Rationale

 The ratings upgrade reflects better-than-expected performance of Suryalakshmi Cotton Mills Limited (SCML) in H1 FY2022, supported by favourable demand conditions, and the anticipated steady operational and financial performance over the medium term. SCML's revenues and earnings have improved steadily from the second half of FY2022 on the back of improved demand conditions, especially in the spinning segment, post the deterioration in the operating performance in FY2020 and H1 FY2021. Further, with the volumes and realisations witnessing some recovery in the recent months, SCML is likely to register a healthy revenue growth of more than 40% and the operating margin is likely to expand by around 300 bps (to ~10%). Despite the likely moderation in the healthy contribution levels witnessed in the spinning segment, SCML's performance over the next 12 to 18 months is expected to be supported by the growth in revenues and earnings from the denim segment. In addition to the growth in earnings, SCML's credit profile has been supported by the lower repayment obligations and reduction in interest rates post the resolution of one-time Covid-19-related debt restructuring in Q1 FY2022. Key coverage metrics including interest coverage and debt service coverage ratios are likely to improve to around 3 times and 1.8 times, respectively over the next 12 months. Nevertheless, SCML's leverage indicators and return indicators are expected to remain at moderate levels, with adjusted debt to operating profits (adjusted for interest-free unsecured loans received by promoters and related parties) of around 3.5 times and the return on capital employed of ~9% for FY2022. The ratings also factor in SCML's established market position in the denim and yarn segments backed by the promoter's long industry experience, a diversified product portfolio across segments and the integrated nature of operations. Further, the ratings consider the working capital intensive nature of operations and exposure of earnings to volatile raw material prices with intense competition limiting pricing flexibility of industry players. ICRA also notes that post the allegations made against the company in December 2019 with respect to the procurement of coal from Western Coalfield Limited and the subsequent CBI investigation, there have been no further updates on the issue. ICRA will continue to monitor if any adverse development arises from the same, which could have a negative impact on the credit profile of the company and take appropriate rating action when necessary. The Stable outlook reflects ICRA's expectations that SCML's performance will continue to benefit from its established presence in the denim and yarn industry segments and long relationships with its key customers, aiding in repeat orders.