industry

Apparel industry to close FY20 with muted sales growth and moderation in profitability: ICRA


The rapid spread of the Covid-19 pandemic across countries, including India, has not spared India’s apparel sector either, adding to the woes of the players who have already experienced a rather challenging fiscal 2020.

Amid a subdued demand scenario in the domestic as well as the international markets, intensifying competition and lags witnessed in the clearance of export incentives, most players across the sector are expected to close FY20 with muted sales growth and moderation in profitability and liquidity. ICRA expects revenues of the Indian apparel players to fall by at least 10%-15% across the sector in FY21, following the Covid-19 impact on operations.

Commenting on this, Mr. Jayanta Roy, Senior Vice-President and Group Head, Corporate Sector Ratings, ICRA, said: “With the 21-day domestic lockdown announced by the Government of India from March 25, 2020 onwards to combat the spread of the virus, domestic apparel sales have come to a complete halt. Further, seven of India’s top apparel export destinations, which account for nearly half of India’s total apparel exports, are among the worst affected regions globally. With most of these regions resorting to lockdowns and social distancing, export demand for apparels has also fallen significantly.”

There are reports of international buyers deferring shipments and cancelling orders, till further notice. As a result, the domestic apparel sector is witnessing significant turbulence and the ongoing Spring-Summer Season 2020 is likely to suffer a major setback. On the supply side as well, social distancing and lockdowns have disrupted production in recent weeks, given the non-essential and labour-intensive nature of operations. This apart, logistical issues are now affecting shipment of material ready for dispatch.

Although companies are likely to undertake some cost rationalisation measures such as employee base optimisation, pay cuts, promotional budget cuts and rental renegotiations, ICRA expects high operating leverage, discounted sales to clear inventory backlog and bad debts to result in a shrinkage of their profit margins. ICRA also expects an increase in the receivable turnover period as well as inventory pile-ups because of market lockdowns.

Additionally, order cancellations and a prolonged impact of Covid-19 beyond the running season could result in inventory obsolescence, necessitating write-offs and discounted sales. Most of the work-in-process and finished goods inventories with the domestic players at present would be for the Spring-Summer Season 2020.

While the companies are negotiating with the customers on a likely delivery schedule and not all orders are likely to get affected, the extent of the impact will depend on the developments on the Covid-19 front, and its economic impact on the companies across regions. Having said that, these factors are likely to add to the liquidity pressures for companies in the near term. As a result, the cushion in drawing power and working capital limits is going to be crucial.

Because of the liquidity pressures in the near term, apparel entities are expected to rely on increased borrowings to tide over immediate liquidity pressures. Together with pressure on revenues and profits, these are likely to translate into moderation in debt coverage metrics. In this context, RBI announced a relief package on March 27, 2020 to ensure continuity of viable businesses. Besides others, these included allowing lenders to extend three-month moratorium on payment of term loan instalments and interest on working capital to entities, and recalculate drawing power by reducing the margins and/or by reassessing the working capital cycle.

“With respect to liquidity, ICRA notes that the RBI’s announcements dated March 27, 2020, are likely to provide some much-needed cushion to the companies. These steps will also give some time to companies to plan and react to the recent developments as well as recover from the immediate impact. However, ICRA expects the immediate impact of Covid-19 to be Negative on the sector. The timing and extent of the recovery are uncertain as of now and will remain a key monitorable for the sector,” Mr Roy added.

The immediate impact aside, even after the spread of the virus is contained, ICRA expects a prolonged impact on the sector, with recovery likely to be gradual over several months. On the demand side, consumer skepticism to visit crowded places initially could keep footfalls subdued in offline retail, even after the lockdown ends. Also, overall pressure on corporate performance, which could trigger further job losses and pay cuts across sectors, as well as the overall stress in the economy are likely to affect buying power, which would affect discretionary consumer spending in the near term, resulting in the deferment of purchases, thus affecting demand for the segment.

Similar to the consumer-side concerns, worker skepticism to return to jobs could play out on the supply side. Moreover, disintegration of labour, particularly the unskilled and contractual labour, who have started moving from production hubs to their hometowns and villages, could result in a prolonged disruption on the supply side, even after the operations resume. This apart, liquidity issues at the manufacturer level are expected to affect their ability to ramp up production for the subsequent seasons. Further, for an effective pick-up, the recovery has to be broad-based across countries, from the demand as well as the supply perspective, given the trade linkages. Having said that, ICRA expects the impact on credit profiles to vary across companies, depending on several factors such as balance sheet strength, liquidity and financial flexibility, which would warrant a case-by-case assessment.

In this context, ICRA notes that operations of apparel entities are primarily working capital intensive and typically require low fixed capital investments. Accordingly, reliance of these entities on term borrowings is generally seen to be lower, which provides some cushion on their balance sheet to absorb the impact.

“Notwithstanding the impact expected on the sector’s performance in the near term, ICRA expects limited reliance on term borrowings and RBI’s recent initiatives to cushion the impact on the sector.”, concluded Mr. Roy.





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