Exit textile stocks before the gains unravel

On December 8, 2015, in the same column, we had recommended the textile stocks (Textile stocks can stitch big gains on yuan, oil). We had explained how the domestic textile industry could benefit from the fall of oil price and rupee exchange rate in relation to Chinese yuan. Since then, while the Sensex has moved up by 10%, many textile stocks have gone up by anywhere from 24% to 100%, well beyond our expectations.

Unfortunately, cotton, a key input, has seen over 40% rise in its price since December 2015. In the last 2 months alone, cotton prices have moved up by about 35%. Most textile firms use synthetic fibre also as the key input along with cotton. Since December 2015, the crude oil price has moved up by about 10%. In fact, from 12-year record low in January 2016, the oil price has moved up by over 57% now. The inputs of synthetic textiles are largely derived from the crude oil. Hence, such a robust rise in the prices of oil and cotton is likely to impact adversely the margins of the textile industry in the short-term. While cotton yarn and synthetic fibre manufacturers are likely to be directly impacted by the rise in input prices, even the final textile product manufacturers are likely to feel the margin pressures due to overall vertical shift in the production costs.

Moreover, the investors need to understand the distinction between wealth creation from the cyclical industries and non-cyclical or growth industries. Even consistently growing industries (like fast-moving consumer goods, information technology, etc,) go through a lot of fluctuations in their market caps due to cyclical nature of both the equity markets and the economies. However, such businesses run by good managements with strong balance-sheets, do come back to the growth path in their market caps sooner or later.

But in industries like textiles and commodities, the fluctuations in the market caps become much wider due to cyclical nature of their businesses in addition to the market and economic cycles. The interplay of all three cycles, in fact, leads to even wealth destruction for the investors who enter late in such stocks. The notional wealth creation evaporates fast for those who enter early in such stocks but fail to capitalise the gains at the peak of the business cycles. Moreover, most textile stocks are part of micro cap and small segments and these two segments, by nature, have more volatility than the large benchmark indices. Hence, it would be a smart move by the retail investors to consolidate their personal wealth by realising the gains made in textile stocks.