The Hindu Business Line : Precot Mills: Hold

AT Rs 310, the Precot Mills stock trades at about 11 times its trailing four quarters' per-share earnings. The Coimbatore-based yarn maker has benefited from rock-bottom cotton prices over the past year, as have most of its peers. Prices of cotton have, however, risen from their lows. A further rise in price can affect the earnings of the company, which derives 85 per cent of its revenues from cotton yarn. Expansion in capacities, however, provides some room for upside in revenues in the near term, while a shift towards value-added segments may ease the pressure on margins. Shareholders can, therefore, hold on to the stock. At about Rs 250 crore, Precot Mills is a mid-size player in the textile space. Like several spinning companies have done in recent years, Precot Mills has tried to forward integrate by setting up weaving and yarn-dyeing plants. Its weaving plant makes fabrics for men's shirts and is a supplier to prominent garment manufacturers such as Madura Garments and Celebrity Fashions. This unit, accounting for about 10 per cent of the total business as of FY05,is yet to make a significant contribution to the revenues. A greater contribution from yarn dyeing and fabric would improve margins, as they are higher up in the value-chain. Precot is increasing its focus on these segments. A Rs 90-crore expansion plan is underway, which would enhance its fabric and yarn-dyeing capacity by about 40 per cent.

The fresh capacities are likely to begin contributing to revenues from the second and third quarter of FY07. It is also expanding its spinning business accordingly to accommodate its internal demand. About Rs 30 crore would be invested in setting up a garment plant with an annual capacity of four-million tonnes, which would be doubled in the second phase of expansion. The facility would go on stream in September 2006. Export houses that are strained for capacity are outsourcing some of their production to domestic players capable of offering quality. Precot Mills should, however, be able to consistently deliver on time, meet quality standards and be adept at tuning to fashion. Several traditional textile companies are entering the garments business. It is early days to evaluate how well they measure up against pure-play garment manufacturers.

Meanwhile, Precot is trying to improve realisations for its yarn. While depressed cotton prices have enhanced margins and profits, a poor export market and low realisations have kept revenues flat. The company has converted its export-oriented unit into a domestic tariff area to capitalise on the better realisations in India. A shift towards compact spinning and targeting corporate customers are also factors that could improve the prices for its yarn.

If cotton prices rise, it could prove to be a major dampener. Prices are right now stable, except for some varieties of cotton, which have already begun to rise. India's production is expected to be on par with that of last year. Consumption too is on the rise, as spinning mills expand capacity. US subsidies to cotton farmers is expected to end in July, which could push prices up further.

If India diverts it bumper crop towards exports, a shortage in supply could drive up domestic prices. Precot's ability to ramp up revenues from its other businesses would help protect its margins to some extent.

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