Stock Market

What Welspun saga tells us: cotton by any other name isn’t…

Deepak Kumar

Mumbai-based textile maker  Welspun India  lost more than a third of its market cap — about 36 percent — in two days following its US client Target Corp cancelling its contract on August 19. Its stock also fell about 20 percent, for the second day in a row, after the news broke.

This 20 percent decline in stock was its worst since January 2008.

Target alleged that Welspun had sold pillowcases and bedsheets with cheaper cotton and not with the premium Egyptian variety it was promised. Soon enough, Welspun’s other global clients, Wal-Mart, Bed Bath & Beyond and JC Penney, also launched their investigations into the textile maker’s product claims.

For Welspun, the allegation is serious: it receives 95 percent of its revenues from international clients alone, and Target is a key part of it. To get to the bottom of it, Welspun has appointed consultancy firm Ernst and Young to audit its entire supply chain. Target, its second largest client, was important for Welspun as it contributed 10 percent of the textile maker’s overall business in FY16.

Target quickly removed all of Welspun’s products from its shelves after rigorous investigations into the usage of non-Egyptian cotton came out positive. Target had been Welspun’s client for about 2 years before it cut its ties. 

Not All Is Lost
Egyptian cotton is less than 2 percent of the total world cotton output, says Arun Kejriwal, Director at Kejriwal Research and Investment. It is a type of high grade long fibre cotton. Due to a shortage of the Egyptian variety, Welspun may have used a similar high grade cotton, he says.

The markets, he says, have overreacted to the news. Welspun stock, which has been under pressure ever since the story broke, fell from a high of Rs 102.8 on August 19 to about Rs 53.8 on September 2. Its market cap on September 2 stood at Rs 5,405 crore, a drop of 47.7 percent from Rs 10,333 crore on August 19.

Things may calm down once the auditors come out with an interim report, which according to Kejriwal may take another 2-3 weeks. 

Severance Affects Both Parties
Meanwhile, Target has been reportedly looking for a replacement to Welspun. Trident, Welspun’s closest competitor, is being considered a favorite. Trident’s stock surged over 20 percent two days after Target cancelled Welspun orders.

But Kejriwal feels consignment the size of what Welspun was providing cannot be shifted to another manufacturer — so soon. It sounds far-fetched.

“Even if the company has idle capacity, getting designs ready and samples made takes a lot of time,” he says. It may take over 9 months but it isn’t easy to replace Welspun so easily,” he adds. 

Severence of such a relationship affects both parties equally, says Kejriwal. 

Textile is a long delivery item. Its supply chain lasts 6-8 months. “What is sold (to the end user) in December will have to be manufactured now and shipped to the US. And no one wants to tinker with Christmas sales. So, most businesses will allow shipments to happen and not hurt business,” says Kejriwal.

The extreme step of cancelling orders is not done by everyone.  It is quite likely that other global clients who have launched a probe into Welspun’s products could pause in their tracks before they decide to pull the plug completely. 

For Welspun the loss in revenue from Target could be significant. Kejriwal forcasts the damage would be limited to a maximum of 15-20 percent of revenues in the next 2-3 quarters. The fourth quarter from now could also have some pain in relation to future orders, believe experts.

It will be a while before Welspun manages to weave itself out of the knot it finds itself in now.