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The textiles gold rush
Shobhana Subramanian |
July 27, 2004
January 1, 2005, is still some months away, but the stock markets are already beginning to sniff profits in the air. Profits from textiles in a quota-free world.
Calendar 2004 has already seen many textile shares outperforming the indices by a safe margin; while the Sensex declined by 15.58 per cent between January 1 this year and July 21, textile shares have either fallen less steeply or even headed the other way: Arvind Mills, for example, put on a decent gain of 13.25 per cent; Vardhman Spinning and Alok Industries posted marginal gains of 2 and 1 per cent, respectively.
The pace of activity is already quickening. Over the next two years, Indian textile companies will more than double the number of shuttle-less looms to around 50,000-60,000 from around 20,000 in FY03.
Organised sector players such as Arvind, Raymond, Welspun and Vardhman are all spending around Rs 400-500 crore (Rs 5 billion) each on new units. Most of the money is being spent on installing weaving and processing facilities. Indo-Rama and Reliance are investing even larger amounts on man-made fibre.
The recent Budget saw the government doing its bit for the industry by bringing down excise duties for natural fibres (cotton and silk) across the product chain to zero or 4 per cent with Cenvat.
Indian firms are, thus, looking forward not only to an export bonanza in a quota-less world, but also a pick-up in domestic demand. KSA Technopak expects the domestic market for textiles to grow at a compounded annual growth rate (CAGR) of 8 to 9 per cent, from Rs 72,000 crore (Rs 720 billion) in FY03 to Rs 120,000 crore (Rs 1,200 billion) by 2010.
With only tariffs to deter exports to the main quota-based trading blocs - the US, Canada and the European Union - the global trade in textiles is expected to treble from current levels of around of $300 billion to about $850 billion by 2015.
And even tariffs are scheduled to slide. In the US, the trade-weighted tariff average is expected to come down to 15.2 per cent ad valorem by next year.
If everything looks hunky-dory on the macro side, it's time for a reality check. Quotas or no quotas, Indian textile companies will have to square up for a fight with China, which is widely reckoned to be the biggest beneficiary of the abolition of all export restrictions.
China is currently the world's largest exporter of textiles and clothing, with an export marketshare of around 17-18 per cent, according to World Trade Organisation figures.
A Goldman Sachs report says, "China has built a complete food chain in textile and apparel manufacturing" in both upstream and downstream businesses. Though China's textile capacities are still somewhat fragmented, many of the world's largest textile manufacturers are already based there, making it easier for the world's big textile retailers - Wal-Mart, J C Penney, Tom Hilfiger, Liz Claiborne, et al - to source from there.
Among the big textile companies based in China are Far Eastern Textile, Weiqiao Textile, Texwinca, Shanghai Haixin, Formosa Taffeta, Fountain Set and Nien Hsing Textile. The end of quotas will make China the overwhelming superpower in textiles.
The US International Trade Commission predicts that China will become the supplier of choice for the US because it can compete "on almost any type of product at any quality level". McKinsey expects the Chinese mainland to account for 50 per cent of the global textile market by 2008, especially in view of its large-capacity plants and superior infrastructure.
Bob Zane, who handles global sourcing for Liz Claiborne, a US retailer, has been quoted by one western publication as saying that China's "impact on the (textile) industry will be nothing short of revolutionary. I think China will become the factory of the world, and they deserve that distinction."
So where does this leave India, with its minuscule 3.4 per cent share in global textiles trade? The consensus is it will be better off, but how much better no one is sure off since the main question mark is about prices.
There are primarily two threats to the rosy scenario: one is the threat of a huge slash in textile prices post-quota abolition, and the other is the fear of the US imposing safeguard duties to limit the damage to its home industry.
The biggest immediate gainers from the end of quotas will be US wholesalers, retailers and consumers as suppliers around the world compete for business.
The old quota regime was, in fact, a major pain for US wholesalers and retailers because it forced them to buy textiles and clothing from several suppliers - because quotes from one country were often not enough to meet their demand.
Post-quotas, therefore, there will be a huge rationalisation of suppliers, which means every supplier will have to cut prices to stay in the reckoning. Liz Claiborne, for example, expects to halve both the number of countries from which it sources its clothes and the factories it uses around the world in the next three to four years, says the Goldman Sachs report.
In the process, China's share of direct overseas sourcing will go from about 15 per cent to about half. India, given its strengths in cotton textiles, will also benefit from the efforts of big retailers to consolidate suppliers, enabling its share of world trade in textiles and clothing to double or even treble.
Indian firms are already suppliers to Wal-Mart, Tommy Hilfiger, J C Penney, Gloria Vanderbilt and a host of others companies, which is proof that they can deliver quality. They are known to have better designing skills than the Chinese and are also possibly more adept at delivering niche orders.
The consensus is that both India and China will gain at the expense of other suppliers in south-east Asia. A Deutsche Bank report says that South-East Asia and other markets could lose out because their labour is not as cheap and efficiency levels not as high.
The bad news: all growth in volumes will come at the cost of prices and margins. Goldman Sachs Global Investment Research foresees a scenario where there could be an immediate price reduction of 30 per cent or more in key apparel categories after quotas are lifted.
Its analysis is based primarily on a calculation of the costs currently imposed on buyers by the operation of quotas. This higher cost is currently reckoned to average around 26 per cent for the top 15 apparel exports to the US.
Once quotas go, the sheer competition for volumes between China's manufacturers and suppliers will ensure that prices drop by at least the same amount. In 2002, when quotas were lifted on 29 categories of apparel, prices crashed by an average of 34 per cent, and sometimes as much as 50-80 per cent.
If this scenario holds, Indian textile companies will also face pricing pressures. Quota premiums for apparel are high and account for between 25 and 35 per cent of the selling price.
Nabankur Gupta, president of Raymond, is not so pessimistic. "Prices may fall at the lower end of the product chain," he says. "But at the higher end, we feel our customers will be willing to pay a better price for the better quality that we deliver". Raymond is readying itself for the export kill by setting up a spanking new unit in Bangalore.
Manufacturers hope that prices may not come down for all categories. Even in segments such as made-ups, which include bed linen and towels, where India has a 17 per cent share of the global market, the fall in prices may not be that steep since India caters to the middle and premium ranges rather than the lower end.
But everyone agrees that there will be pricing pressure, and the only dispute is about its intensity. While price declines may vary from category to category, observers say an erosion in margins for some companies between 200-300 basis points cannot be ruled out. The thing to watch out for is whether the erosion will be compensated sufficiently by growth in volumes.
Longer-term, though, there is greater optimism due to India's relative advantage in cotton. China may be the world's largest producer of cotton but it also imports large quantities of cotton and yarn, estimated at between 15 and 20 per cent of its needs.
India today grows enough cotton and has the highest acreage in the world. It produces 2.7 million tonnes annually, though the yield is among the lowest. Proximity to cotton growing-areas helps textile companies in India in terms of shorter lead times, savings on freight and access to different varieties.
With a share of 25 per cent of the global cotton yarn market, which can be used domestically if the demand picks up, access to raw material is assured. Moreover, there is scope for cotton yields to improve.
R R Mandawewala, executive director, Welspun India, says Indian firms will not have to contend with shortage of cotton in the immediate future, which gives them a distinct advantage over China. India's other key strength lies in its pool of skilled labour.
While China, too, has a growing population of young, trainable people, the Economist Intelligence Unit says wages in India are lower than in China by about 30 per cent.
However, where China scores over India is in its productivity levels which are unquestionably better. As Gupta puts it, "our wages may be marginally lower, but given our dated labour laws, so is our productivity." This means the product cost per person is better in China.
China's other big advantage over India is scale. Chinese textile companies have built up huge capacities, thanks to the foreign direct investment that's gone into the industry over the last few years.
China's spinning capacity is estimated at 53 million spindles compared to India's 39 million; in weaving, China's is estimated have 1,60,000 shuttle-less looms compared to India's 20,000 (now being increased to 50,000-60,000). While fresh investments are being made in brand new plants to make terry towels, T-shirts and tuxedos, the investments are probably not enough to measure up against China.
While the scenario immediately after January 2005 is difficult to visualise, it is clear that in the long run Indian textile players should come through with flying colours, especially the larger integrated firms. The sector, therefore, should witness a re-rating - a process that has already begun.
The fortunes of this industry tend to fluctuate with fashion trends, which, if not anticipated, can have a debilitating impact on companies. Both apparel and fabric exporters will need to keep a watch on changing fashions.
A sobering fact: At the end of the day, textiles are still a commodity business with prices being a function of global and domestic demand-supply balance. Thus, value-addition alone can help companies maintain margins and make them less vulnerable to the peaks and troughs of the commodity cycle.
The Big Players
Having created capacities in denim, shirting and knitted gaments, Arvind is now adding value by making denim apparel. It also plans to expand its shirt-making and knitted garment capacity, nearly doubling the apparel capacity. Apparel manufacture - being relatively less capex intensive - would drive cash flows.
Being fully vertically integrated, Arvind, which sells to J C Penney, Marks & Spencer, and Levis is well-positioned to scale up operations to cash in on the demand growth.
Kotak Securities expects the turnover to grow from Rs 1,435 crore (Rs 14.35 billion) in FY04 to Rs 1,515 crore (Rs 15.15 billion) in FY05, driven by higher apparel sales and a marginally better profit of Rs 116 crore (Rs 1.16 billion) in FY05, resulting in an EPS of Rs 5.70.
With its large integrated business model, across the value chain from yarn to retail, Raymond already supplies to some US retailers. It is putting up two new units in Bangalore for apparel, and denim wear and also expanding its denim capacity.
After its new 10 million metre plant goes on stream, Raymond will be India's second-largest denim maker. The garment export facility which includes 0.5 million suits, 1 million trousers and 3 million jeans, should see a 25 per cent capacity utilisation in the first year.
Refco Sify believes that in FY05, Raymond will fare better due to the growth in denim and branded garments but a fall in other income could drag down profits.
It expects denim to be a major profit driver in the future but has concerns about the company being able to sustain the high growth in the domestic garments business which includes the Colour Plus brand. Refco Sify has projected net sales of Rs 1,437 crore (Rs 14.37 billion) in FY05 and an adjusted PAT of Rs 95.2 crore (Rs 952 million). This would translate into an EPS of Rs 15.50.
The company has capacities in spinning, weaving and processing and plans to double its fabric processing capacity to 50 million metres. The expansion will cost only Rs 70 crore (Rs 700 million) and margins should expand with improved utilisation levels.
Vardhman is an approved supplier to global retailers such as GaP, Target, and Tommy Hilfiger which would help it ramp up sales post-2005. It however, does not have a presence in knitting and garmenting. Refco Sify has estimated net sales of Rs 636 crore (Rs 6.36 billion) for FY05 with net profits of Rs 35.8 crore (Rs 358 million), translating into an EPS of Rs 22.4.
Welspun is among the top five manufacturers of terry towels in the world and sells its products in 24 countries. It is a supplier to retailers such as Walmart, J C Penney , accounting for as much as 15 per cent of Wal-Mart's requirements and 100 per cent of Shopko.
The company has a processing capacity of 10,8000 mtpa of terry towels which will go up by 12,000 mtpa. It is setting up a bed sheet making capacity of 100,000 metres per day at a cost of about Rs 5 billion. Welspun is well positioned to capture the growth in the made-ups segment post-2005 which, according to McKinsey, will grow at 10 per cent per annum. Alchemy Shares has projected net sales of Rs 496 crore (Rs 4.96 billion) for FY05 and net profits of Rs 38.7 crore (Rs 387 million), resulting in a fully-diluted EPS of Rs 6.80.