Ambika Cotton is engaged in the production of specialty cotton yarn which is used in the manufacturing of premium quality shirts and t-shirts. While yarn manufacturing is a commodity business, Ambika has managed to carve out a profitable niche for themselves. Consistent with the commodity nature of the business, most other companies’ margins fluctuate with the raw materials. Also, as we will see the spinning sector is characterized by over-investments during the recovery cycle, which leads to overcapacity and depressed pricing thereafter during the downturn. We will also see how in this industry Ambika has stood apart from the bunch and differentiated itself. There are two aspects to the performance of Ambika – relentless focus on the quality of the product and a conservative and ethical management with capital allocation skills which are sorely lacking in most.
The picture below demonstrates the value chain for garments manufacturing. Ambika Cotton is currently engaged in the step 2 of the value chain – spinning/ twisting for production of cotton yarn and to a limited extent in stage 3 as well.
The apparel industry has evolved over the years in such a way that most of the power is concentrated in the hands of retailers and marketers at the end of the value chain. While a few companies have managed to carve a niche for themselves in the intermediate stages as well. But in general, the intermediate stages are commoditized with little value addition and hence little bargaining power. This is explained for the high-quality cotton value chain in the excerpt below from the article – “Peru in the High-Quality Cotton Textile and Apparel Global Value Chain”.
The apparel industry is the quintessential example of a buyer-driven value chain marked by power asymmetries between the suppliers and global buyers of final apparel products. This is also true of the high-quality cotton market segment, particularly where high quality cotton is being used for mass-market brands. Unlike producer-driven chains, where profits come from scale, volume and technological advances, profits in the buyer-driven apparel global value chain (GVC) come from combinations of high-value research, design, sales, marketing, and financial services that allow the retailers, designers and marketers to act as strategic brokers in linking overseas factories and traders with their main consumer markets. The companies that develop and sell brand-name products thus have considerable control over how, when, and where manufacturing will take place, and how much profit accrues at each stage, essentially controlling how basic value-adding activities are distributed along the value chain. This has resulted in the restructuring of the global industry and the relocation of a great deal of T&A production to low cost locations around the world, forcing many higher cost countries out of the industry. Lead firms include retailers and brand owners that are typically headquartered in the leading markets—Europe and the US.
Ambika occupies an unwanted space in this value chain. But as mentioned above they have managed to turn this unwanted space into a profitable niche for themselves.
Raw Material (Cotton Fibre)
It all starts with cotton crop. Now, cotton has been around for a very long time. Earliest evidence of domesticated cotton crop comes from Mexico and Indus Valley Civilization way back from 5,000-6,000 BC. Isn’t that astonishing? Now that we are talking history let me digress and give a little more personal historical perspective for all of us Indians. Cotton, unbeknownst to many of us played an important role not only in the colonization of India but in the ensuing freedom struggle as well.
Production and use of cotton fabric was quite common in India in 17th Century. While the Europeans at this time had still not discovered cotton fabric. Most of the Europeans up until this time were using linen or woolen fabrics. When the cotton was first imported in Europe, Europeans were impressed with the new material. Europeans found it difficult to believe that the cloth could grow on trees since they were exposed to wool which is derived from animals such as sheep. Many Europeans initially believed that in India the cotton producing sheep grow on trees!! I’m not kidding, please see below a figure with artistic impression of what such a tree looks like.
Cotton, imported from India was introduced in the UK by East India Company (EIC). In fact, the cotton fabric became very popular in Europe especially among fashion conscious women. Cotton’s popularity was such that it overtook spice as the biggest traded item by value for EIC by late 17th century. This is sighted by many historians as one of the reasons why EIC colonized India, to get control of this precious commodity. Most of the Cotton was diverted to UK to be used as a raw material for production of cloth in their factories, leaving precious little for the domestic market. This destroyed the local cotton industry including the small artisans. By 1830, India was totally incapable of exporting the cloth. The British destroyed all Indian spinning wheels and arrested anyone who tried to make their own cloth. As an act of resistance, Gandhi kept his spinning wheel, made his own clothes, and refused to buy British cloth. I’m sure we have all seen the iconic photographs of Gandhi with his spinning wheel.
Moving on, lets briefly understand the value chain of the cotton industry. So, after harvesting cotton from the plant, the next step for cotton is the ginning factory whose purpose is to remove the impurities like seeds, leaves and other waste material from cotton. The ginning factory produces pure cotton in the form of cotton bales which then move to the spinning factory for further processing and conversion to yarn. Each bale of cotton is like a rectangular slab which weighs ~480 lbs. These bales of cotton are sent to the spinning factory which converts them into yarn. And this is what Ambika specializes in.
However, not all yarn is created equal and neither is all the cotton. The length of the fibers of the fluffy bud of the cotton plant determine the quality of the cotton. Ambika Cotton uses the highest quality of cotton – known as Extra Long Staple (ELS) cotton, as the raw material. A generic ELS cotton fiber has a length of ~ 1 ⅜” or longer, as opposed to Long Staple cotton which has a length range of 1 ¼” but less than 1 ⅜” and regular cotton which has a length of less than 1 ¼”. ELS cotton is among the softest and most durable of the cotton fibers. It is the fiber of choice for premium shirts and bedsheets at luxury retailers, including Brooks Brothers, Polo Ralph Lauren, Lands’ End, Uniqlo, Agave Denim, Everlane and James Perse. ELS cotton generally sells at a premium of 50-60% from the LS cotton and ~100-120% from the regular cotton.
This luxury cotton requires specific weather conditions for its growth. Major part of ELS cotton comes from the US, Egypt and China. ELS cotton production represents only 2-3% of the total cotton produced worldwide. During the 2016 season, the annual global cotton production was ~103 million bales (1 bale equals 480 lbs), while the global ELS cotton production was ~2.1 million bales only.
Cotton market – current status
Cotton, like all commodities is cyclical in nature. Its prices move in cycles as a result of the mismatch between supply and demand. There was an unusual run-up in the price of cotton during the period March 2009 – March 2011. During this period cotton prices increased from a low of 51c to a high of 229c. The unprecedented rise in the prices of cotton resulted in a lot of overcapacity in the industry as is common for any commodity. As a result of the overcapacity created the prices promptly dropped to 80c by November 2012. After briefly increasing the prices again started falling and bottomed out at 65c in March 2016. Since then prices have rebounded and currently at 80c in April 2017. In some ways, the industry is still struggling due to the capacity which came on stream during 2009-11.
Ambika Cotton was incorporated in 1988 and its 4 manufacturing facilities are located in Tamil Nadu. It has a total spindle capacity of ~108,000.
The company was originally incorporated as Ambika Cotton Mills Private Ltd as a private limited company and subsequently converted into a public limited company in September 1994. The company was promoted by P K Ganeshwar, Rathanasamy and P V Chandran, for setting up a cotton spinning mill. The mill located in Dindigul, Tamil Nadu, commenced operations in January 1990 with an initial capacity of 6,048 spindles. They have expanded capacity gradually over the years. In 2007, the capacity expanded by 43,000 spindles to reach their current capacity of ~108,000 spindles.
Due to unknown reasons, the two promoters Mr. Ganeshwar and Mr. Rathanasamy seem to have exited the business during FY 2006. At the end of FY 2005, the promoters had a combined shareholding of ~70%. At the end of FY 2006, the other two promoters sold their shareholding leaving Mr. Chandran with a shareholding of 25%. Currently the business is being managed by Mr. PV Chandran who is also a dominant shareholder. Mr. Chandran has increased his shareholding consistently through the years – increasing to 35% in FY 2008, 40% in FY2011, 46% in FY 2012, and 50% in FY 2017. Other prominent shareholders in Ambika include Catamaran Advisors with 4.20% and Valuequest India Moat Fund with 3.86%.
The company’s clientele consists of well-reputed manufacturers engaged in manufacturing shirts/knitwear products, both in the domestic and international markets. An average yarn manufacturer sells their products to either yarn traders or weavers. Since an average yarn manufacturer sells a commodity product, they are price takers and have to accept the market price of the yarn. On the other hand, Ambika produces specialty yarn which has put them in an enviable position amongst yarn manufacturers. Ambika’s yarn, due to its superior quality, sells at a premium as can be seen from the table below. They have high pricing power over their customers. Warren Buffett and Charlie Munger have talked about pricing power”
WB: The single most important decision in evaluating a business is pricing power. If you’ve got the power to raise prices without losing business to a competitor, you’ve got a very good business.
CM: There are actually businesses, that you will find a few times in a lifetime, where any manager could raise the return enormously just by raising prices—and yet they haven’t done it. So they have huge untapped pricing power that they’re not using.
I suspect Ambika has untapped pricing power. They can raise prices further and their customers will still remain with them. While there is no way I can prove this, this is demonstrated by the strength of their customer relationships as we will see.
The table below compares Ambika with a few competitors on – “sales per spindle” (A). Sales per spindle can be further broken down into – production per spindle (B) multiplied by Sales realization (C). As we can see sales per spindle for Ambika is the second highest after Nitin Spinners. Although production per spindle is the lowest for Ambika, however they are way ahead of others in terms of sales realization. Hence, they are able to command pricing premium of 30% over their closest competitor.
However, the sales per spindle for Ambika is the lowest amongst their competitors. As far as I understand, this is because they have to maintain a balance between quality and quantity. Since, Ambika produces one of the best quality yarn, that limits the quantity they can produce. But the good thing is that they are getting more efficient with time as demonstrated by increase in quantity over the years.
The manufacturing process for the higher count yarns for manufacturing specialized yarn is quite unique. It requires advanced technology and specialized machinery. But more importantly, it requires expertise which is developed over a period of many years. While the manufacturing process is automated, but it is not possible to eliminate the human factor in spinning. It is crucial to maintain the right amount of moisture and temperature at various steps of yarn manufacturing to get the best quality of yarn.
They are focused on the quality of the product. In fact, they are obsessed with the quality. It is because of this obsession with quality that customers literally que up to get their yarn. For premium shirts, Ambika is the go to guy in India. The kind of techniques of production, quality checks which they have in place are extremely difficult to match. Even if they are matched, an organisation would have to hire lots of professionals (who will cost a lot) and create a sustained track record in order to attract customers.
While most of the yarn manufacturers have hundreds of customers. Ambika, on the other hand has a select few customers. Ambika sells their yarn to the end customers instead of through agents. They have a dedicated set of customers to whom they have been supplying for long period of time. Many of their customers have been with them for the last 17-18 years. In fact, their largest customer accounts for 26% of their revenues. While they have so far declined to disclose name of their customers due to confidentiality reasons, I was able to get some names from older reports. Their domestic customers include Arvind Mills, Raymond, Aashima Textiles and Morarjee. Its main overseas clients are Quannitex Enterprise Corporation, Taiwan, Pacific Textiles, Hong Kong, and Winnitex Investment Company, Hong Kong.
Ambika manufactures only on the basis of firm specific market demand rather than producing and selling factory specific products. And all of this shows in their financials. They stand out in stark contrast to their peers as we will see in the table below.
Let us look at the highlights.
One, they have the best margins in the industry. But more importantly they have managed to maintain the margins over the years. Because this is a cyclical industry there are periods of overcapacity resulting in lower margins. FY 2009 and FY 2012 were two such years when the margins of most of the companies turned negative. Ambika did not have a single year with negative margins. In fact, they experienced only mild decrease in their margins compared to their peers even during these periods.
Second, like all cyclical industries spinning is prone to indulge in overcapacity during periods of increasing prices. During the last 10 years, a lot of capacity has come on stream especially due to the unprecedented price increase during 2009-11. One way to quantify this is to measure the increase in assets of various companies. During the period 2007-16, assets have increased at a CAGR of 6% (KPR Mills), 7% (Nitin Spinners), 5% (Nahar), 8% (Bannari Amman). The increase in assets has been financed by more debt in all the cases. The debt has increased at a CAGR of 4% (KPR Mills), 5% (Nitin Spinners), 5% (Nahar) and 6% (Bannari Amman). During the same period, the capacity for Ambika has not increased at all. They have invested in modernizing their existing machinery and making their operations more efficient. Hence their assets have increased at a CAGR of 1%. However, during the same period their debt has REDUCED at a CAGR of 21%.
The asset build-up has resulted in increased revenues and profits for most companies. For these companies, revenues and profits have increased at a CAGR of 15%/10% (KPR Mills), 19%/ 19% (Nitin Spinners), 8%/ -2% (Nahar), 22%/ 1% (Bannari Amman). For Ambika the revenue and net profit have grown at a CAGR of 13%/ 10%. This is outstanding performance given that they have not grown their assets at all as compared to all the other companies.
The allure of higher size is very hard to resist. And as we can see everyone has fallen for that during the past decade except Ambika. During this period Ambika has focused on making their operations more efficient and invested in upgrading their plant and machinery. At the same time, they have managed to bring down the debt to almost zero. However, they have not stopped there. Ambika also announced and completed a share buyback program in February 2017. They bought back ~2.5% of all outstanding shares at a total cost of INR 15.7 cr. And finally, they are in the process of increasing their capacity after almost a decade by ~28%.
PV Chandran embodies all the qualities of a good, hardworking, intelligent manager. It is Mr. Chandran who is responsible for the terrific performance of Ambika so far. He has single handedly launched Ambika from its modest beginnings to its current orbit where they are amongst a select few spinners globally in terms of the quality of their yarn. This had a flip side to it as well. This exposes the company to key man risk with little clarity on succesion planning.
He is an owner cum manager who is not chasing after growth only. And that is refreshing in today’s growth at all cost ethos. Mr. Chandran is not after making a quick buck and wants responsible growth for Ambika. In this respect, he is an exemplar of delayed gratification. He annulled the variable portion of his annual compensation in FY2016, which is 2% of net profits amounting to INR 8,900,000. He is content with the dividend he receives from the company just like any other shareholder. His focus is firmly on the long-term sustainability of the business rather than on short term gains. In the short-term Mr. Chandran is not afraid of sacrificing growth for quality. Unlike other spinners he does not add capacity and then wait for the customer orders to fill that capacity. He increases the capacity only against firm customer orders.
Over the years, Ambika has grown its revenues through a combination of increase in the capacity of manufacturing as well as through increased efficiency. For example, although the capacity has remained at the same levels since 2007, revenue has increased from INR 140cr in FY2007 to INR 490cr in FY2016 at a CAGR of 13%. The company is currently in the process of adding a further 30,000 spindles, which is ~28% of existing capacity.
However, the second negatives about Ambika (the first being key man risk) is that the runway for growth is limited. That is because Ambika manufactures specialty yarn which is a niche product with a limited market. In addition, the market for premium yarn is growing at a rate which is much lower than that of the yarn sector in general. Secondly, as we have already seen the management of Ambika will not go after growth at any cost. Because of these reasons, we should not expect spectacular growth in Ambika. Their growth can be volatile, but it will be sustainable without compromising the quality of the product. Additionally, they will never take unnecessary risk for the sake of growth.
Mr. Chandran has been asked previously on growth plans for the next 5-10 years. He has clearly stated that he does not have a strategic plan for the future. He will continue to do the right thing at that point of time for the business and his shareholders and leave the rest to God. I like the promoters who are not loath to admit that they do not have any grand plans for the future.
I don’t know the future of Ambika. However, what I can say with certainty is that they will continue to run the business as they have in the past. Their focus will always be in the long-term interest of the business. While doing so, they will steer clear of unnecessary risks and unprofitable growth. I believe that although the future is not clear at this stage, but as Mohnish Pabrai says – uncertainty is not the same thing as risk. Mr. Chandran is building a sustainable business which will be stronger in the future. Looking at his track record, I have no reason to doubt him. It will be very interesting to see where this business goes under his stewardship in the years to come.
 Peru in the High-Quality Cotton Textile and Apparel Global Value Chain, January 2016
 Thematic report on textiles, Axis Direct, 11 Jan 2017