By Sanjay Arora, Wazir Advisors (sanjay@wazir.in), Aditya Rajyan, Wazir Advisors
India is the largest producer of Cotton Yarn in the world with US$3 billion worth of cotton yarn exported in 2019-20. India’s current spindle capacity is 56.6 million spindles which are 2nd largest in the world, most of which are dedicated to producing cotton yarns only. Overall the Indian spinning industry is estimated to grow at a CAGR of 6.3% to reach 11 million tons by 2025 from the current market of 8.0 million tons. However, the rising cotton prices of this season have become a subject of concern to the domestic spinning industry as the mills are facing not only a spike in raw material prices but also a shortage in availability. There is a rising fear among the spinners regarding the uncertainty of the cotton prices as it is hitting their product prices which might lead to unwanted losses in the business or even shutting down of some mills till the balance is restored. But, the biggest question is whether the prices are going to settle down or the spinners have to see a way around and seek buyers to accept the inflated prices of cotton yarns as well. Let us explore in the below section the cause and effect of the cotton price situation. And also learn the possible solution for Indian Spinners to stay profitable or reduce losses in this unprecedented time.
Why the surge??
A year ago, the spot price for cotton was about Rs. 40K-45k per candy which has now shot up to Rs. 90k-95k per candy. Also, compared to global cotton prices, the surge in Indian cotton prices is the highest. There are a number of forces in play due to which the cotton prices have shot up unexpectedly.
The first and foremost reason is that the crop yield is significantly lower this year. In the case of India, this is the second year when cotton producers have experienced lower crop yields. Another major producer such as China has also experienced considerably lower crop yield this year. Although, in the case of the US and Brazil the crop yield is closer to the mean, since India and China are the largest producers of Cotton, the lower crop yield created a global shortage of cotton raw material, thus increasing the price exponentially.
Secondly, Cotton consumption has increased significantly. According to the world consumption data, there is a significant increase in cotton consumption globally. In India, the consumption of cotton has shot up by approx. 15%. Similarly, in Bangladesh and Pakistan, consumption has increased considerably. Hence, the increase in consumption led to increasing demand and resulted in inflated prices.
The third is the case of ‘Revenge Buying’. Although the phenomenon is a rather general one and can be associated with any product, it cannot be denied that it has also played an important role in increasing the demand for cotton products. As the economic situation across the world started improving, consumers started buying products free of their needs which led to the increase in demand for cotton-based products. A year ago, when the prices were lower, the economy was going through a major pandemic. The demand was lower and production was majorly at a halt, but as the world started recovering from the covid shock, the economy began to get stronger. Retail activity in the key global market such as the US, UK and EU picked up significantly and supply on the other handis still catching up. Moreover, there is increased liquidity in transactions which encouraged buyers to place new orders and build trust that the market is now stabilizing.
Will the inflated prices result in increased acreage in the coming season?
Well, all the signs do look favourable for an increased acreage next season. For instance, the price attractiveness is there and also the consumption is increasing, however, the expected increase will be on the lower side, not more than 8% to 10% due to the following reasons:
- There are other competing crops as well, which are giving higher returns to the farmers and are less prone the climatic conditions. For example, Oil sides are doing great this year. In Gujarat, which is the largest cotton-producing state in India, groundnut is the biggest competitor and is also in demand. In Maharashtra, Soybean is the major competitor of cotton which is also in demand and is less prone to climatic conditions. So, from a farmer’s pov it is not just that cotton is doing well, there are other seeds as well which are high in demand and doing well in the market hence’ a farmer will decide on the relative comparison of the commodity as to which crop should be sown and in how much acreage.
- Availability of the fertilizers is also an increased concern because of the ongoing war between Ukraine and Russia the supply of fertilizers has been greatly affected. Russia is the second-largest producer of ammonia, urea, and potash and the fifth-largest producer of complex phosphates. The country accounts for 23% of the global ammonia export market, 14% of urea, 21% of potash and 10% of complex phosphates. The majority of Fertilizers in India are imported from Russia only, hence, for India, the conflict will most likely impact fertilizer suppliers and prices significantly which in turn will lead farmers to grow less cotton as cotton requires more amount of fertilizers. So, even if the acreage is more, the yield might be significantly lower
- The weather on the other hand is also not ‘quite favourable’ for the cotton crops this time. For instance, the weather in South Texas, US is going very extreme currently. The city is going through a massive drought and heatwaves and if the conditions don’t improve soon, there shall be significantly lower crop yield this time.
- Moreover, Contract farming will also be on the lower side in Africa. In the case of East Africa, if the cotton prices are going very well then, the majority of farmers will sow cotton seeds, however, if the prices are underperforming then the majority will drop cotton. As of now as there is not much clarity in terms of cotton prices, there will not be much increase in contact farming from east Africa. In west Africa, conditions are much more stable comparatively as there is a captive farmer base, the government fixes the price of seed at the beginning of the season so the merchants can’t buy below the decided price hence, in west Africa price disruption will not be applicable. That means, new companies might not place any orders for contract farming however realizing the price at the end of the current season, the buyers who are already present in the African market might increase their scale hence, contract farming from Africa will also not lead to a significant increase in acreage next season.
Therefore, in India, no doubt that the season acreage will be higher than this year but the yield is still uncertain because of poor weather conditions and the availability of fertilizers. Hence, there will be an increase in acreage but not as expected.
Effect on the Indian Spinning Industry…
The Indian spinning industry has performed exceptionally well post covid. The performance and the price realization observed this time, have not been observed in the last 5 years. Realizing this opportunity many spinners have begun their long-awaited expansions. It has been estimated that approximately 45 lakh new spindles will be installed in India within the next two years. the expansion is also boosted by government schemes such as PLI and MITRA which are expected to bring large investments into the value chain.
The notion of ‘China plus one’ has also led to a major boost in the spinning expansion in India and also across other major spinning countries such as Pakistan, Bangladesh, Turkey and CIS countries According to a recent report, the spinning machine manufacturers are booked for at least next two years. In the case of Turkey, the other factor that is driving the expansion is that Europe needs shorter lead times thus it is pushing Turkey to develop further and put up capacities to match the demand. In the case of CIS countries, the other factor is their supply relationship with the Russian Federation and Turkish composite mills.
Before the cotton price inflation, the spinning industry was enjoying the increased margins and abundance in orders but now the story has changed, Although, there is still high demand and plenty of orders the costing gap has significantly affected the conversion rate. Buyers are not ready to accept the increase in yarn price which has made it difficult for Indian spinners to continue production in large capacities. Large spinners are still able to run their mills as they have the financial bandwidth to operate on lower margins and also handle losses but small and medium scale spinners are finding it hard to keep up the operations, there are even reports of spinners reducing their capacities or shutting down their mills to minimize the losses.
So, the question here is, is this the new normal, will cotton prices will decrease in the near future? The answer is Yes, this is the new normal, the prices are here to stay and are not going to settle down in the near future. However, the prices are at the ceiling in terms of the absorption by the market, and any further increase will be at the cost of compromising the quality of the products as spinners will somehow need to manage their margins if buyers are not going to accept the inflated prices. For example, spinners will most likely lower the combing ratio which is generally 15% for a shirt yarn, which will come down to 10% to 12%.
Another effect on the spinning industry will be that smaller or mid-scale spinners will change their product mix, a higher ratio of blended yarns and synthetic yarn such as PC, PSF and Viscose will be manufactured as these yarns are also in demand and prices are much more stable than cotton.
So, in a nutshell, it is expected that the spinning industry might suffer a loss of 5%-8% on Back to back basis, however, most of the time the mills have 1-2 months advance cotton booked against their yarn so, in this rising market, it will help and spinners are safe till June. The real effect will take place after June when the spinners will have to book against the prevailing prices and if the acceptance in the market did not improve then the losses are going to be big and some serious changes in the operations will also be observed. For instance, the smaller mills will move to blended or PSF yarns or reduce capacities which are about 20% of the mills in India. The consumption of smaller mills is elastic in nature, which means for them shifting their product mix is easier. However, the rest 80% of the mills fall under the rigid sector and they will continue to operate even at massive losses but will not shut down.
But on a good note, the price rise for yarns will come. It is inevitable for example, even if let’s say 15% of the capacity move to other types of yarns or 5-10% of the mills stop their operations, it will create a sudden supply shortage and the spinners will be able to push higher prices against the demand. So, although, the weak hands will suffer first in the long run it will lead to consolidation and price acceptance in the market.
How spinning mills can maintain their profits in this challenging situation…
Well, no manufacturer, whether small or big, would want to shut their operations due to the market challenges. Challenges are a part of the game. Therefore, till the price acceptance occurs in the market, Spinners must look for other ways to reduce the cost and also make long term strategies to sustain in the future. Spinning mills, especially in India have a lot of scope to bring down their costs. Some top of the shelf short-term suggestion especially for small scale manufacturers would be to reduce their consumption, change yarn counts, effective and efficient blending of yarns, change product mix to more profitable yarns and go for closers on some particular days. In Long term scenario, the following are some methods for spinners which can be implemented to bring down the cost.
- Improving the yarn realization: Indian spinning mills are known to have lower yarn realization rates and poor production efficiency; the reason can vary from poor machine maintenance to unoptimized process parameters and a minimum approach to manufacturing excellence. Just by applying a proper approach to manufacturing excellence and improving the yarn realization, the mills can easily increase their profits
- Bringing down manufacturing costs: High manufacturing cost is one of the major issues that Indian spinning mills face on daily basis. Spinning is a process with lots of intricate operations involve hence, many times it is difficult for manufacturers and their production teams to go in-depth into the operations and analyze data to locate the issue and solve it. But, improving the manufacturing cost can definitely guarantee better EBITDA.
- Long term Strategy Planning: There are two key opportunities on which Indian spinners must plan to sustain in the future, first is the product diversification & value addition and the second is the vertical integration. It is highly recommended that Spinners should maintain a diversified product portfolio and also vertically integrate themselves to manufacture fabrics and garments or any other value-added product. Vertical Integration will give manufacturers better control over the prices of their products as well as open up new markets and buyers. Moreover, not only the exports are rising from India but also, the domestic market is rising in double digits. Expansion is a risky game and requires careful planning. Deciding what products to diversify into and what kind of integration expansion is most lucrative is a very complicated and time taking process. Most of the time the manufacturers lack time bandwidth to actively work on these expansion strategies hence, they expand into whatever is trending in the market. The investment sometimes brings short term profits but mostly fail in long term scenario. So, it is very crucial to have a scientific study done for expansion projects that take into consideration both short-term and long-term benefits for the company.
Advantages of having an expert team to optimize the spinning business…
Relying on your own professional team is possibly a good idea but hiring an expert operations team can aid your business growth in a better way. Typically, an in-house team of engineers already have a lot of work on their hands from managing daily production to making sure of meeting the production targets, managing buyers, managing operating staff, packing products and finally shipping. Hence, when the production team is given the task of improving the yarn realization or reducing manufacturing costs, their actions and efforts are not as fruitful as there is a high possibility of overlooking or ignoring certain processes that may not seem as crucial but are highly cost-effective or may not realize that some process is not optimised as per the available raw material, machine condition and other resources. Hence, the risk of becoming a ‘Jack of all trades’ when what you really need is the help and support of an expert team to cover those key areas of the business is highly irrational. This may sound alarming but engaging with an expert team in these difficult times can be the difference between success and failure.
Wazir’s houses a dedicated team of industry experts for spinning operation, implementation and strategy solutions. The team comprises highly professional industry engineers who have years of working experience with leading spinning mills. To date, the team has delivered numerous spinning optimization projects with a 100% proven success rate.
Wazir’s expert team has the experience of working with various mills globally and so their rate of locating the issue and solving it within a limited time frame is much higher than the in-house team of engineers. The team follows a pre-defined extensive set of procedures to study the entire plant operations from receipt of raw material to final packaging and leave no stone unturned, their job is to dive deep in the process, locate the issue come up with a solution, set the Best Operating Procedure (BOP) and also train the in-house team for sustaining the same.
Wazir expert team first benchmark the SOPs of the mill against the best practices, then the team will carefully analyze the gaps and prepare an implementation roadmap to improve realization, lower manufacturing costs and eventually increase the profitability of the company.
What’s promised will be delivered…
Unlike any other expert team out there, the Wazir team motto is to keep it simple and to the point. Before the commencement of the project, the team of experts will observe the plant, churn through production data and will clearly lay out the best possible solution and achievable improvement in the current EBITDA. The team will then work hard to deliver the promised numbers within the set timeframe.
What Wazir Advisors Do…
Wazir Advisors is a management consulting firm with a special focus on textile value chain assisting clients in operation excellence, strategy formulation and implementation, forming alliances and joint ventures, investments, market understanding, sector analysis and due diligence – thereby providing end to end solution spanning the complete business cycle in the textile sector. Wazir’s team of sector experts possess experience across functions – projects, operations, sourcing and marketing. The team members have worked on strategy and implementation assignments in all major textile and apparel manufacturing and consumption bases across the globe.