxury items, and these items tend to be more discretionary in nature. There can be some price cyclicality related to changes in consumer discretionary spending patterns for nonluxury apparel, but it tends to be less cyclical for luxury goods.
For apparel and related companies, volume cyclicality exists because of the more discretionary nature of the products.
Moreover, if an investor observes the key raw material whose costs have the most impact on the textile industry, then these are cotton and manmade fibre. Cotton, as well as manmade fibre (depending on crude oil prices), are volatile commodities following their own demand and supply cycles.
Rating methodology – textiles (spinning) by ICRA, March 2022, page 11:
Spinning industry is cyclical in nature, given that its performance is linked to the level of volatility in commodity prices (oil or cotton).
In addition, the textile sector sees a high level of seasonality where most of the sales are seen in the winter season. There are two factors contributing to the same. First, the shopping for garments increases in the festive season, which happens in winter. Second, winter garments are usually more high-value in nature than summer garments. As a result, the sales of the textile industry especially apparel pick up in winter every year.
Rating Methodology for Entities in the Textile Industry – Apparels, ICRA, April 2020, page 8:
The apparel sales are seasonal with most of the sales in the second half of the year during festival season in both the domestic and export markets, and the sale of higher value winter wear apparels.
Therefore, an investor may note that on average the value of garment sales increases during the second half of the year in the winter and declines during the first half of the year in the summer.
Apart from cyclicity linked to general economic cycles and the seasonality during the year, many times, in some segments of the textile industry, the boom and bust cycles are due to suboptimal capacity planning by the players.
For example, in the denim segment, the cyclicity is driven by capacity additions. During the boom phases, many companies start capacity additions, which take time to get complete. When these capacities start operations simultaneously, they lead to overcapacity in the industry. As a result, capacity utilization falls leading the companies to compete on prices to get orders to run their plants. As a result, every player witnesses a decline in realizations.
Rating methodology for entities in the textile industry – fabric making, ICRA, April 2020, page 2:
The cyclicality in denim fabric manufacturing industry, which is a small segment of the weaving industry, is also driven by capacity additions as strong growth results in capacity addition, leading to over-capacity and depressing the capacity utilisation & realisations.
An investor may read the detailed analysis of one of the denim players, Nandan Denim Ltd in the following article: Analysis: Nandan Denim Ltd.
7) Diversification, Premiumization and Integration:
From the above discussion, an investor would appreciate that the business of textile companies is cyclical with low-profit margins. This is true for all the segments i.e. spinning, fabric and apparel.
In order to improve the profit margins and reduce the cyclicity and seasonality risks, many textile companies go for different strategies like diversification in operations, focusing on premium business segments as well as vertical integration of operations i.e. forward or backward integration.
7.1) Diversification:
An investor would notice that most of the textile companies in the fragmented industry producing commodity products running a capital-intensive business with very low pricing power are running a very fragile business. This is evident by the fact that many small-scale textile units go out of business in each economic downturn, which is common due to the cyclical nature of the textile business.
One strategy used by the textile mills to reduce the risk in their business is to diversify. Companies diversify their business in terms of different products, customers, market geographies, sales channels etc.
Spinning mills diversify their product range by bringing in flexibility to use different fibres (cotton, manmade, blended etc.) as well as producing yarn of different count ranges. Such companies can effectively handle the challenges in any one product segment by shifting production to another segment, which might be doing good.
Rating Methodology for Cotton Textile Manufacturing, CARE, September 2018, page 3:
Product diversification: Players having a diversified product portfolio tend to have more stable revenues…Companies having capacity to produce multiple count yarns have better product flexibility. Further, companies producing blended yarn rather than only cotton yarn, can efficiently tackle the cyclicality in the cotton yarn demand.
Rating Methodology for Cotton Textile Manufacturing, CARE, November 2020, page 2:
Also, cotton spinners which are capable of producing multiple counts/ varieties of yarns using different varieties of cotton fibres are viewed favourably as it allows them to shift from one variety to the other in case of price fluctuations in one variety.
Similarly, a fabric manufacturing unit can diversify its product range by becoming flexible to use different kinds of yarn like cotton or manmade or blended. In addition, the fabric maker can diversify its product range by producing fabric of different specifications like grams per square meter (GSM), knitted, woven or for products like suiting, shirting, denim, home textiles as well as other features like colour/dyed and finishing like wrinkle-free etc.
Rating methodology for entities in the textile industry – fabric making, ICRA, April 2020, pages 3-4:
For a fabric unit, diversification relates not only to fibre content and type of yarn (spun vs filament) but also to the gsm range, pick range, width, variety and finishing of the fabric manufactured.
A diversified product portfolio includes a presence across the type of fabric manufactured (knitted/ woven), product category (suiting, shirting, denim, towels, bed sheets etc.), material used (cotton, polyester, rayon, blends, etc), and finishes (grey, yarn dyed, dyed, value-add finishing such as wrinkle free, water/oil resistant, etc)
Having the flexibility to alter the product range as per the ongoing market demand helps a fabric manufacturer to handle cyclicity in different product segments better.
In the case of the apparel segment, companies usually diversify by catering to different customer segments by launching multiple brands focusing on different price points, age groups etc.; so that a slowdown in any target segment or any challenges faced by one of the brands would not hurt the whole business significantly.
Rating Methodology for Entities in the Textile Industry – Apparels, ICRA, April 2020, page 4:
Brands: A retailer with diversified brand offerings catering to different target markets on the lines of price points, customer segments, age groups etc. will be less prone to loss of business from a particular brand owing to factors such as reputational risk and customer perception issues, vis-à-vis a retailer with a concentrated portfolio.
Therefore, an investor would notice that all the textile companies, be it spinning mills, fabric or apparel units attempt to diversify their product range and bring in flexibility to reduce risk in their business model.
Apart from product diversification, companies also focus on targeting different geographical markets and customers so that they may protect themselves from issues related to any particular market/customer.
Rating Methodology for Manmade Yarn Manufacturing, CARE, December 2020, page 4:
Diversified customer base helps mitigate the risk of business getting affected in case financial health of the counterparty deteriorates. This holds increased importance due to the cyclical nature of the textile industry.
Many times, textile companies also focus on the mix of sales channels i.e. direct sales to customers or via dealers to diversify their business risks and improve their profitability.
Direct sales to the customers are usually more profitable because such sales save on the commissions paid to dealers. However, such sales come with an added burden for the companies in terms of order sourcing, customer servicing, the credit risk of non-payment by customers etc., which is avoided when companies engage with dealers.
Rating Methodology for Cotton Textile Manufacturing, CARE, November 2020, page 5:
Direct sales to the end customers can lead to better profitability margins for the textile companies vis-à-vis sales made through the dealer network or through buying houses. However, the same can lead to elongated payment terms and exposes the companies to credit risk of the end customers, especially if major sales are being derived from a particular set of customers. Sales through the dealer network, on the other hand, can result in bulk production for the mills and timely payment realisation.
Many times, textile mills, which are mostly small-scale units prefer not to handle these sales & marketing activities and in turn, they route even the direct orders received by them via dealers. Dealers add further value by acting as financiers for textile mills by making them faster payments even before they are received from customers. In addition, dealers also share the credit risk for the textile companies on behalf of the customers brought in by them.
Rating methodology for entities in the textile industry – fabric making, ICRA, April 2020, pages 3-4:
ICRA notes that dealers play an important intermediary role for fabric units like order aggregation, customer service and sometimes financing as well by making faster payments to the units. Dealers also add value by sharing the fabric player’s credit risk. As a result, sometimes, even direct sales are routed by the entities through dealers for client servicing, faster payments and for managing the credit risk. Nevertheless, direct relationships typically act as positive attributes and result in better profitability by saving on dealer commissions.
However, doing business via dealers reduces the bargaining power of textile companies because the dealers may create a higher price-based competition among the mills by choosing a supplier based on the lowest price.
Rating Methodology for Entities in the Textile Industry – Apparels, ICRA, April 2020, pages 3-4:
However, sourcing orders through dealers/ buying houses also results in limited bargaining power for manufacturers as buying houses can source from different suppliers on the basis of the lowest pricing.
Therefore, an investor would appreciate that dealers in the textile industry have built their place in the system by solving the problems of small-scale textile companies related to sales & marketing, financing and customer credit. Therefore, an investor may keep this in mind while assessing the sales strategy of any textile company.
Apart from diversification, another strategy used by textile companies to strengthen their business model and survive cyclicity associated with the economic downturn is the premiumization of their product range.
Further advised reading: How to do Business Analysis of a Company
7.2) Entry into premium and value-added products:
From the above discussion, an investor would appreciate that most textile companies produce a commodity, non-differentiable product where a customer can easily switch from one supplier to another. Such a business takes away the pricing power of companies and results in intense price-based competition in the industry. As a result, their business model is very weak.
However, some textile companies from each of the segments of spinning, fabric and apparel venture into value-added and premium products to strengthen their business model.
Value-added products (VAPs) bring in customer stickiness where the customer faces a high switching cost if she intends to replace one supplier with another.
Rating methodology for textiles sector by India Ratings, August 2020, page 5:
VAPs also offer the possibility of a strong degree of integration with customers. The tailoring of products to meet specific end-customer needs can make it more difficult for these customers to easily switch suppliers and adds stability to producer earnings
To focus on the premium segment, spinning mills focus on producing yarn of higher counts. Fine quality yarn of higher counts is used in premium apparel and therefore, has a high realization and profit margins. In addition, the demand for premium apparel does not decline with moderate changes in its price i.e. price inelastic. As a result, the textile companies get room to increase prices in case their input costs go up without a significant decrease in the demand for their products.
Rating methodology for textiles sector by India Ratings, August 2020, page 5:
spinners manufacturing finer-quality yarns, measured by counts, are less vulnerable to raw material price changes as end-product higher realisations are less elastic to raw material price movements
Rating Methodology for Cotton Textile Manufacturing, CARE, November 2020, page 3:
players having ‘finer count’ yarn or ‘higher thread count’ fabric in their product mix, cater to the elite market segment where demand is relatively price inelastic and margins are high.
In the case of fabric makers, apart from making premium fabric and selling it to apparel manufacturers (B2B), a few players sell their fabric directly to customers (B2C) who wish to get their clothes stitched instead of wearing readymade garments. Such companies usually create brands around their B2C offering and are able to earn a high price and profit margin.
Rating methodology for entities in the textile industry – fabric making, ICRA, April 2020, page 4:
Brand strength: In addition to being sold to garment manufacturers, fabric is sold directly to customers who prefer customised stitching over ready-made garments. Thus, entities focusing on the B2C model, which are able to establish their brand in the markets by virtue of their designs, quality, product range and other requisites, are able to command superior pricing power and higher realisations. Thus, they have higher profit margins compared to entities which are mostly present in the unbranded commoditised segment.
Similarly, apparel manufacturers attempt to create strong brands, which can give them pricing power, high-profit margins and customer stickiness.
Rating Methodology for Entities in the Textile Industry – Apparels, ICRA, April 2020, page 5:
Brand strength: For branded apparel retailers, brand strength manifests itself in the form of pricing power and the ability to grow.
An investor would appreciate that strong brands whether in the fabrics or apparel space have higher pricing power, realizations, and profit margins over unbranded commoditized products. The demand for products of strong brands is usually price-inelastic i.e. the demand does not fall when there is a moderate price increase. As a result, companies can pass on the increase in their input costs to their customers and strengthen their business model.
Additionally, a strong brand, due to its premium pricing and high-profit margins, allows companies to handle economic downturns better by offering discounts, which maintains sales during the tough time from existing customers as well as other customers who buy products at a reduced cost during discounts.
Rating Methodology for Entities in the Textile Industry – Apparels, ICRA, April 2020, page 5:
Strong and established brands enjoy a premium pricing over others and also have better pricing power. In addition, because of the strength of the brand, the demand is relatively less price elastic, which provides flexibility to pass on the increase in the input costs to maintain the profit margins. Moreover, given the premium pricing, strong brands have the cushion to offer discounts during economic downturns to sustain the demand from existing customers and potential customers who were earlier reluctant to buy because of higher prices.
Therefore, an investor would appreciate that entry into the premium segment, offering value-added products and creating strong brands helps companies in strengthening their business model.
Apart from diversification and premium offerings, textile companies also attempt to integrate their business operations to make their operations cost-effective and resistant to cyclical changes in the economy.
7.3) Vertical Integration:
An investor would appreciate from the earlier discussion that the textile industry is intensely competitive where most of the companies operate at a very low-profit margin. As a result, the companies’ business is very sensitive to any changes in demand or raw material prices. Numerous small players go into losses during economic downturns and even shut their businesses.
In order to improve their profitability, reduce volatility and reduce the impact of fluctuating raw material prices, a few textile mills opt for vertical integration, both forward and backward integration so that they may perform more value-adding steps in-house leading to higher profitability. In addition, they are able to control the supply and quality of raw materials as well as save on transportation and packaging costs of raw materials.
Rating Methodology for Cotton Textile Manufacturing, CARE, November 2020, page 2:
companies which have integrated nature of business (from yarn-to-fabric/ from fabric-to-garment/ or, from yarn-to-garment) are generally benefitted by the synergies associated with lower raw material procurement cost/lower logistics cost and are viewed positively.
In the case of spinning mills, the companies go for both backward as well as forward integration. Under backward integration, spinning mills may engage farmers for contract farming of cotton and own in-house ginning facilities for preparing cotton for yarn.
Rating Methodology for Cotton Textile Manufacturing, CARE, November 2020, page 4:
Spinning mills having their own ginning facilities or engaged in contract farming of cotton get the advantage of uniformity in raw material quality. Such companies ensure regular supply of quality cotton.
As mentioned above, in the case of forward integration, spinning mills may go to the extent of yarn-to-fabric or yarn-to-garment integration and use their in-house production of yarn to make fabric or apparel. Such a forward integration is better for the spinning mills as it leads to stability as well as an improvement in profit margins because the company saves on many components of raw material costs and benefits from relatively stable profit margins of the fabric business.
Rating methodology – textiles (spinning) by ICRA, March 2022, page 11:
While the prices of fabrics also tend to fluctuate in relation to the yarn prices, the profit margins in fabric-making are steadier vis-a-vis yarn manufacturing, considering higher raw material holding requirements as well as greater exposure to volatility in prices of raw materials (cotton/ polyester) in the yarn business. Besides diversification benefits, captive yarn availability for in-house consumption results in savings in transportation, packing and selling costs. Hence forward-integrated mills with sizeable in-house yarn consumption tend to witness lower volatility in margins than a standalone spinning mill.
Along similar lines, fabric makers go for backward integration in spinning as it reduces their raw material costs and provides better control on the quality of yarn available to make the fabric.
Rating Methodology for Cotton Textile Manufacturing, CARE, November 2020, page 4:
Fabric manufacturers having backward integration with spinning units save on to their freight expenses, selling cost and packaging expenses apart from having better control on the quality.
Fabric manufacturers who go for forward integration into the apparel/garmenting business earn a better profit margin and simultaneously reduce the cyclicity in their business operations.
CRISIL Ratings’ criteria for the cotton textiles industry, May 2013, page 2:
Fabric manufacturers, who integrate forwards into garmenting will therefore face lesser cyclicality risks and command better margins.
From the above discussion on the capital-intensiveness of textile businesses, an investor would remember that out of all the segments, spinning and fabric-making are fixed capital intensive whereas garment manufacturing is not fixed capital intensive. Instead, garment manufacturing is a labour-intensive process.
Therefore, apparel manufacturing units do not prefer to opt for backward integration into capital-intensive fabric and spinning units.
Rating methodology for textiles sector by India Ratings, August 2020, page 5:
The integration assessment is primarily applicable to the spinning, fabric and home textiles sub-sectors. Apparel manufacturers are not expected to have a high level of integration due to the asset-light nature of their business model.
Moreover, most apparel retailing companies tend to keep their business as light as possible because it keeps their investments in the business low, which improves their return on capital. Additionally, these companies are better able to handle demand slowdowns due to their lower fixed costs and are able to increase sales fast during recovery phases as they can increase the outsourcing of garments to meet the high demand.
Rating Methodology for Entities in the Textile Industry – Apparels, ICRA, March 2018, pages 2-3:
Apparel entities with an asset-light business model, involving outsourcing of manufacturing, have lower fixed capital requirements (investment in building and plant & machinery) as well as lower working capital requirements in comparison to those entities which have entire manufacturing in-house, as the need for stocking raw materials/work-in progress gets eliminated. As a result, such entities are better equipped to face the demand slowdown because of lower fixed overheads. On the positive side, during an upturn in demand, with outsourcing systems in place, the operations can be scaled up with increased outsourcing / adding new suppliers to cater to the demand, without missing out on market opportunities.
Nevertheless, whenever apparel-manufacturing units choose to go for backward integration into the fabric of yarn making, then it is mostly the large players, which can afford to spend significant money on the plant and machinery. As the companies are now able to capture more value-adding steps in-house; therefore, backward integration improves the profit margins of garment units.
Rating Methodology for Cotton Textile Manufacturing, CARE, November 2020, page 4:
A garment manufacturing unit can also have backward integration with a fabric or a yarn manufacturing unit (though restricted to large players only because of the capital intensive nature). The same generally leads to relatively higher profitability margins owing to the presence of more number of value-added jobs in-house. For a garmenting unit, backward integration with a fabric manufacturing unit also allows it to have better control on the quality at the weaving and processing stages.
Therefore, an investor would notice that in general, any vertical integration for spinning, fabric as well as garment manufacturing units helps the companies in increasing their profit margins as well as reducing the volatility in the margins.
Nevertheless, an investor would appreciate from the earlier discussion that in the textile value chain, the spinning mill segment is much higher capital-intensive than fabric and apparel businesses. In addition, the spinning mills need to stock cotton for the non-harvest season leading to high inventory levels and increase risk of inventory losses.
Therefore, a company that is primarily a yarn manufacturer i.e. spinning mill and forward integrates into a fabric and garment-making business, then it is moving into segments, which are less capital intensive and with easy-to-manage inventory levels.
On the contrary, when fabric or garment-making units backwards integrate into the spinning business, then they enter into a segment, which is much more capital-intensive with difficult inventory management.
Therefore, many times, when fabric and garment units attempt to backwards integrate into the spinning section, then these companies face many challenges.
For example, when a fabric maker enters into the spinning business, then it is a segment with different business risks and a higher inventory risk and higher volatility of margins linked to raw-material price fluctuations. As a result, when cotton prices in the open market decline, then the integrated fabric player (fabric + spinning) faces inventory losses whereas if it had stayed a standalone fabric maker, then it would have benefited from lower raw material costs.
Rating methodology for entities in the textile industry – fabric making, ICRA, April 2020, page 3:
While integration is a positive, it poses challenges as well such as reduction in operational flexibility in responding to market conditions and heightened business risks…The risk to profitability is particularly higher in the case of backward integration into cotton yarn spinning.
overall profit of an integrated fabric manufacturer is exposed to the risk of inventory loss in times of declining cotton prices, whereas non-integrated fabric manufacturers would benefit from the procurement of lower-cost yarn from the market in such times
Similarly, when garment manufacturers decide to enter into backward integration to the level of spinning, then their risk to profitability increases.
Rating Methodology for Entities in the Textile Industry – Apparels, ICRA, April 2020, pages 10-11:
The risk to profitability is particularly higher in case of backward integration into cotton yarn spinning.
As a result, garment manufacturers usually limit their backward integration only to fabric manufacturing, which provides most of the benefits of integration and the companies do not need to mandatorily integrate spinning into their business because the high-quality yarn is easily available in the market.
Rating Methodology for Entities in the Textile Industry – Apparels, ICRA, April 2020, pages 10-11:
backward integration for apparel entities is largely restricted to fabric weaving and processing and not as much in yarn spinning. This in turn can be explained by larger quality control requirements in the weaving and processing stages and abundant availability of quality yarn in the domestic market.
Whenever we come across yarn-to-garment integrated players, they are mostly the cases of originally spinning players who had forward-integrated into apparel manufacturing and rarely, garment manufacturers who have backwards-integrated into spinning mills. Usually, the apparel manufacturing divisions of such forward-integrated spinning mills are very small in comparison to the spinning operations.
Rating Methodology for Entities in the Textile Industry – Apparels, ICRA, April 2020, pages 10-11:
While some of the spinning entities have forward integration into apparel manufacturing, however, given the large scale of their spinning operations, the extent of such forward integration is limited with apparel manufacturing consuming only a small percentage of their yarn production
Nevertheless, from the above discussion, an investor would notice that the integration of operations by textile players helps the companies improve their profit margins because, now, they can perform a higher number of value-adding functions in-house and they can save on costs like packaging and transportation of raw material.
Further advised reading: How to analyse New Companies in Unknown Industries?
8) Export uncompetitiveness of Indian textile companies:
While analysing different markets that the Indian textile industry caters to and the competition they face, an investor gets to know that Indian textile companies are at a disadvantage compared to many other nations.
One of the primary reasons for such cost disadvantages hurting the Indian textile industry is the duties imposed by the govt.
Rating methodology for textiles sector by India Ratings, August 2020, page 8:
The sector is exposed to international competition where domestic players have constrained pricing power due to differential duty structures.
As a result, when an investor assesses the competitiveness of Indian cotton spinning mills with respect to the producers in China and other South-East Asian countries, then she notices that Indian spinning mills are less competitive on a global scale.
CRISIL Ratings’ criteria for the cotton textiles industry, February 2021, page 13:
the Indian spinning sector compares poorly with that of China and Southeast Asian countries, thus constraining global competitiveness.
The poor competitiveness of Indian spinning mills is not limited only to cotton yarn. In fact, in the manmade fibre (MMF) yarn as well, Indian yarn producers are not competitive enough. Higher taxes and adverse custom duties levied by the Indian govt seem to have put Indian MMF yarn producers at a disadvantage.
On the contrary, the favourable environment experienced by Chinese MMF yarn players has led them to have large capacities and benefits from economies of scale improving their cost competitiveness.
Rating methodology – textiles (spinning) by ICRA, March 2022, pages 3 & 4:
The MMF segment’s growth in India in the past has been marred by the adverse indirect tax structure on the manmade fibres against cotton. Besides being taxable at higher rates, the MMF segment has an inverted duty structure which affects competitiveness of players in the segment.
weak competitive positioning vis-a-vis international players (like those in China) which have significantly larger manufacturing capacities for manmade fibre and benefit from economies of scale.
As a result, Indian manmade fibre yarn producers are not able to export their yarn and most of the production of India’s manmade yarn is consumed domestically.
Rating methodology – textiles (spinning) by ICRA, March 2022, pages 1 & 4:
Due to lack of competitiveness in the export market, manmade yarn produced in India is largely used for domestic requirements and consumption
Indian apparel manufacturers also face a challenging environment where they have witnessed a reduction in export incentives. As a result, their profitability and in turn export competitiveness have come down. Apparently, the govt. has to reduce the export incentives to comply with the directions of the World Trade Organisation (WTO).
Rating Methodology for Entities in the Textile Industry – Apparels, ICRA, April 2020, page 7:
in recent years wherein frequent revisions in the export incentive rates, partly to make the export incentive structure compliant with the World Trade Organisation (WTO) norms, have affected profitability of the Indian apparel exporters.
Export incentives usually contribute about 2% to 7% of the revenue of exporters in the textile sector.
Rating methodology for textiles sector by India Ratings, August 2020, page 2:
Changes in the government’s export policy and incentives schemes may impact the earnings profile of exporters as export incentives account for 2%-7% of their revenue.
From the earlier discussion, an investor would remember that as per ICRA, in the last 5 years, spinning mills had a net profit margin (NPM) of 1% whereas fabric makers and apparel manufacturers had a net profit margin of 3%. In light of the low net profit margins of textile companies, any change in export incentives that contribute 2%-7% of revenue may push the company into losses.
It seems that the export incentives to the textile sector in India are less than the incentives like favourable duty structure available to textile companies in Vietnam, Sri Lanka, Bangladesh and China. As a result, textile companies of these countries are able to export to India and give a lot of competition to Indian textile companies in the Indian market.
Rating methodology for textiles sector by India Ratings, August 2020, page 2:
Global and Local Competition: The Indian textile industry faces tight competition from local players as well as from companies in Vietnam, Sri Lanka, Bangladesh and China, which have cost advantages (labour, power, taxes) as well as a favourable duty structure on exports
Therefore, an investor would appreciate that despite all the fiscal incentives and subsidies given by the Indian govt., in the export market, the Indian textile sector seems to be at a disadvantage when compared to China and other South Asian and South-East Asian countries.
Summary
The Indian textile industry is characterised by intense competition between numerous small-scale players. Large-integrated players constitute only a very minor portion of the industry. Most of the textile players, be it spinning mills, fabric or garment/apparel manufacturers produce commodity products, which are non-differentiable from each other; therefore, customers can easily switch from one supplier to another.
The commodity nature of products has led to intense price-based competition between textile companies, which has taken away the pricing power of the companies. As a result, nearly all textile companies earn very low-profit margins. During economic downturns, demand slowdowns, and phases of raw material (cotton or manmade fibre) price increases, many textile players go into losses and even shut their businesses. The business model is very fragile. Only the largest players with economies of scale and low cost of production are able to earn sustainable profit margins.
The spinning segment is highly capital-intensive with a large investment needed to install the mills and a large investment in inventory stocking during the cotton-harvesting period. It is a power-intensive business where companies need to continuously spend money on the expansion and modernization of plants to make them more efficient. Until now, the capital and interest subsidies by the govt. have supported the capital expenditure by textile companies.
Small-sized commodity yarn producers face many challenges to sustain their business under intense competition; however, large players and those who focus on value-added and premium yarn (high count range) are able to earn a high-profit margin and develop competitive advantages. A few yarn producers do vertical integration in contract farming, ginning units, and fabric and apparel manufacturing divisions to improve their profit margins. Some also diversify to become flexible in using different yarn inputs, produce fibre of different count ranges etc. to mitigate the impacts of cyclical phases.
Fabric making is also a capital-intensive business; however, it has relatively lower inventory intensity because good quality yarn is available throughout the year unlike cotton, which has harvesting seasons. Nevertheless, fabric making is also a commodity business where the pricing power is low and the business is susceptible to cotton and crude oil prices (for manmade fibre yarn).
However, the volatility of profit margins of fabric makers is lower than spinning mills because, first, fabric makers do not have to stock yarn for full-year production and second, they produce fabric mostly after getting confirmed orders, which are priced after factoring in current yarn prices.
A few fabric makers go for diversification into processing different types of yarn (cotton or manmade) and producing different kinds of fabric (GSM, colour, texture, wrinkle-free water/oil resistance etc.) to mitigate the impact of the cyclical business environment. To improve their profit margins, fabric producers focus on the premium segment with price-inelastic demand. A few players sell fabric directly to consumers under their own brand name. These steps give some pricing power to the fabric manufacturers where they can pass on the increase in yarn costs to their customers.
Some fabric makers also go for vertical integration into spinning mills as well as garment making to earn a higher profit margin. However, entering into the spinning division is risky because it is much more capital-intensive and has different inventory management dynamics. During times of lower cotton prices, an integrated fabric maker suffers losses on its cotton stock whereas a standalone fabric maker would benefit by buying cheaper yarn from the open market. Therefore, most of the time, fabric makers do forward integration and limit backward integration.
Garment manufacturing, as well as retailing, has low fixed-capital intensive nature; however, it is raw material and labour intensive because stitching garments need a lot of manual intervention and the company needs to stock a lot of fabric as well as finished garments of different designs, sizes and colours to supply to retail shops.
Unbranded garments are near commodities where the companies do not have any pricing power. However, branded garment makers differentiate themselves by design and product quality. As a result, established brand companies have some pricing power backed by price-inelastic demand where garment manufacturers produce clothes after getting confirmed orders and price them by factoring in the latest fabric/yarn/cotton prices. Therefore, the pricing power in the apparel segment is limited to established brands; however, it is not a very strong pricing power because all the brands whether Indian or International have to offer discounts and match them with the competitors to attract customers to their shops.
To improve profit margins, garment manufacturers also do vertical integration like extending into fabric production and yarn spinning. However, most of the time, backward integration is limited to fabric making because the control over fabric making serves most of the benefits as the quality yarn is easily available. Moreover, spinning yarn is a capital-intensive business with a lot of inventory stocking, which exposes integrated garment manufacturers to a lot of business risk.
Apparel players prefer to stay asset-light because they can easily outsource garment manufacturing to capture a high demand and the low fixed-cost nature of the business helps them survive economic downturns better.
Therefore, while analysing any textile company, an investor should focus on the following points:
- Premium/value-added products: Whether it deals in commodity products or focuses on the premium and value-added segment. Premium players have a relatively strong business model.
- Large and integrated operations: Whether it is a small-scale player or a large player with a big manufacturing capacity and integrated operations. Large integrated players have a stronger business model.
- New modern plants: Whether their plants are new and modern or old. New modern plants are cost-efficient. Moreover, old plants would need capital-intensive modernization to stay competitive.
- Diversified business with flexible production: Whether it is focusing on a single product segment or is diversified with the flexibility to use a variety of inputs and produce a variety of products. Diversification and flexibility in the production process bring strength to the business model.
We believe that if an investor focuses on these factors while assessing the business of any textile company, then she would be able to get a more realistic picture of its business strength.
Regards,
Dr Vijay Malik
P.S.
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Disclaimer
I, Vijay Malik, am a SEBI-registered Research Analyst (Regn. No. INH100008364). This article is for educational purposes only and does not constitute investment advice or a recommendation to buy or sell any securities. Investors should do their own research before making any investment decisions.
I, or my immediate relatives, do not have any financial interest in the companies discussed as on the date of publication of this article, nor do we hold one per cent or more of the securities of such companies at the end of the month immediately preceding it. I do not have any material conflict of interest and have not received any compensation or other benefits from the companies or any third party in relation to this article during the 12 months preceding its publication. I have not served as an officer, director, or employee of the subject companies, nor have I been engaged in market making activity for them.
4 thoughts on “How to do Business Analysis of Textile Companies”
Due to abundant availability of cotton fibre and relatively higher indirect taxes on the manmade one which impact export competitiveness, the Indian spinning industry is largely skewed towards the cotton spinning and cotton yarn accounts for ~70% of the total spun yarn production in the country.
I don’t think this is valid now in terms of tax struture bcz GST is 5% on MMF right?
Hi Drishti,
Thank you for reading the article carefully and for raising this point.
You are right that tax rates on manmade fibre have changed over time. The highlighted quotation is not meant to reflect current tax levels. It is used to point to a broader, long-term structural feature of the Indian spinning industry, namely its historical preference for cotton and the factors that shaped it over many years.
Industry structure typically reflects the cumulative impact of policy history, raw material availability, export demand, customer preferences, technology, and capital investment cycles. These structural characteristics do not usually change immediately with individual tax or policy adjustments.
The objective of the article is to explain how the industry evolved and what that implies for business risk and cyclicality. Readers should always combine such frameworks with the latest data and disclosures when forming their own views.
I appreciate your thoughtful comment on the article.
All the best for your investing journey!
Warm regards,
Dr Vijay Malik
Very detailed article.
All the best!