INDIA RATINGS: High Global Inventory Pressures Edible Oil, Cotton Players

Mumbai, January 25, 2013: India Ratings has maintained a negative outlook for the Indian edible oil and cotton sectors for 2013. This is driven by increased margins pressures exerted by the global inventory buildup of these agricultural commodities.
Favourable weather conditions caused palm oil production to significantly outstrip muted global demand in the 2011-2012 palm season (November-October). As a result, inventory surged, with the current global stock as a proportion of usage estimated to be at a six-year high. Global palm oil prices have fallen in the range of 25%-28% (USD terms) over the last 12 months, with Indian prices mirroring a similar trend with a lag. Regulatory interventions by major palm oil exporting nations are unlikely to address the price pressure, if global demand does not pick up.
The existing palm oil refiners are likely to focus more on trading operations at the expense of refining operations. This is because falling palm oil prices and imposition of domestic import tax are likely to reduce the viability of domestic palm oil refining operations post import. An increase in focus on palm oil trading, which is a low-margin business, may result in margin pressures. However, companies with increased control over suppliers extending to the plantation level would be able to offset this risk to a limited extent. While high trading activity may potentially reduce working capital requirements, low trading margin would more than offset any positive impact on financial leverage.
India Ratings expects domestic cotton prices to stabilise at the current low levels or decline by 5%-10%. The current global cotton inventory is at a multi-decade high, with stocks to usage ratio estimated to be at 71% (source: USDA). Around 50% of this global inventory is in China. The way the Chinese policy makers decide to handle the close to 9mt cotton inventory is the single largest event risk in the world cotton market. Additionally, global production levels staying significantly above the current global cotton consumption levels may pull cotton prices down.
The credit profile of major cotton traders would be driven by their ability to handle inventory. To the extent traders keep their inventory days low by entering into back-to-back contracts with producers and consumers, they would remain less affected by any significant downside in cotton prices. However, margin pressures are likely to continue for such players.
The outlook for the edible oils and cotton sectors could be revised to stable in the event of a revival of global consumption demand would reduce the current global inventory glut causing the prices of such agricultural commodities to recover. However, this is unlikely to happen in the next 12 months.