KARACHI: Lower cotton output this year could result into a decline of around 100 to 200 basis points in margins of the textile manufacturers of the country.
Textile companies enjoyed fiscal year 2005 as a year of strong profitability growth by virtue of sharp increase in gross margins following the 26 percent decline in cotton procurement cost due to the bumper cotton crop of 14.6 million bales last year.
Apart from soft cotton prices, another boon for the textile sector during fiscal year 2005 was the relatively firm price trend of yarn and fabrics. Against a 26 percent decline in cotton costs, yarn prices were 14 percent lower year-on-year from July 2004 to June 2005.
The government had set an initial cotton output target of 15 million bales for fiscal year 2006. This target has recently been revised downward to 12.5 million bales.
We estimate cotton production to be around 13 million bales, said Faraz Farooq, an analyst at Jahangir Siddiqui Capital Markets Limited.
Cotton output is forecast to be on the lower side compared to previous year's bumper crop due to crop damages caused by floods, rains and pest attack. On the other hand, being stimulated by the opportunities of World Trade Organization (WTO) regime, textile industries have invested heavily in expansion and Balancing, Modernization and Replacement (BMR) activities. Thus, cotton consumption continues to increase in response to strong export and domestic demand.
As expected according to a recent report of the Pakistan Cotton Ginner s Association (PCGA), cotton arrival as of November 1 were down by 24.3 percent from 6.26 million bales last year to 4.74 million bales, which could be attributed to above normal winter and spring rains and floods, which collectively increased surface and ground water. Unusual rains in September resulted in attacks of pest while floods during the month of October slowed down the harvesting process.
This year Punjab's contribution dropped from 77 percent to 70 percent since a total of 3.34 million bales arrived from Punjab, down by 45 percent from last year s figure of 4.83 million bales.
This is because of flooding in Punjab, which not only damaged but also delayed the crop arrival. In Sindh, the production till the beginning of November 2005 was recorded at 1.40 million bales as against 1.43 million bales last year, showing a marginal decline of two percent.
With the declined output and increased demand during the current fiscal year cotton prices will go up. With average cotton to fibre blending ratio of 81:19, cotton price is by far the most important earnings driver for the textile sector. Cotton costs make up for nearly 50 percent to 70 percent of the total manufacturing costs and its price has a major impact on textile companies margins.
Average mill procurement cotton costs may range between Rs 2,300 per maund and Rs 2,500 per maund. This hike in raw material cost will squeeze margins of textile companies by about 100 bases points to 200 basis points.
Mr Farooq said textile exports were up by 13 percent to $6.3 billion in the first nine months of the calendar year after the elimination of quotas. Textile exports are expected to rise further on the back of higher export opportunities ensuing from greater market access amid restrictions imposed on Chinese textile products by the United States.
Moreover, European Commission has agreed to allow 20 percent concession in customs duty to Pakistani textile products effective from January 2006. However, higher interest rates would hit the profitability of the textile firms, because textile companies have borrowed huge amounts to finance expansions and BMR activities.
