Industry Risk Score. Textiles- Denim. Contents. Introduction. Punjab National Bank Punjab National Bank. June June 2016.

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1 Industry Risk Score Punjab National Bank Punjab National Bank June 2016 June 2016 Textiles- Denim Introduction Contents Industry Risk Score (IRS) reflects the impact of industry variables on the cash flows and debt repayment ability of the companies in the industry over 3-4 years. The risk score for an industry is arrived at, by aggregating the scores assigned to the parameters relevant for the industry. June 2016 Executive summary 3 Background 4 Industry parameters include variables such as demand-supply outlook, cost structures, competition and financial performance. The parameters are selected based on the extent to which they affect the debt-servicing ability of the companies operating in the industry. Scores on these parameters reflect the extent of positive/negative impact on cash flows, and the degree of variability in cash flows of the companies. The industry risk scores have been graded on a seven-point scale, with 1 indicating high risk and 7 indicating low risk. Risk score Risk factors Highly favourable Favourable Marginally favourable Neutral Marginally unfavourable Unfavourable Highly unfavourable Industry risk parameters 5 Demand-supply 5 Government policies 5 Input-related risk 5 Extent of competition 6 Financial risk 6 Annexure 7

2 TEXTILES- DENIM About CRISIL CRISIL is a global analytical company providing ratings, research, and risk and policy advisory services. We are India's leading ratings agency. We are also the foremost provider of high-end research to the world's largest banks and leading corporations. CRISIL is majority owned by S&P Global Inc., a leading provider of transparent and independent ratings, benchmarks, analytics and data to the capital and commodity markets worldwide. About Research CRISIL Research is India's largest independent integrated research house. We provide insights, opinion and analysis on the Indian economy, industry, capital markets and companies. We also conduct training programs to financial sector professionals on a wide array of technical issues. We are India's most credible provider of economy and industry research. Our industry research covers 86 sectors and is known for its rich insights and perspectives. Our analysis is supported by inputs from our network of more than 5,000 primary sources, including industry experts, industry associations and trade channels. We play a key role in India's fixed income markets. We are the largest provider of valuation of fixed income securities to the mutual fund, insurance and banking industries in the country. We are also the sole provider of debt and hybrid indices to India's mutual fund and life insurance industries. We pioneered independent equity research in India, and are today the country's largest independent equity research house. Our defining trait is the ability to convert information and data into expert judgements and forecasts with complete objectivity. We leverage our deep understanding of the macro-economy and our extensive sector coverage to provide unique insights on micro-macro and cross-sectoral linkages. Our talent pool comprises economists, sector experts, company analysts and information management specialists. CRISIL Privacy Notice CRISIL respects your privacy. We use your contact information, such as your name, address, and id, to fulfil your request and service your account and to provide you with additional information from CRISIL and other parts of S&P Global Inc. and its subsidiaries (collectively, the Company ) you may find of interest. For further information, or to let us know your preferences with respect to receiving marketing materials, please visit You can view the Company s Customer Privacy at Last updated: April 2016 Disclaimer CRISIL Research, a division of CRISIL Limited (CRISIL) has taken due care and caution in preparing this Report based on the information obtained by CRISIL from sources which it considers reliable (Data). However, CRISIL does not guarantee the accuracy, adequacy or completeness of the Data / Report and is not responsible for any errors or omissions or for the results obtained from the use of Data / Report. This Report is not a recommendation to invest / disinvest in any company covered in the Report. CRISIL especially states that it has no financial liability whatsoever to the subscribers/ users/ transmitters/ distributors of this Report. CRISIL Research operates independently of, and does not have access to information obtained by CRISIL s Ratings Division / CRISIL Risk and Infrastructure Solutions Limited (CRIS), which may, in their regular operations, obtain information of a confidential nature. The views expressed in this Report are that of CRISIL Research and not of CRISIL s Ratings Division / CRIS. No part of this Report may be published / reproduced in any form without CRISIL s prior written approval.

3 Executive summary The denim industry is more capital-intensive in nature as compared to other segments of the textile value chain, which makes it more organized and consolidated.demand for denim in the domestic market has grown at a strong pace of about 7.5 per cent CAGR in the past 5 years (2010 to 2015). This is attributed to favourable demographics of the country coupled with changing lifestyle trends. Exports of denim fabrics and jeans have grown at a robust pace of about per cent CAGR in the same period on account of a healthy demand in major export markets of India (US and EU).Main raw material for denim is cotton yarn of coarser count. Cost of raw material constitutes per cent of the sales. Profitability of denim manufacturers is affected in times of high volatility in cotton yarn prices as players have limited ability to pass on the increase in raw material prices. Large integrated players, which have in-house spinning capacities, are able to reduce this risk. Parameter Weightage Score Textiles- Denim: Industry risk score 3.41 Industry characteristics Demand-supply gap Government policy Input-related risk Extent of competition Industry financials Operating margin of industry RoCE of industry Source: CRISIL Research 1

4 TEXTILES- DENIM Background Denim is a fashion-oriented product and is used mainly in jeans and jackets. Being a fashion driven product, the industry is susceptible to fashion cycles.being highly capital-intensive in nature, denim fabric industry is fairly organized. There are close to 35 denim manufacturers in India which together produce about 1200 million meters per annum.cotton yarn (of coarser counts) is the key raw material used for manufacturing denim fabrics. As cotton is a seasonal commodity and is dependent on the vagaries of the monsoons, timing its procurement is critical for industry players.exports account for about 30 per cent of the production of the industry. Direct export of denim contributes about 15 per cent of the overall demand, while derived demand constitutes the rest. As India has surplus availability of cotton, it enjoys a cost advantage to other countries such as Turkey and Indonesia in export markets. The competitor countries have to import cotton which increases their cost of production. 2

5 Industry risk parameters Demand - Supply Denim is one of the fastest growing products among textile product basket. Favourable demographics, rapidly increasing per capita income, changing lifestyle trends and increasing brand consciousness are some of the factors that are driving the demand of denim in the country. Over the past 2-3 years, the industry increased its capacity by about 300 million meters on anticipation of robust demand. As slowdown in demand coincided with sharp increase in capacities, players started suffering with fall in utilisation rates.in , we demand for denim is estimated to have remained stable. While, export demand is expected to moderate on account of decline in demand from Europe, domestic demand is expected to improve on better economic environment.over the next 2-3 years, despite improvement in denim demand, we expect the oversupply situation in the industry to continue, as about 100 million meters of capacity will come onstream during this period. Government policies The government policies have been largely supportive of the growth in the textiles industry given its potential for employment generation.schemes like Technology Up Gradation Fund Scheme (TUFS) have significantly reduced capital costs for the industry with government providing capital as well as interest subsidy. Some of the state governments (Gujarat, Maharashtra, MP, Rajasthan and West Bengal etc.) have come up with their own textile policies over and above TUFS. Gujarat government provides an interest subsidy of 5 per cent (over and above TUFS subsidy) coupled with the training support for power loom sector. Maharashtra government provides a maximum interest subsidy of 7 per cent.however, Amended-TUFS (notified in January 2016) removed interest subsidy for capital investments and placed a cap on capital subsidy at a maximum of Rs 300 million. As a result, A-TUFS will largely benefit small and medium investment projects (upto Rs 2 billion) and will be unattractive for larger players Input - related risk Cotton yarn, the main raw material used, typically accounts for per cent of the industry`s sales. Volatility in cotton / cotton yarn prices influences the margins of denim fabric producers. Being a commoditised product, manufacturers find it difficult to completely pass on the increase in raw material prices.after increasing by about 44 per cent in , cotton yarn prices declined in However, after increasing in the next two financial years ( and ) prices fell by about 9 per cent in on account of slowdown in demand for yarn (primarily due to a decline in cotton yarn exports during the year). Over the medium term as well, cotton yarn prices are expected to trade lower than the levels seen in (where prices averaged Rs 215 per kg). Lower prices will slightly improve players' pricing flexibility going ahead.however, inability of players to pass-on the increase in raw material price in times of high volatility is a risk for the industry. 3

6 TEXTILES- DENIM Extent of Competition Being highly asset-intensive in nature, the denim is a fairly organized industry. There are around 30 denim fabric mills in India. The extent of competition, therefore, is low as compared to the other parts of the textile chain. Although, relatively consolidated, the industry faces stiff price competition due to the commoditised nature of the product.a large part of the denim that is produced by the industry comes under basic segment, where-in the scope for product differentiation is limited. Therefore, the players operating in this segment have limited pricing flexibility.companies which are able to offer products with innovative designs and features (such as mixing cotton yarn with lycra while making denim fabric) command higher realizations in the domestic market. But, due to global linkages in the export market, the pricing power remains limited. Financial Risk Textiles- Denim: Financial parameters Select Financial parameters Unit Mar-09 Mar-10 Mar-11 Mar-12 Mar-13 Mar-14 Mar-15 Aggregate turnover Rs million Operating profit margin Per cent Return on capital employed Per cent Net profit margin Per cent Return on equity Per cent Interest coverage ratio Times Debt-equity ratio Times Current ratio Times Assets turnover ratio Times Raw materials days Days WIP holding days Days Finished goods days Days Debtors days Days Creditors days Days Nos. of companies No Source: CRISIL Research Textiles- Denim: Cost aggregates Cost Structure (% of net Sales) Unit Mar-09 Mar-10 Mar-11 Mar-12 Mar-13 Mar-14 Mar-15 Raw material cost Per cent Power and fuel cost Per cent Other operating costs Per cent Employee cost Per cent Selling cost Per cent Nos. of companies No Source: CRISIL Research 4

7 Annexure Companies used for calculating sector aggregates Aarvee Denims & Exports Ltd.,Arvind Ltd.,Ashima Ltd.,Blue Blends (India) Ltd.,K G Denim Ltd.,Rainbow Denim Ltd.,Suryalakshmi Cotton Mills Ltd.,Nandan Denim Ltd. These companies represent around 50 per cent of the industry's turnover Textiles- Denim - Sector Aggregate - Interim results % of % of % of % of Oct-Dec Oct-Dec Apr-Dec Apr-Dec (Figures in Rs Million) net net net net Sales Sales Sales Sales Net sales % % % % Total Operating exp % % % % Raw Material exp % % % % Purchase of Finished goods % % % % Change in stock % % % % Salaries and wages % % % % Power & Fuel % % % % Rent & lease rent 0 0 % 0 0 % 0 0 % 0 0 % Selling & distribution expenses % % % % Other expenses % % % % OPBDIT % % % % Depreciation % % % % OPBIT % % % % Interest % % % % OPBT % % % % Other Income % % % % Non-op Income 0 0 % 0 0 % 0 0 % % Extraordinary Income/Expenses % % % % PBT % % % % Total Tax % % % % Current tax % % % % Deferred tax % % % % FBT 0 0 % 0 0 % 0 0 % 0 0 % Net profit % % % % Nos. of companies Companies included in interim sector aggregate Aarvee Denims & Exports Ltd.; Arvind Ltd.; Ashima Ltd.; Blue Blends (India) Ltd.; K G Denim Ltd.; Nandan Denim Ltd.; Rainbow Denim Ltd.; Suryalakshmi Cotton Mills Ltd. 5

8 TEXTILES- DENIM Textiles- Denim - Business risk evaluation Risk entity name Weightages Operating Efficiency 70 Capacity Utilization 25 Denim is a capital intensive industry, with a higher share of fixed cost (interest and depreciation constitute over 10 per cent of revenues). Low capacity utilization increases the fixed cost per unit sold and impacts profitability directly (asset turnover ratio of about 1.1). Availiability of Raw Materials 20 Denim manufacturers use cotton as raw material. Being an agri-commodity, the supply of cotton fluctuates from time to time. Its unavailability causes companies to operate at lower utilization levels, thereby impacting their competitiveness. Management of Price Volatility 30 Denim realizations tend to be volatile because of global linkages in the industry. Players also face risk of currency fluctuation due to about 30 per cent share of exports. Managing price volatility determines competitiveness of companies within the industry. They are also subjected to vagaries of cotton prices. Integration of Operations 25 Integration of operations, from spinning to garmenting (jeans products), reduces impact of volatility in prices and creates synergies. Consequently, the margins become less volatile as compared to a standalone denim manufacturing company. Market Position 30 Diversified Markets 30 Market diversification in the denim industry plays an important role. Companies, having an appropriate mix in terms of domestic and exports' share in revenues, are able to manage risks better. Export contribute around one third of the total production. Also, within the export markets, excessive reliance on few big markets (Bangladesh, Turkey and Sri Lanka) exposes companies to demand shocks in th Long Term Contracts / Assured Offtake 25 Denim manufacturers tend to get affected by an oversupply, during bouts of capacity additions. Having assurance of sales, during such times, reduces the business risk of any company Distribution Setup 20 Denim companies with a wide distribution set up tend to be face lower risks, as demand shocks arising from few customers does not impact them significantly. Financial Ability to Withstand Price Competition 25 The denim industry is characterized by high competition, in both domestic as well as international markets. Increase in raw material prices during phases of low demand tend to lower profitability of players. Companies with the ability to absorb price competition would be better placed to survive downturns. Source: CRISIL Research 6

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