MOSL: INDO COUNT INDUSTRIES (Neutral)-Multiple headwinds hurting margins

Indo Count Industries: Multiple headwinds hurting margins; But capacity ready to capitalize on business environment turnaround

(ICNT IN, Mkt Cap USD0.4b, CMP INR118, TP INR128, 9% Upside, Neutral)

We recently hosted Indo Count Industries’ (ICNT) management at our ‘Midcap Conference,’ wherein we gained detailed insights into how the overall textiles business environment is shaping up post a muted 1HFY18. We note that the first half of the current fiscal for textiles was plagued by multiple headwinds – from sharply higher raw material prices, to a reduction in duty drawback and ROSL rates. However, encouragingly, cotton prices have started correcting this quarter, partly easing pressure on margins.

-ICNT's margins contracted significantly by 645bp YoY to 15% in 1HFY18, led by multiple factors:

oHigher raw material prices: ICNT reported a 64bp YoY rise in raw material prices in 1HFY18 (+260bp in 2QFY18), as cotton prices increased sharply to INR42,000 per candy. However, prices have corrected back to INR38,000 per candy, backed by an improvement in cotton acreage.

oIncrease in fuel and job work charges: Other expenses increased by 485bp YoY in 1HFY18, mainly driven by higher power, fuel and job work charges.

oOne-offs: The company suffered from GST-transition related issues (impact of ~INR60m) in 1HFY18. INCT also reported an MTM loss of INR140m during the same period, which impacted profitability.

-Partial relief on incentive front: With effect from 1st October 2017, the Indian government had modified the incentive rate structure, with the duty drawback rate reduced from 7.5% to 2%, and the ROSL from 3.9% to 1.55%. However, in the most recent announcement, the government has increased the MEIS rate from 2% to 4%, and the ROSL rate for cotton garments has been set at 1.7%. The earlier announcement was expected to erode margins by ~250bp, but the latest revision should lower the impact to ~100bp.