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INDUSTRY UPDATE ON: Cotton Textiles Industry

1.0 1.1

Background: We have adopted new credit risk rating models for assessment of credit risk for proposals under commercial advances w. e. f. F. Y. 2005-06. A circular No. BCC/ BR/ 99/ 41 dated 10th Feb.07 is issued in this regard advising the replacement of 2- models (Comprehensive & Smaller) by -11- models and elaborating the modus operandi for implementation of these models based on the audited financials as on 31/03/2006 and onwards. The Rating models are based on two dimensional rating methodologies specified under Basel - II requirements wherein -4- types of risks viz. Industry risk, business risk, financial risk and Management risk are assessed pertaining to the characteristics of an obligor while facilities considered / sanctioned to a company are assessed separately under second dimension of rating viz. facility rating. The Products covered under Cotton Textiles Industry as per the classification of RBI for submission of DSB returns / ASCROM statements are mapped for the purpose of assessment under Industry Risk scores with the group consisting of the following sub sectors for classification under CRISIL Models: ASCROM Classification: Cotton Textiles Industry Mapping under New (CRISIL) Models for Rating: As under.

1.2

1.3

Sr No

Sub sector

Usage

1 2 3 4 5

Cotton Yarn Cotton Fabrics Ready Made garments Denim Worsted fabrics

Raw Materials Raw Materials Finished Product Finished Product Finished Product

Existing Industry Risk Score (on Production Server) out of maximum of 10 3.60 4.00 5.4 2.7 6.7

Revised Industry Risk Score out of maximum of 10

3.4 4.0 2.7 2.7 6.2

1.4

The following update covers analysis of critical issues for a particular industry required during the assessment of a company operating within that particular Industry / sector under the new models. Thus, Industry Risk Scores are automatically made available as & when a rating officer selects that particular sub sector for borrowers to be rated under all models except SME (Mfg) / SME (Ser) & Traders.

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1.5

The update also encompasses recent developments in the Industry useful for assessment of various Industry / company specific parameters under Module for assessment of Business Risk. This is based on the information provided by M/s CRISINFAC and other sources. We endeavor to keep these updates on our Banks INTRANET site www.intranet.bankofbaroda.com and for accessing the profile / updates the path to be followed after logging on to the site is >organisation >corporate > Risk Management > Industry / Product profile The Main Section: The detailed developments in the Indian Cotton Textiles Industry on all India basis are narrated as under: Parameter Background Observations Industry Segmentation: Cotton Textile industry

2.0

Sr. No 1

Raw Materials

Finished goods

Cotton Yarn

Ready made garments

Cotton Fabrics

Denim

Fabrics

Handlooms

Power looms

Mills hosiery

The industry can be segregated into two basic segments viz. Raw Materials and Finished Products. Raw Materials are Cotton Yarn and cotton fabrics while the Finished Products for the industry are fabrics, Ready Made Garments, Denim etc. The fabric industry comprises handlooms, power looms, mills and hosiery (knitting) units.

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The Industry may also be divided into organised and unorganised sectors. The mills constitute the organised sector, while the unorganised sector includes the decentralized power loom segment, the handloom segment and the hosiery segment. A composite mill is a textile mill that undertakes spinning, weaving and processing of cloth. A handloom is a hand-operated machine, while a power loom is driven by power (for example, an electric motor), and is used for converting yarn into fabric.

Domestic Industry Size / Contribution to GDP:

The Indian textile industry contributes about 14 per cent to industrial production, 4 per cent to the country's gross domestic product (GDP) and 17 per cent to the countrys export earnings, according to the Annual Report 2009-10 of the Ministry of Textiles. It provides direct employment to over 35 million people and is the second largest provider of employment after agriculture. Total textile exports have increased to US$ 18.6 billion during April09-January10, from US$ 17.7 billion during the corresponding period of the previous year, registering an increase of 4.95 per cent in rupee terms. Further, the share of textile exports in total exports has increased to 12.36 per cent during April09-January10, according to the Ministry of Textiles. Cotton Textiles industry comprises of various producers in the value chain such as the cotton yarn industry as raw material suppliers (cotton farmers or ginners), cotton yarn manufacturers (spinners) and fabric manufacturers who convert cotton yarn into fabric. The cotton Fabrics also are subjected to the processing like bleaching, washing, dyeing, printing etc before providing to the Ready made garment Industry for cutting / stitching, finishing, packing etc.

Industry Critical factors: Production Technology: There are two types of spinning technologies for manufacturing of cotton yarn. The Open End and Ring Spinning. The open end spinning process is more cost competitive as

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compared with the traditional ring spinning process, which is suitable for manufacturing of coarser cotton yarn. Nevertheless, the open end spinning is more capital intensive compared to Ring Spinning. The most critical area of the spinning process is the ring-spinning machine as it determines the quality of the yarn. The ring-spinning machine has to be adjusted to produce the desirable quality consistently at the same setting, impart adequate twist to the yarn, and minimise breakages. This requires the right quality of machines, and proper / regular maintenance of the machines. Cyclicality / seasonality: Cotton is an agricultural product and its production is seasonal. Usually the cotton season in India is OctoberSeptember and the harvesting period, when the deliveries are the maximum, is January-February and October. However, the cotton yarn production and hence the demand for cotton is spread evenly throughout the year. Thus the cotton prices witness a seasonal pattern. The domestic prices of cotton are determined not only by the demand-supply scenario in India but also across the globe, as cotton being a commodity follows the landed cost parity and the domestic cotton prices nearly align the landed costs. Cotton is the key raw material required to produce cotton yarn. It accounts for above 75 per cent of the operating costs indicating raw material intensity in the total cost of production Minimum Support Price (MSP) scheme of GOI: The basic objective of this scheme is to ensure adequate production of cotton, the main raw material for yarn. In order to provide incentives to cotton growers, the Government announces a minimum support price for cotton. This ensures adequate returns to the growers over the input costs. Whenever cotton prices decline to below the minimum support price, the Cotton Corporation of India (CCI) provides price support. The quality of cotton is determined by a unit called count, which measures the weight in grams of the yarn per one hank length. (One hank is 840 yards.) Hence, lower the count, the coarser is the cotton, as it contains more strands.

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The blending process assumes importance as the cotton of the same grade, received from different sources, is blended together, in order to ensure that the quality produced by the mill is consistent. International Competitiveness: Reduction in customs duty adversely impacts the prices of products due to shrinkage in margins. International prices are linked to International Cotton Exchange prices, London.

Global Scenario: India accounts for approximately 25 per cent of the world's total cotton cultivation area and about 18 per cent of the global cotton production. Cotton yields are low in India; the average yield in India is around 463 kg per hectare as compared to the world average of 723 kg per hectare. The primary reason for low productivity is crop damage by insects and pests. Low yields are also the result of poor farming practices, since Indian farmers lack appropriate knowledge in this regard. However, it was reported that about Rs 12 billion worth of pesticides were used in India just to control the bollworm during 2005-06. China is the largest cotton producer in the world. Market scenario: The buyer-driven commodity chains dominate the global clothing market, in contrast to the auto, computer, and aircraft industries that are driven by producer commodity chains where manufacturers exert control over raw material suppliers as well as distributors and retailers. In the buyer-driven structure, large retailers and branded marketers play pivotal roles along global supply chains by setting up decentralised production networks linked to the countries in the developing world and by coordinating the range of activities like design, production, and marketing 2 Major events in the Industry 1. Mergers/ Acquisitions 2. Announcemen ts by Industry Associations like FICCI/ CCI / ASSOCHEM etc. S Kumars Nationwide has formed a joint venture (JV) with Donna Karan International to design, produce and distribute the entire range of DKNY menswear apparel across the world except Japan for 10 years. The new venture will invest US$ 25 million for expansion of Donna Karans menswear brand and expects to record sales of about US$ 140 million in the next three years. (IBEF June 2010). The Andhra Pradesh government has allocated over 1000 acres of land for the Brandix India Apparel City (BIAC) in the states special economic zone (SEZ),

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which was inaugurated in May 2010. The apparel city is expected to attract an investment of US$ 1.2 billion (around Rs 5,400 crore). (IBEF June 2010) NSL Textiles, part of the Rs 1,500-crore group that owns Nuziveedu Seeds Ltd, has set up a textile processing facilty at Chandoulu near Guntur with an investment of Rs 300 crore. The company plans to launch its own mens apparel brand Constelloaround Diwali.(BS Sept 01) The Kerala Industrial infrastructure Development Corporation (Kinfra) is setting up a series of rural apparel parks in the State and the first is coming up in kozhikode. The programme, announced in the 201011 Budget, is envisaged to give a boost to give a boost to the textiles sector and also provide largescale in the rural areas. (July 23 10 BS)

Scores relating to the Industry risk factors and the relevant Business Risk factors for the above stated industry sub sectors is as per the Annexure 1 to 4. Annexure: 1 Cotton Yarn Annexure: 2 Cotton Fabrics Annexure: 3 Ready Made Garments Annexure: 4 Denim Annexure: 5 Worsted Fabrics Annexure: 6 SWOT Analysis Banks Experience As per the statement from ASCROM for sectoral deployment of industry wise credit as on 30.06.2010 the / Position on total Domestic exposure to Cotton Textiles Industry is Exposure. Rs.3832.68 crore out of which credit outstanding of Rs.3797.66 Cr is classified as standard while balance amount of Rs.35.02Cr is classified as NPA. Thus the ratio of NPAs to the exposure to that industry (Rs.35.02Cr / Rs.3832.68Cr) as on 30.06.2010 for Cotton Textiles Industry works out at 0.9% at our Bank. Industry Risk Factors (For LCM models except for SME (Mfg / Services) and Traders) Further, PWO amount for Cotton Textiles sector at our Bank as on 30/06/2010 is Rs.89.20Cr and the ratio of NPA with PWO added back as on 30/06/2010 works out 3.16% (NPA: 35.02+ PWO: 89.20/ Exp.: 3832.68+ PWO: 89.20)*100. The exposure / other details of our major ten Borrower Accounts under Cotton Textile industry as on 30/06/2010 are as under: -

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(Rs in Cr) SR BRANC NO H 1 COTTO N 2 CORAH M 3 ALKAP U 4 COIMB A 5 PARLIA 6 COIMB A BORROWER NAME K P R MILL LTD ARVIND MILLS LTD GRASIM INDUSTRIES LTD PREMIER MILLS LTD SHRI LAXMI COTSYN LTD PREMIER SPG &WEAVI PVT LTD AMBIKA COTTON MILLS SANATHAN TEXTILE P LTD SCM GARMENTS P LTD SHRI LAXMI COTSYN LTD Total CLS Balance CR.RT O/s STD 365 BOB 4 STD 253.5 STD 100 STD 107.5 STD 89.07 STD 71.31 BOB 4 BOB 3 BOB 2 BOB 3 BOB 2

COIMB A 8 CRAWF O 9 COTTO N 10 PARLIA

STD 82.5 STD 58.86 STD 62.91 STD 54.05 1244.7

BOB 3 BOB 4 BOB 4 BOB 3

Top 10 borrowers exposure (Rs 1244.7 cr) is 32.47% of total industrial exposure (Rs 3832.62 cr) 5 Risk Appetite / Gap Available for The details for available gap based on the Risk Appetite Assessment for this sector is as under: Growth during 2008- 09. Industry Domestic Cap Max Exposure based on Gap Available Exposure Stipul Domestic Credit of for Growth as on ated Rs.186745.45Cr as on during 20010- 11. 30/06/10 (%) 31/03/10. Rs. Cr.

Cotton textiles

3832.68

7.50%

13500

9667.32

Rajender Gujjula Corporate Research Cell Risk Management Deptt. Bank of Baroda, Baroda Corporate Centre,

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BKC, MUMBAI-51. Date: 23102010 Annexure: 1 Summary of Cotton Yarn Introduction: Yarn is the end product of spinning. It is the primary component for any woven or knitted fabric. Yarn is usually measured in English count, which is the number of hunks of yarn of length 840 yards required to make one pound. Higher the count, finer is the yarn, and vice-versa. Example: 80s cotton yarn is finer than 40s cotton yarn The Indian Spinning industry is an old one, and hence, mills are at different stages of modernization. Moreover, the industry is basically commoditised, as there is a lack of product differentiation. This has encouraged a large number of players to enter the market, which has led to severe price competition. The spinning industry is fragmented with 1,602 spinning mills, 177 composite mills and 1,219 small-scale spinning units. Spun yarn capacities are concentrated in Tamil Nadu, Maharashtra, Gujarat, Andhra Pradesh and Punjab. These states account for 75 per cent of the total spinning capacity in India. Besides, no single player has an influence on prices given the industrys highly commoditised nature. The top five players account for less than 5 per cent of the industry's capacity. Manufacturing process at a glance:

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Demand-supply: Demand for cotton yarn stems from consumption of fabrics used in readymade garments and other textiles Domestic Demand: it refers to the local consumption of the yarn used in fabrics for manufacturing garments at home textiles Derived demand: it refers to the demand arising from yarn that is consumed in fabrics used to manufacture garments and home textiles that are exported. Direct yarn exports demand: it refers to the demand from countries that import cotton yarn from India Domestic demand constituted 59 percent of total yarn consumption in 2009-10, while derived demand and direct yarn exports accounted for 22 per cent and 19 per cent, respectively.

2003- 200404 05 India (production) 3,043 4,131 India (consumption) 2,987 3,265 India (Exports) 119 136 (million kg)

200506 4,097 3,655 751

200607 4,760 3,908 960

200708 5,219 4,050 1,530

2008-09 E 4,930 3,863 515

2009-10 E 4,963 4,252 1,360

CAGR 1 3.7 5.4 58.5

CRISIL Research expects demand for cotton yarn to increase at a CAGR of 4.5 per cent, to 3,274 million kgs in 2011-12 from 2,998 million kgs in 2009-10, with domestic demand

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being the major driver. Demand for cotton yarn used in textiles (meant for exports) is expected to rebound on a slow and gradual recovery in the US and EU markets. Direct yarn exports, however, are to remain subdued on lower demand from countries like Korea, Japan, Turkey (as their exports are expected to reduce) and China, Bangladesh (due to backward integration). In addition, in the domestic market, cotton yarn is expected to face substitution from PFY in the blended yarn category on account of a widening price differential. Operating rates for spinners declined sharply to 62 per cent in 2008-09 from 68 per cent in 2007-08 because of significant capacity additions (around 2 million spindles). During the same time, demand for yarn declined given economic slowdown thus, causing a drop in operating rates. During 2009-10 to 2011-12, we do not expect a significant addition in capacity and with revival in yarn demand; we expect operating rates to improve slightly to 66 per cent from 62 per cent. However, the existing overcapacity will continue to limit pricing flexibility of yarn manufacturers. Government policies: Government policies have a major impact on the cotton textile industry, and so far, they have generally been favorable for the sector. The Government launches textile packages, such as the technology Upgradation Fund scheme (TUFS), to make the sector competitive in terms of productivity and costs. EXIM policy contains export promotion measures such as the duty Entitlement passbook scheme (DEPB) and duty drawback scheme Recent government measures: 1. In the union Budget 2010-11, the 2 percent interest subvention on pre-shipment and post shipment export credit has been further extended till March 31, 2011 2. The Union government set up a s-250 billion fund under TUFS for providing aid to textile projects. The scheme, which commenced from April 1,1999, provided 5 % interest subsidy on loans borrowed from specified institutions to all segments across the textile value chain. The scheme has been extended till the Eleventh plan period (2007-2012) 3. Duty entitlement passbook scheme was introduced to promote exports of various goods, including textile products. Under the DEPB scheme, the exports are granted credit for exports at specified rates. 4. The duty drawback scheme was introduced to promote exports from India. Under this scheme, the exporters are allowed to get refund of excise and import duty on its raw material so as to make the products more competitive in the international market. 5. The Union Budget 2004-05 removed cotton textile products from the chain of mandatory Cevant. 6. The cotton technology mission was introduced in February 2000 for increasing the yield and quality of cotton available for domestic spinning mills. Input Related Risk Despite higher production in 2009-10 cotton seasons, domestic cotton prices are increasing on account of rebound in consumption and higher exports on firm international prices. CRISIL Research expects domestic cotton prices to increase from Rs 63 per kg in 2008-09 to Rs 69-71 per kg for 2009-10 cotton seasons and Rs 71- 73 Rs per kg for 2010-11 cotton

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seasons. Yarn manufacturers will not be able to pass on the hike in cotton prices fully due to overcapacity, thus affecting margins as cotton accounts for 70 per cent of operating costs. Extent of Competition The cotton yarn industry is highly commoditised. As a result, no single player can influence prices. The top five players make up for less than 5 per cent of the industry capacity. The high degree of fragmentation and commoditised nature has caused intense competition among spinning companies. Although India enjoys its status as the least-cost producer, capacity additions in spinning by China and Bangladesh are a cause for concern. From 2000 to 2008, Bangladesh added 5.2 million spindles, taking its spindle capacity to 20 per cent of Indias (36 million) while China added 33.3 million spindles, making its spindle capacity twofold Indias capacity. The backward integration of these countries is resulting in higher raw cotton exports to their markets from India. Financials

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3.0

Evaluation of Business risk Parameters (Total Marks 100): Wt 35% Cotton Textiles sub sector Cotton Yarn: The following Industry Specific Parameters are selected centrally for the purpose of scoring. Thus, during the rating process with New (CRISIL) Models a credit officer is required to evaluate these parameters based on the company specific information available and the industry specific supplementary information provided as follows:Weight ages 70% 20 25 Remarks

Sr. Risk entity name No Operating efficiency Capacity 1 Utilisation Availability of 2 Raw Material 3 Integration of operations

25

The basic raw material viz cotton (agricultural crop) is abundantly available in India though a seasonal commodity. Integration for the purpose of cotton yarn unit from cotton bails as the basic raw material and packaged gray cloth as the finished goods. Horizontal / vertical

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Management of Price Volatility

30

process like bails opening /cleaning, carding, spinning, coning, weaving and further packaging of gray cloth etc may be considered for evaluation of linkages. As per the data at table above, the average sales / distribution costs for the industry is 4.2% for 200708. The average raw material price for the industry is 57.2 for the year 207-08. The factors to be considered for market diversification are sales spread is with exports, all India basis, regional basis etc. This factor assesses the stability of demand pattern and earnings stability thereof. It needs to be scored depending upon the confirmed sales arrangements backed by contracts etc. This factor assesses the companys /groups ability to withstand aggressive pricing by market leader by price undercut. This factor assesses the quality of production achieved over a past period of 2 -3 years. The factor also calls for evaluation of quality standards achieved by the company like ISO, ISI etc as also the percentage of rejection.

Market position Diversified 5 Markets 6 Long Term contracts / assured off take Financial Ability to withstand price competition Consistency of Quality

30% 20

30

20

30

Out look of the industry: CRISIL Research expects cotton yarn demand to increase at a CAGR of 4.5 per cent (volume terms) from 2009- 10 to 2011-12, primarily supported by demand from the domestic readymade garment and home textile industries. Gradual recovery in the EU and US markets will result in higher cotton textile imports from these countries, thus further driving cotton yarn demand. However, direct yarn exports are expected to remain subdued. The industry continues to function at low operating rates, around 64-66 per cent given the prevalent overcapacity in the spinning segment. Output in the 2009-10 cotton season increased on account of higher acreage. This increase is due to a 38.7 per cent hike in Minimum Support Price (MSP for Shankar-6 variety) announced at the beginning of the previous cotton season. In addition, cotton consumption is expected to increase on account of demand pickup in the domestic market and gradual recovery in the export market. Increased consumption and higher exports of cotton due to firm international prices is causing domestic cotton prices to increase rapidly. CRISIL Research expects domestic cotton prices to be at Rs 69-71 per kg for 2009-10 cotton seasons and at Rs 71-73 per kg for 2010-11 cotton seasons. We do not expect yarn manufacturers to pass on this hike in cotton prices fully on account of overcapacity. For mitigating the risk of exposure to a commoditised market, established cotton yarn spinners have forward integrated into manufacturing fabric and home textiles. However, this has resulted in highly leveraged balance sheets, increasing the financial risk of manufacturers.

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Derived demand for cotton yarn

Domestic demand of cotton yarn

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Annexure: 2 Summary of cotton fabrics As a industry: The Indian cotton fabric industry produces about 27 billion square metres of fabric, accounting for around 50 per cent of total domestic cloth production. It is a highly fragmented industry with 177 composite mills, 1.9 million power looms and 3.9 million handlooms, leading to intense price competition. Prior to 2004-05, the excise duty exemption awarded to the power loom sector resulted in a great disadvantage to the organised mill sector, causing a high level of fragmentation in the fabrics segment. The organised mill sector could compete with the unorganised sector on a level playing field after the removal of the mandatory central value added tax (CENVAT) on the entire cotton textile chain (from yarn to garments) in the Union Budget of 2004-05. Demand Supply: The domestic market for readymade garments will be the major driver for demand for cotton fabric. Recovery in the US and the EU, leading to higher imports of cotton-based readymade garments and home textiles, will also support demand for cotton fabrics. CRISIL Research expects demand for cotton fabrics to record a CAGR of 4-5 per cent (volume terms) from 2009-10 to 2011-12. Government initiatives: The government policies have been largely supportive of the growth of the textile industry, given its potential for employment generation. The budgetary support to TUFS (Technology Upgradation Funds Scheme) is at Rs 22.7 billion in 2010-11, down from Rs 28.9 billion in 2009-10. The TUFS has been extended till the Eleventh Plan in the Union Budget of 2007-08, though with some modifications. The interest subsidy for the spinning sector has been lowered to 4 per cent, while other parts of the textile value chain still continue to benefit from the 5 per cent interest subsidy. This has been done to correct the skew in investments under TUFS towards spinning, and diverting more funds into weaving and processing. Furthermore, the weaving industry benefits from the Credit Linked Capital Scheme (CLCS), wherein the government provides a 20 per cent capital subsidy on the capital cost. In the Union Budget of 2010-11, the government also continued the 4 per cent optional excise duty on pure cotton textiles beyond the fibre stage. Since this is optional, it will not have any negative impact on the industry. In fact, this will benefit manufacturers with accumulated CENVAT credit, as they will have the option to utilise this credit. Input Related Risk: In spite of higher production in the 2009-10 cotton season, domestic cotton prices are increasing on account of rebound in consumption and higher exports on firm international prices. CRISIL Research expects domestic cotton prices to increase from Rs 63 per kg in 2008-09 to Rs 69-71 per kg for the cotton season of 2009-10 and Rs 71-73 per kg for the 2010-11 cotton season. The composite mills that buy cotton spin it into yarn for captive weaving. These mills will not be able to fully pass on this hike in cotton prices due to overcapacity, thus affecting margins.

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Extent of competition The Indian cotton fabric industry contributes around 50 per cent of the total domestic cloth production. It is a highly fragmented industry with 177 composite mills, 1.9 million power looms and 3.9 million handlooms, leading to intense price competition and thin margins for players. The composite mill sector contributes only around 3 per cent of the total cloth production. Indian cotton fabrics face competition from imported cotton fabrics from China and cheaper fabrics made of blended yarn and manmade fibers. Financial Risk

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3.0

Evaluation of Business risk Parameters (Total Marks 100): Wt 35% Cotton Textiles sub sector - Cotton Fabrics: The following Industry Specific Parameters are selected centrally for the purpose of scoring. Thus, during the rating process with New (CRISIL) Models a credit officer is required to evaluate these parameters based on the company specific information available and the industry specific supplementary information provided as follows: -

Sr. No

Risk Entity name

Weight ages 70% 20 20

Remarks

Parent - Operating efficiency 1 2 Capacity Utilisation Energy Costs

Management of Price Volatility

30

Integration of Operations

30

As per the data at table above, the average energy costs for the industry is 11%in the year 2008-09 The average raw material price for the industry has shown no clear trend and as such the same is 57.4% in 2007-08,and 61% in 2008-09. Integration for the purpose of Cotton Fabrics unit may start may start from cotton yarn as the basic raw material and packaged cotton fabrics as the finished goods. Horizontal / vertical process like bleaching, dying / printing, sanforising, calendaring, finishing, packaging etc may be considered for evaluation of linkages.

Parent - Market position 5 Diversified Markets

30% 20 The factors to be considered for market diversification are sales spread w. r. t. exports, sales on all India basis, regional basis etc. This factor assesses the companys /groups ability to withstand aggressive pricing by market leader by price undercut. This factor assesses the quality of production achieved over a past period of 2 -3 years. The factor also calls for evaluation of quality standards achieved by the company like ISO, ISI etc as also the percentage of rejection. Composition of high value added product partially insulates the margin. Thus, presence

Financial ability to withstand price competition Consistency of Quality

20

30

Value Addition

30

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of such products in the overall product mix is desirable/ taken into account for assessment of this parameter. OUT LOOK OF THE INDUSTRY The demand for cotton fabrics is expected to record a compound annual growth rate (CAGR) of 4-5 per cent (volume terms) from 2009-10 to 2011-12. It will be driven by growth in the domestic market for cotton-based apparels and home textiles. CRISIL research expects domestic cotton prices to increase to Rs 69-71 per kg for the cotton season of 2009-10 and to Rs 71-73 per kg for the 2010-11 cotton seasons. However, yarn manufacturers will not be able to fully pass on this hike due to overcapacity in the spinning segment, thus putting pressure on margins of composite mills with integrated operations from spinning to weaving. The government has extended the Technology Up gradation Fund Scheme (TUFS) till the Eleventh Plan to support the sector. This will enable players to finance their projects at a lower cost. The cotton fabric industry is highly fragmented, with thin margins. Composite mills face competition from the unorganised power loom sector. Cotton fabrics also face substitution from cheaper fabrics made of blended or synthetic yarn.

Traffic Signal Evaluation based on IRS: -

Industry Red Risk (IRS Range) Score 4.0 or 0% to 42.5% 40%

Yellow (IRS Range) Above 42.5% up to 75%

Green (IRS Range) Above 75%

Result

Red

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Annexure: 3 Summary of Readymade garments Back Ground: The textile industry, with the apparel sector being an integral part, is a key contributor to the Indian economy. The industry is a significant foreign exchange earner, contributing about 15 per cent to total exports. Apparel exports account for 6-7 per cent of the countrys total exports. After almost 4 decades, the system of imposing quota restrictions on textile and apparel exports to the US, the EU and Canada ended on January 1, 2005. Therefore, India and other countries now enjoy unrestricted access to these markets for the sale of textiles and apparel. The domestic market for garments comprises 65-70 per cent of the total market. Although, garments are manufactured across the country, the units are concentrated according to the type of garments manufactured, i.e. woven garments in Delhi, Mumbai, Chennai and Bangalore, and knitwear units in Ludhiana and Tirupur. Within these centres, there is a further level of product specialisation. While Delhi specialises in garments for women, Mumbai, Chennai and Bangalore focus on mens shirts and trousers, Ludhiana specialises in woolen and acrylic knitwear and Tirupur in cotton knitwear. Industry overview

Demand Supply Domestic consumption has increased at a rate of 6-7 per cent in 2009-10. CRISIL Research expects the trend to continue in 2010-11. The domestic demand for readymade garments will be mainly driven by rising income levels. Also, the growth in organised retailing, growing urbanisation and changing consumption pattern will further support the growth of the readymade garment industry. With the start of the revival process in the US and EU economies, CRISIL Research expects the exports to pick up and grow at a CAGR of 5 per cent from $ 9.6 billion in 2009 to $ 10.6 billion by 2011. However, India faces stiff competition from other countries having low cost of production, especially China, Bangladesh and Vietnam. Domestic market break-up

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Domestic textile market RMG Tailor-Made Domestic RMG market Mens Wear Womens wear Kids wear

Value (Rs billion) 1,466 1,116 350 1,116 522 463 131

Per cent 76.1 23.9 46.8 41.5 11.7

Market size and segments The Indian RMG industry can be classified as on the basis of geographical areas into domestic and export segments. In 2008, the total expenditure on RMG in India was estimated to be Rs 1,116 billion, whereas the turnover of the industry from garment exports in 2008 was around Rs 420 billion ($9.7 billion).

The exports market can be further divided on the basis of raw materials, from which the apparel is manufactured into RMG from cotton, man-made fibers, silk, wool and other materials. Exports of RMG produced from cotton, which accounts for nearly 75 per cent of the apparel exports from India, amounted to Rs 135 billon out of the total garment exports of Rs 420 billion in 2008.

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Government policies The government policies have by and large been favorable for the sector. In the Union Budget 2010-11, the 2 percent interest subvention on pre-shipment and post-shipment export credit has been further extended till 31st March, 2011. This extension of the interest subvention will lower interest costs on working capital loans thereby benefiting small exporters. In the Union Budget 2010-11, the government has allocated Rs 3.50 billion to promote integrated textile parks with improved infrastructure facilities, including power, water, roads and drainage systems. These steps have been taken towards making India a hub for textile products.

Input Related Risk India has a diversified fibre base (cotton, silk and jute) and large cotton spinning and manmade fibre industries (polyester, nylon, viscose etc). It is the world`s second-largest producer of cotton. But with the weaving and processing stages under-developed due to the lack of adequate investments, there is limited supply of good quality processed fabric. Extent of competition The domestic RMG industry is highly fragmented with few organised players and a large number of unorganised players. Unorganised players face the brunt of price competition in the domestic market. The organised segment is relatively better off as benefits of branding and positioning accrue to them in the form of better price realizations. Competition amongst the organised players is likely to intensify with international brands entering India and some exporters diverting capacities to serve the domestic market. On the export front, India faces stiff pricing pressure from low cost countries such as China, Vietnam, Bangladesh, Indonesia, and Pakistan which have been able to garner a substantial portion of the US and EU markets on the basis of lower prices. Financials

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Evaluation of Business risk Parameters (Total Marks 100): Wt 35% Cotton Textiles sub sector Ready Made Garments: The following Industry Specific Parameters are selected centrally for the purpose of scoring. Thus, during the rating process with New (CRISIL) Models a credit officer is required to evaluate these parameters based on the company specific information available and the industry specific supplementary information provided as follows: -

Sr. Risk entity name No Parent - Operating efficiency 1 Product design & Development

Weightings 30% 30

Remarks

The industrys product life cycle is estimated from 6 months to 12 months reflecting constant change of

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Availability of skilled Labor

25

Integration of operations

25

Selling Cost

20

consumer preference for different designs of garments. The companys product innovations / design changes etc may be evaluated in this context. This external parameter is focused for critical assessment of quality of labour force available in / around the area so as to achieve minimum wastage, reasonable quality and in turn better sales realization. Integration for the purpose of readymade garment unit may start from textile cloth as the basic raw material and packaged garments as the finished goods. Horizontal / vertical process like designing, cutting /stitching, ironing, packaging etc may be considered for evaluation of linkages. As per the data at table above, the average sales /distribution costs for the industry is 4.1% for 2008-09.

Parent - Market position 5 Diversified Markets

70% 30 The factors to be considered for market diversification are sales contributed by exports and the geographical spread as to sales on all India basis, regional basis etc. This factor assesses the stability of demand pattern and earnings stability and to be scored depending upon the confirmed sales arrangements / irrevocable other types of contracts entered into by the company. The level of distribution set up viz. restricted to the same city, region, state vis--vis all India presence of distributors. Composition of high value added product partially insulates the margin. Thus, presence of such products in the overall product mix is desirable.

Long Term contracts / assured off take

20

Distribution set up

30

Product Range

20

Conclusion: The domestic consumption of ready made garments has grown at a rate of 6-7 per cent and is expected to grow at the same rate in 2010-11. The US and EU together account for around 80 per cent of India`s total RMG exports. As these countries were severely hit by the economic deceleration, India`s exports were also affected considerably. The exports

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decreased from $9.7 billion in 2008 to $9.6 billion in 2009.However, CRISIL Research expects a slow but steady revival in exports. The high level of fragmentation in the industry has restricted India from gaining a greater share of the global apparel market. Moreover, the lack of adequate investments in the weaving and processing industry has also impacted the competitiveness of garment manufacturers. Degree of fragmentation in the apparel industry The garment industry is the least capital-intensive part of the textiles value chain and is therefore characterised by low entry barriers. This has led to a high level of fragmentation in the industry. There are 8,200 exporters registered with the Apparel Export Promotion Council (AEPC).

Traffic Signal Evaluation based on IRS: Industry Red Yellow Risk (IRS Range) (IRS Range) Score 4.30 or 0% to 42.5% Above 42.5% 43.00% up to 75%

Green (IRS Range) Above 75%

Result

Yellow

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Annexure: 4 Summary of Denim Background: Denim is a fashion-oriented product and is used mainly in jeans and jackets. Being a fashion driven product, margins of players are susceptible to fashion cycles. Cotton yarn (of coarser counts) is the key raw material used for manufacturing denim fabrics. It accounts for 50-55 per cent of operating costs. As cotton is a seasonal commodity and is dependent on the vagaries of the monsoons, timing their procurement is critical for industry players. India enjoys several cost advantages due to abundant availability of cotton. In the international market, India faces stiff competition from countries such as China, Pakistan and Turkey, as the labour costs in these countries are lower. Demand Supply gap: Overcapacity characterises the global denim industry, with total capacities estimated at 6 billion metres and consumption significantly lower at around 4.5 billion metres. The Indian denim industry is also facing an oversupply scenario, with capacities estimated at around 500 million metres vis--vis a demand of 400 million metres in 2008-09. Denim exports from India are in the range of 175-200 million meters per annum (MMA). Exports of denim and denim-based garments have been affected severely due to the slowdown in the US and the EU economies and capacity expansions undertaken by importing countries such as Bangladesh and Turkey. Denim fabric production in Bangladesh was estimated at 160 MMA at the end of 2007. Bangladesh was originally a large importer of denim fabric from India. The fabric was then converted into apparel for exports to the US and EU. Government intiaves The government policies have been favourable towards the textile sector as a whole. The budgetary allocation to Technology Upgradation Fund Scheme (TUFS) amounted to Rs 22.67 billion in the Union budget for 2010- 11. The government has maintained the interest subsidy for the weaving and processing sector at 5 per cent. Input Related Risk Cotton typically accounts for 50-55 per cent of the industrys operating costs. Hence, cotton/ cotton yarn prices influence the margins of fabric producers. Domestic raw cotton prices are expected to increase to Rs 69 per kg in cotton season 2009-10 and further to Rs 73 per kg in 2010-11 following increase in international prices, which has made exports attractive for the domestic players. As a result, the margins of denim players, for whom cotton is a key input, are expected to remain under pressure. Extent of competition Domestic denim players are facing tough competition in the global markets. Bangladesh and Turkey, which were originally importers of denim, have now set up and expanded their own denim capacities. This has resulted in oversupply and intense competition in the international market.

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Financials

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Sr. Risk entity name No Parent - Operating efficiency Capacity Utilisation 1 Availability of Raw 2 Material

Weight ages 70% 25% 20%

Remarks

This external parameter is focused for critical assessment of a company to achieve minimum wastage, reasonable quality and in turn better sales realization. India being the third largest producer of cotton; the availability of raw material at reasonable price is abundant.

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Integration of operations

25%

Management of Price Volatility

30%

Integration for the purpose of Denim unit is cotton fabric as the basic raw material and packaged Denim readymade garments as the finished goods. Horizontal / vertical processes like designing, fabrics processing, cutting, stitching, finishing, packaging etc may be considered for evaluation of linkages. As per the data at table above, the average sales / distribution costs for the industry is 5.4% for 2008-09. The factors to be considered for market diversification are sales spread with respect to exports, sales on all India basis, regional basis etc. This factor assesses the stability of demand pattern and earnings stability and to be scored depending upon the confirmed sales arrangements backed by contracts etc. The level of distribution set up viz. restricted to the same city, region, state vis--vis all India presence of distributors

Parent - Market position Diversified Markets 5

30% 30%

Long Term contracts / assured off take

25%

Financial Ability to withstand price competition Distribution set up

25%

20%

Conclusion: The domestic denim industry is more organised and consolidated as compared to other segments across the textile vertical. The production stands at 400 million meters, of which 50 per cent is exported to countries such as Bangladesh and Turkey. These countries have undertaken capacity expansions in the recent past, leading to over supply in the global markets. The domestic as well as the global denim industry has been operating at low rates of around 75-80 per cent following continuous capacity expansions. This has led to intense competition and pressure on profitability in the industry. Government policies have been favorable in this industry, and have focused on promoting textile exports. An interest rate subsidy of 5 per cent has also been given for the weaving and processing sectors under TUFS. Cotton yarn, a key raw material in the manufacture of denim, accounts for 50-55 per cent of the total operating costs of players. Prices of cotton, the key raw material used in the manufacture of cotton yarn, are expected to increase to Rs 69 per kg in cotton season (October-September) CS 2009-10 and further to Rs 73 per kg in CS 2010-11 as the prevailing high international prices have made exports attractive. Recovery in domestic demand is also expected to contribute to price rise. As a result of higher input costs, the margins of denim players are Expected to remain subdued in the current and the next cotton season.

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Traffic Signal Evaluation based on IRS: Industry Red Risk (IRS Range) Score 2.7 or 0% to 42.5% 27.00% Yellow (IRS Range) Above 42.5% up to 75% Green (IRS Range) Above 75% Result

Red

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Annexure: 5 Summary of worsted fabric Demand for worsted fabric is largely derived from its use in premium suiting and shirting. The industry is characterised by a few large organised players, limited competition and greater pricing flexibility. Demand in the worsted fabric industry is sensitive to cheaper substitutes like blended fabric (wool blended with polyester) due to the better crease resistance that it offers. Wool is the main raw material used in the industry. India is the eleventh largest producer of wool in the world, producing around 50 million kg in 2007-08 (approximately 1.8 per cent of world production). However, only about 5 per cent of the indigenous wool is apparel grade and hence around 95 per cent of the wool used for worsted fabric is imported. With the revival in domestic market, demand for worsted fabric is expected to pick up. With a view to catering to future demand, Raymond Ltd, the market leader in this segment, invested in spinning and weaving in 2008- 09. Its spinning capacity has been increased from 37,704 spindles in 2007-08 to 55,656 spindles in 2008-09, while weaving looms have been increased to 243 from 149 units. Demand-Supply The market for worsted fabrics in India is small, wherein demand mainly arises from the premium segment of the market for products like suits and blazers. However, demand has been witnessing steady growth. The overall slowdown in textile demand did not significantly affect the demand for worsted fabric, due to its premium and niche status. Demand in the domestic market is expected to grow at a moderate pace. Also, being a niche market, pricing flexibility for players depends on the brands strength. Government policies The worsted fabric industry enjoys the benefit of the Technology Up gradation Fund Scheme (TUFS), which provides a 5 per cent interest subsidy on loans borrowed for expansion or upgradation purposes. The customs duty on wool as well as polyester staple fibre (PSF) is 5 per cent. In the Union Budget 2010-11, excise duty on PSF was increased from 8 per cent to 10 per cent, causing PSF prices to rise. Nevertheless, PSF will still continue to pose stiff competition to wool. Input Related Risk The availability of quality wool is a serious concern in the country. India produced around 50 million kg in 2007-08, of which, only 5 per cent was used for apparel fabric. Due to the inferior quality of Indian wool, the industry depends on imports from Australia, New Zealand, etc. In 2007-08, nearly 75 million kg of wool, accounting for 95 per cent of the total wool used in fabric, was imported. Although pricing flexibility is high for companies with strong brands, a sharp increase in international wool prices may compress margins. Global wool prices declined during 2008-09 on account of capacity additions in countries other than Australia, the traditional source for Indian manufacturers. In 2009-10, prices dipped further due to global demand slowdown. With demand recovery in EU and US markets and higher import demand from China, international wool prices for fine quality wool have started rebounding from September 2009 onwards. The prices have increased

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from 867 cents per kg in September 2009 to 975 cents per kg in February 2010, and are expected to remain firm in the medium term on account of revival in demand. On the other hand, polyester prices are likely to remain soft in the medium term. Polyester can be blended along with wool in worsted fabrics and hence the price differential may impact the blending ratio. Extent of competition Worsted fabric is a high-end premium segment, catering to the quality-conscious, brandloyal customers. The domestic market is dominated by few large organised players leading to limited competition. Brand image and distribution network are key success factors for the industry. Raymond is the market leader in the premium category. Financial Risk

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3.0

Evaluation of Business risk Parameters (Total Marks 100): Wt 35% Cotton Textiles sub sector - Cotton Fabrics: The following Industry Specific Parameters are selected centrally for the purpose of scoring. Thus, during the rating process with New (CRISIL) Models a credit officer is required to evaluate these parameters based on the company specific information available and the industry specific supplementary information provided as follows:-

Sr. No

Risk Entity name

Weight ages 40% 40

Remarks

Parent - Operating efficiency 1 Availability of raw material

This external parameter is focused for critical assessment of a company to achieve minimum wastage, reasonable quality and in

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turn better sales realization. India being the third largest producer of cotton; the availability of raw material at reasonable price is abundant. 2 4 Management of price volatility Integration of Operations 20 20 Integration for the purpose of Cotton Fabrics unit may start may start from cotton yarn as the basic raw material and packaged cotton fabrics as the finished goods. Horizontal / vertical process like bleaching, dying / printing, sanforising, calendaring, finishing, packaging etc may be considered for evaluation of linkages.

5.

Employee Attrition rate

15

Parent - Market position 5 Brand Equity

60% 35 The factors to be considered for market diversification are sales spread w. r. t. exports, sales on all India basis, regional basis etc. This factor assesses the companys /groups ability to withstand aggressive pricing by market leader by price undercut. This factor assesses the quality of production achieved over a past period of 2 -3 years. The factor also calls for evaluation of quality standards achieved by the company like ISO, ISI etc as also the percentage of rejection. Composition of high value added product partially insulates the margin. Thus, presence of such products in the overall product mix is desirable.

Distribution set up

30

Consistency of Quality

20

Product Range

15

Conclusion: Demand for worsted fabric is largely derived from its use in premium suiting and shirting. It is, therefore, a niche market and is characterised by brand consciousness. Wool is the main raw material used in worsted fabric. The industry is heavily dependent upon supplies of high-quality wool imported from countries like Australia, New Zealand, etc. Raymond enjoys a dominant position in this industry.

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Traffic Signal Evaluation based on IRS: -

Industry Red Risk (IRS Range) Score 6.2 or 0% to 42.5% 62%

Yellow (IRS Range) Above 42.5% up to 75%

Green (IRS Range) Above 75%

Result

Yellow

Annexure: 6 SWOT ANALYSIS Strengths: Indian textile Industry is an Independent & Self-Reliant industry. Abundant Raw Material availability that helps industry to control costs and reduces the lead-time across the operation. Availability of Low Cost and Skilled Manpower provides competitive advantage to industry. Availability of large varieties of cotton fibre and has a fast growing synthetic fibre industry. India has great advantage in Spinning Sector and has a presence in all process of operation and value chain. India is one of the largest exporters of Yarn in international market and contributes around 25% share of the global trade in Cotton Yarn. The Apparel Industry is one of largest foreign revenue contributor and holds 12% of the countrys total export. Industry has large and diversified segments that provide wide variety of products.
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Growing Economy and Potential Domestic and International Market. Industry has Manufacturing Flexibility that helps to increase the productivity. Weaknesses: Indian Textile Industry is highly Fragmented Industry. Industry is highly dependent on Cotton. Lower Productivity in various segments. There is Declining in Mill Segment. Lack of Technological Development that affect the productivity and other activities in whole value chain. Infrastructure Bottlenecks and Efficiency such as, Transaction Time at Ports and transportation Time. Unfavorable labor Laws. Lack of Trade Membership, which restrict to tap other potential market. Lacking to generate Economies of Scale. Higher Indirect Taxes, Power and Interest Rates.

Opportunities: Growth rate of Domestic Textile Industry is 6-8% per annum. Large, Potential Domestic and International Market. Product development and Diversification to cater global needs. Elimination of Quota Restriction leads to greater Market Development. Market is gradually shifting towards Branded Readymade Garment. Increased Disposable Income and Purchasing Power of Indian Customer opens New Market Development. Emerging Retail Industry and Malls provide huge opportunities for the Apparel, Handicraft and other segments of the industry. Greater Investment and FDI opportunities are available. Threats: Competition from other developing countries, especially China. Continuous Quality Improvement is need of the hour as there are different demand patterns all over the world. Elimination of Quota system will lead to fluctuations in Export Demand. Threat for Traditional Market for Power loom and Handloom Products and forcing them for product diversification. Geographical Disadvantages. International labor and Environmental Laws. To balance the demand and supply. To make balance between price and quality.

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