India Cotton yarn stocks

We mentioned our bullishness for cotton yarn companies for 2013 few weeks back. Lot of our friends do not like anything related to textile sector because of bad past experiences, corporate governance issues with lot of promoters in this sector and fluctuation in earnings. They are right but we personally believe every sector has a day and under ownership itself will make a case of re-rating for a beaten down sector stocks with strong promoters. So, we have taken a positive view on cotton yarn companies - Bannari Amman Spinning, KPR Mill, Super Sales, Rajapalayam Mills, Vardhaman Textiles etc. for 2013. We will continue to monitor results and global raw cotton prices and see if we have got it wrong. 

Now, Why are we positive on sector. Very few analyst know that Cotton Yarn companies actually being processors of raw cotton one must first have view on global raw cotton prices. If we check recent history we have seen strong correlation of raw cotton prices in US with Indian Cotton yarn stocks. US raw cotton prices started uptrend in March 2009 from $41 to $219 in March 2011 so all cotton yarn companies stock did well from March 2009 to Oct/Nov 2010. Due to inventory reasons Cotton yarn companies peaked in Oct/Nov 2010 before actual raw cotton peak in March 2011. After this peak price of $219 in March 2011 raw cotton prices crashed all the way to $66 in Jun 2012 and are in narrow band of $66-$77 since last 6-7 months. Note even cotton yarn stocks stabilised from June 2012 and are in narrow band currently :-).Technically, We think given recent narrow band consolidation of raw cotton prices its is highly likely that they start upward pull back to around $97 from current $76.

Secondly, If we check last 2 quarterly results (Q1 FY13 and Q2 FY13) of all these companies we see that sales remained flat or grew marginally but OPM expanded dramatically to 20%+ from negative to around 5-7% YoY. We do not see major volatility currently so we think even Q3 and Q4 results could be just in line with first 2 quarters. This means all these companies may give ROE of around 20-25% for FY13 and are quoting at forward PE of 3-4 for FY13 and market cap to sales ratio around 0.4 which looks cheap to us because if raw cotton prices start rising slowly (our view) in next few months sales and earnings for FY14 may see 20-25% jump setting a stage of re-rating of whole sector.

Thirdly, Cotton yarn companies are exporting 30-40% of sales so Rupee will help them in months to come and lastly, all these companies have hidden value in wind mills though used for captive consumption. 

Disc: We have vested interest in cotton yarn stocks. We personally and our clients own KPR Mill on the day of writing  Clients also own Bannari Amman spinning on the day of writing. We personally/clients may buy and/or sell and/or trade in these stocks in future.