Textile: An Industry of Spins And Turns

BERKSHIRE HATHAWAY is a testimony of the costliest mistake made by the world's greatest investor, Warren Buffett. The reference is not to the $670-billion investment powerhouse of today, but to its avatar in the '60s. In 1965, enamoured by a deep value bargain in Berkshire Hathaway, then a textiles manufacturer based out of Massachusetts, Buffett took control of the company and kept the business running for 20 years, even acquiring another textile maker Waumbec Mills in 1975. But, in 1985, he pulled the plug on the business and later sold off the company's 18-acre complex for $215,000. In 2010, Buffett commented in an interview that the current business would have been "worth twice as much as it is now" had he not wasted money in a dying business.

What Buffett's analysis showed was that though the textile industry kept investing money in capex and technology, returns stayed anaemic. His takeaway was, "If you're gonna be brilliant with a lousy business, why not be brilliant with a good business?" While Buffett has since moved on, the nature of the textiles business hasn't changed in all these years — it continues to suck in more capital through its lifetime but rewards investors in short, intermittent cycles.

In this year's edition of Fortune India's The Next 500, textiles is the fourth-largest sector accounting for 7.73% of the cumulative turnover of the list and 4.72% of its cumulative net profit. True to Buffett's observation, among all sectors, on a cumulative turnover of ₹60,087 crore, the profit of ₹2,504 crore works out to a mere 4.17% of total income, the lowest among industries with similar heft and constituent count (See: Loose Strings). Pearl Global Industries leads the textiles pack with net sales of ₹2,713 crore and a profit of ₹68 crore. Pallak Seth, son of Pearl Global founder, Deepak Seth, who runs a unique asset light business (PDS Multinational Fashions) in the same sector and features in the marquee Fortune 500 India list with a turnover of ₹8,828 crore, says: "The bane of textile manufacturing is that to do a 100 million sale, you have to invest 50 million in asset and that limits your ability to grow beyond a point." It's not surprising then that Seth runs a business where manufacturing accounts for only 10% of its turnover.

Achieving scale in a traditional textile manufacturing set-up is difficult, and it can be gauged from the presence of only nine companies in the list with a turnover of ₹2,000 crore, with 16 companies clocking sales between ₹1,000 crore and sub-₹2,000 crore and 15 companies below ₹1,000 crore but above ₹700 crore. The list though is not a homogenous one as the companies are engaged in diverse offerings — cotton yarn to blended yarn, readymade apparels to suiting and shirting.

In FY22, four companies slipped into the red with a cumulative loss of ₹1,736 crore on a combined turnover of ₹4,604 crore. Bombay Rayon Fashions was the biggest loss-making company at ₹1,254 crore on a turnover (net sales) of ₹777 crore. The textile maker is undergoing insolvency proceedings by an operational creditor since June 2022 and has admitted claims worth ₹6,690 crore from secured financial creditors, including 91% of debt share from JM Financial ARC, and 9% of claims from Axis Bank.

The next big loss was from the Wadia group-owned Bombay Dyeing and Manufacturing Company, which clocked a turnover of ₹2,000 crore and a loss of ₹460 crore. In January, CARE Ratings had assigned "BBB; Stable" rating to the long-term bank loan and fixed deposit programme of the firm worth ₹2,855 crore.

The ratings take into account the company's weak financial risk profile since it has a highly leveraged capital structure with a negative net worth over the past two fiscals, says Arti Roy, analyst, CARE Ratings. "There have been consistent cash losses since the past two fiscals with debt repayment being supported by infusion from promoter group companies and external refinancing," Roy says in the rating update.

The concerns around the textile industry have much to do with the cyclical nature of its business. "The industry is sensitive to economic conditions and factors such as consumer demand, inflation, disposable income levels and demographic trends. Margins are exposed to volatility in raw material prices and competition. Profitability margins are also susceptible to fluctuations in key raw material prices and forex fluctuation risks," states Roy.

Hence, "value" from an investing perspective can be a tricky affair in a cyclical sector where quite a few stocks are trading in single multiples. Of the 39 listed stocks, only six are in the black in the current calendar year, while the rest are all down between 3% and 30%. "Like commodities, it's a cyclical business and investors have hardly made money consistently in this sector," says noted mid- and small-cap investor Vijay Kedia, who had invested in Ambika Cotton Mills (which ranks 432 in The Next 500 list), and in his second textile stock this year, Siyaram Mills.

Of late, the textile industry is going through a difficult period owing to a combination of high cotton prices and low demand, particularly in the West. As a result, most companies in the sector have been operating at low capacity, and major global retailers have been left with high levels of inventory due to consumers prioritising other essential items in the face of inflation, say analysts Abhineet Anand and Chinmay Kabra at Emkay Research. The situation has been particularly challenging for exporters in India, where cotton prices have been trading at a significant premium compared to international prices for the past five months, exacerbating the impact of slowing demand. This has resulted in over 40% of Indian spinners either shutting down or operating at reduced capacity owing to negligible yarn and cotton spreads. Cotton is the mainstay, accounting for 58% of fibre consumption in the textile industry. While China, Brazil, and Turkey enjoy higher cotton yields of up to 1,800 kg lint per hectare, in contrast, India's yield is low at around 460 kg, way below world average yield of 800 kg. As a result, despite accounting for 39% of the world's cotton cultivation area, India only contributes 23% of the total cotton production. According to analysts, the home-grown textile industry is experiencing a slow decline in margin and volume growth as rising freight expenses and inflation have jacked up cotton prices by over 30% in 2022 to ₹46,700 per bale.

The seasonality impact on crops is one variable that sticks out as a sore thumb for the sector. "All crop-based businesses such as tea, textiles and sugar are prone to seasonal swings in crop production. Hence, making money in these sectors is quite difficult," says Kedia. Similarly, erratic demand swings only compound the problem. For instance, Kedia last year invested in Ambika Cotton Mills, which manufactures and sells specialty cotton yarn to premium branded shirt makers. "It is one of the finest firms in cotton spinning mills. It has a good product and sound management, yet I exited the stock as it was impacted by gyration in cotton prices," says Kedia. At the AGM held last September, P.V. Chandran, CMD of Ambika Cotton, told shareholders that the strong demand for cotton yarn impacts demand for cotton and its prices.

This time around, Kedia has bought into Siyaram Mills, which has seen the highest year-on-year total income growth of 114% to ₹2,048 crore in FY22 among profitable textile companies in this year's list. The company also reported a 59-time jump in net profit to ₹216.24 crore. Kedia bought around five lakh shares in the December quarter, which amounts to a 1.07% stake in the company. "Unlike Ambika, Siyarams is a manufacturer of fabrics, readymade garments, and other textile products, with a diverse range of offerings. It has strong brands and a diverse fabric mix. In a commodity business, having brands can help you weather the storm well," says Kedia. Just like Kedia, Chennai-based Dolly Khanna, too, owns a textile stock, Nitin Spinners, in his portfolio. The company was the 500th on the Fortune 500 India list 2022 with a total income of ₹2,788 crore and a net profit of ₹326 crore.

While the pandemic has played truant with the industry, the China+1 strategy and controversy over Uighur (largest cotton region in China) crackdown by the authorities had helped Indian yarn makers last year. This time around, there is talk that the earthquake in Türkiye has impacted the Gaziantep region, known for its spinning mills. As a result, the Turkish garment industry is looking to source yarn from other markets, including India. In fact, it is the largest textile product imported by Türkiye from India. But, on the other hand, the calamity is also expected to impact garment exports to the country, though China is a bigger supplier. In fact, overall textile exports would be under pressure owing to rising inflation impacting disposable incomes in developed markets.

Kedia is not too surprised about the spate of news flow. As a disclaimer of sorts, he tells Fortune India: "I have bought the stock as it has strong domestic brands and was available at low-digit PE. But by no means should prospective investors see this as an indication of this textile stock being a multi-bagger. I have taken a 'chance'. Mr Market is very fickle as a value stock can remain in the 'value' zone for longer than you can imagine," says Kedia with a chuckle.

In essence, for those looking for a bargain in textile stocks, buying a shirt for keeps is better than losing one!