Detailed Rationale

CRISIL Ratings has reaffirmed its 'CRISIL AA+/FAAA/Stable/CRISIL A1+' ratings on the bank loan facilities and debt instruments of Vardhman Textiles Limited (VTXL; part of the Vardhman group).

 

CRISIL Ratings has also withdrawn its rating on Non-Convertible Debentures (NCDs) of Rs 300 crore (See Annexure 'Details of Rating Withdrawn' for details) on receipt of independent confirmation of their redemption. The rating is withdrawn in line with CRISIL Ratings’ rating withdrawal policy. VTXL has outstanding NCD amount of Rs 394.8 crore as on November 18, 2021.

 

The ratings continue to reflect the strong and diversified business risk profile of the Vardhman group, especially in the textiles business, and the healthy operating capability. The ratings also factor in the strong financial risk profile and robust liquidity. These strengths are partially offset by the large working capital requirement, modest market position in the steel business and vulnerability of operating profitability to volatility in input prices.

 

On the performance front, revenue is likely to grow by 40-45% year-on-year in fiscal 2022, while the operating margin is expected to improve to 24.5% in fiscal 2022 from 15.8% in fiscal 2021, albeit over a low base, driven by revived demand. The company reported a stellar set of numbers in the first half of fiscal 2022. Operating income and margin of Rs 4,312 crore and 26.8% were reported respectively in first half of fiscal 2022 due to higher price realisations and strong recovery in demand and supply both in the domestic and international markets. Cotton yarn and fabric capacities operated at near to full capacities in the first half of this fiscal.

 

The improved performance observed in the current fiscal was post moderation in fiscal 2021. Revenue dropped slightly by 8.81% year-on-year in fiscal 2021 due to the sharp negative impact of the Covid-19 pandemic in the first quarter. However, business picked up in the second half of fiscal 2021, led by a recovery in export demand and higher realisations. Operating margin rose to 15.8% in fiscal 2021, from 14.3% in fiscal 2020, mainly due to an improvement in the second half, aided by increased cotton yarn spreads and liquidation of bulk of the high-cost inventory.

 

The steel business is likely to sustain the improvement in operating performance with recovery in demand in the automobile sector. Equity infusion from Aichi Steel Corporation (a Toyota group company and main supplier of steel to Toyota) and investments should benefit the company in the medium term. 

 

The financial risk profile of the group remains robust with healthy cash accrual and moderate debt levels. Despite increase in capex to Rs. ~2,000 crore over the next 3 years, financial profile to remain strong with modest dependence on debt and healthy cash generation. As a result, net debt to earnings, before interest, tax, depreciation and amortization (EBIDTA) which stood at 1.1 times in 2020 and improved to 0.9 times in 2021, is expected to remain below 0.5 times over medium term.

 

Liquidity too remains comfortable with cash and equivalents of over Rs 2219 crore as on September 30, 2021, at a consolidated level and unutilised bank limit of over Rs 1,700 crore (backed by drawing power). Against the same, the debt repayments are modest at Rs 465 crore this fiscal.

Analytical Approach

CRISIL Ratings has combined the business and financial risk profiles of VTXL and its subsidiaries, VMT Spinning Co Ltd (VMT Spinning), Vardhman Acrylics Ltd (Vardhman Acrylics) and Vardhman Nisshinbo Garments Co Ltd (VNGCL). This is because all the entities, collectively referred to as the Vardhman group, are in the textile business, with an integrated treasury and strong intra-group operational linkages, including procurement of cotton. The business and financial risk profiles of VTXL’s subsidiary, VTL Investments Ltd and VTXL’s associate, Vardhman Special Steels Ltd (VSSL) have also been combined because of history of support from the group and demonstrated track record. The business and financial risk profiles of Vardhman Yarns and Threads Ltd (VYTL) have not been included since fiscal 2017, as VTXL has divested most of its stake in VYTL, and is now a minority shareholder.

 

Please refer Annexure - List of entities consolidated, which captures the list of entities considered and their analytical treatment of consolidation.

Key Rating Drivers & Detailed Description

Strengths:

• Strong, diversified business risk profile, especially in the textiles business:

The Vardhman group is present across the yarn, fabric and steel segments, which accounted for 57%, 25% and 13% of revenue, respectively, in fiscal 2021, Though the group is a small player in the steel business, it has a strong market position in the cotton yarn and fabrics segment, on the back of large capacity and established relationships with leading global apparel manufacturers (over 600 clients). It is one of the largest spinners in the domestic market, with an installed capacity of 12 lakh spindles, accounting for 2% of the total installed spindles in India. Additional capacities of around 97,000 spindles to be added by fiscal 2023, and 1,30,000 spindles by fiscal 2024, should help the healthy growth momentum sustain in the medium term.

The group is also among the top three woven fabric manufacturers in India, with grey and processed fabric capacity of 1,550 looms and 170 million meter per annum (mmpa), respectively. It is an approved supplier to large retailers such as Wal-Mart (rated 'AA/Stable/A-1+' by S&P Global Ratings), GAP (rated 'BB-/Negative' by S&P Global Ratings), Hennes & Mauritz, and Aditya Birla Fashion & Retail Ltd ('CRISIL AA/Stable/CRISIL A1+'). The group is also one of the largest players in the domestic acrylic fibre market (3% of revenue), with capacity of 20,000 tonne per annum (tpa). The capacity expansion at Madhya Pradesh will augment presence in the textile sector.

 

• Healthy operating capability:

Strong business position in the textiles business is reinforced by healthy operating capability. The group has continuously invested towards enhancing its spinning productivity. Being one of the largest consumers of raw cotton in the country, procuring over 15 lakh bales per annum, the group enjoys a preferred-buyer status and considerable pricing benefits. Cotton yarn spreads have grown by 20-25% to reach a five-year high of Rs 125-130 /kg this fiscal, buoyed by revived global and domestic demand, restricted cotton supply from China due to the US ban, and lower cost of inventory. This has resulted in operating margin to improve to 26.8% in H1 of fiscal 2022. However, these spreads are likely to normalise in near to medium term and operating margin is expected to remain in the range of 18-20%.

 

• Strong financial risk profile:

Net cash accrual is expected to improve to nearly Rs 1,800 crore in fiscal 2022, led by improved operating profitability. Capex of around Rs 2,000 crore, to be incurred over the next 3 years, will be partially debt funded. As a result, debt is expected to increase from Rs 1,685 crore currently, to nearly Rs 1,800 crore in fiscals 2022 and 2023. Better profitability and prudent debt funding will aid debt metrics. However, any sharp increase in short-term debt for stocking of cotton is a monitorable.

 

Debt/EBITDA is expected to be lower at 0.77 time in fiscal 2022, as compared to 2.14 times in fiscal 2021, aided by lower debt and higher operating margin. The ratio is expected to increase to 0.9 time in fiscal 2023, due to increased debt and moderation in operating profit.

 

Weaknesses:

• Vulnerability of operating profitability to volatility in input prices:

The group remains susceptible to volatility in prices of key raw materials, cotton (which accounts for half the cost of yarn) and steel. Cotton prices are exposed to risks such as unfavourable monsoon or pest attacks, and are linked to the international demand/supply scenario. Though the group benefits from VTXL's large procurement and adequate risk management systems, profitability remains susceptible to volatility in raw material prices. Operating margin has thus ranged between 13.9% and 23.9% in the past decade and was adversely affected during fiscals 2020, 2018, 2015 and 2012, when profitability was hit by the slowdown in demand from China, and government interventions. Similarly, in the steel business, operating margin depends on prices of raw materials such as sponge iron, manganese and nickel.

 

• Large working capital requirement:

As cotton is a seasonal crop, its availability and quality is generally an issue post the cotton season. Driven by its commitment to deliver quality products, the group procures cotton during the season and maintains large inventory at the end of the fiscal. Inventory levels fall by September as the stock is consumed in the first half of the fiscal. They start increasing once the cotton season begins from October, and remain high in March. VTXL has receivables averaging 46 days (though they were higher at 63 days as on March 31, 2021, amidst the Covid-19 pandemic). Against this, the group had payables of about 31 days. Gross current assets were thus high at 230 days as on March 31, 2020 and 276 days as on March 31, 2021 (against an average of 200 days for the five fiscals prior to March 2021). In the steel business, dependence on the automotive industry resulted in sizeable working capital requirement, with receivables of 85 days and inventory of 87 days as on March 31, 2021.

 

• Modest market position in the steel business

Through VSSL, the group has a relatively smaller presence in the steel business. As it derives over 85% of revenue from the automotive sector, it remains vulnerable to cyclicality in the automotive segment. Better utilisation and focus on cost optimisation has ensured steady performance, also reflected in the operating margin rising to 12% in fiscal 2021, from 2.4% in fiscal 2015.  However, competition from several unorganised players limits the pricing power.

Liquidity: Strong

Liquidity is driven by cash and equivalents of over Rs 2,219 crore at a consolidated level in September 2021, and unutilised limit of over Rs 1,700 crore backed by drawing power. Long-term debt of around Rs 300 crore per annum over the medium term, will be serviced via internal accrual. Moderate capex in fiscal 2022 is likely to be met via marginal debt, internal accrual and existing liquidity.

Outlook: Stable

CRISIL Ratings believes the Vardhman group will sustain the healthy credit risk profile, backed by its strong market position in the textiles business, diversified product portfolio and strong liquidity.

Rating Sensitivity factors

Upward factors:

• Substantial ramp up in scale and market share, driven by product diversity, along with steady operating margin of over 18%
• Debt-to-EBITDA ratio declining below 1.0x on a steady-state basis
• Healthy liquidity surplus of at least Rs 800 crore

 

Downward factors:

• Net debt-to-EBITDA ratio exceeding 1.2x times on a sustained basis in fiscal 2022, due to larger-than-expected capex, stretch in the working capital cycle or a sharp decline in EBITDA
• Sizeable reduction in liquidity due to buyback of shares, more-than-expected dividend payout, and additional capex.

About the Group

The Vardhman group, headed by Mr S P Oswal, is one of the leading textile groups in India, with operations across the yarn, fabric, sewing threads, fibre, special alloys, and garment sectors. In fiscal 2018, the yarn business accounted for 58% of the consolidated operating income, followed by the fabric and steel alloy segments (28% and 9%, respectively), and the acrylic fibres and garments business forming the remainder. The group has 18 production plants in Punjab, Madhya Pradesh, Gujarat and Himachal Pradesh.

 

VSSL produces special and alloy steels, and has capacity of 200,000 tpa of steel billets and 180,000 tpa of steel rolled products. VMT Spinning produces cotton yarn, and has 45,120 spindles. Vardhman Acrylics manufactures acrylic fibre, and has capacity of 20,000 tpa. VNGCL produces garments, and has capacity to manufacture 18 lakh shirts annually. Presently VTXL is in the process of merging VMT spinning and VNGCL with itself.

 

For the six months ending September 30, 2021, VTXL posted revenue of Rs 4,312 crore and operating profit of Rs 1156 crore, as against Rs 2443 crore and Rs 143 crore, respectively, for the corresponding period of the previous fiscal.

Any other information: Not applicable