ANZ INSIGHTS COMMERCIAL BANKING ASIA TEXTILE & GARMENT INDUSTRY MARKET UPDATE JULY 2012

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1 ANZ INSIGHTS COMMERCIAL BANKING ASIA TEXTILE & GARMENT INDUSTRY MARKET UPDATE JULY 2012

2 TEXTILES AND GARMENTS AN INDUSTRY TRANSFORMATION IN THE MAKING > The Textile and Garment industry is dynamic and has witnessed multipie shifts throughout its history. Recent events in China, the single largest producer and exporter of textile and clothing, have created a hint of change that may represent the early stages of another geographical shift for this industry. > Any structural change in China has the potential to change the industry s shape, potentially creating opportunities for those able to exploit them. > China s textile and garment industry has built its current dominance on the lowest production costs in the world, but this foundation for success is being undermined by the country s growing wealth. Labour, land and regulatory costs are on the rise, pushing prices up and driving some customers to South East Asia and beyond. > While there is some evidence of increased investment interest in other South Asian countries that provide cheap labour (particularly Vietnam and Indonesia), supply chain and scale benefits enjoyed in China will take years to replicate. > Other emerging trends that are likely to drive the evolution of this industry are the increased use of a China plus one strategy, often associated with the re-shoring of some production (most evident in America), in addition to manufacturing moving inland into other Chinese provinces in search of cheaper labour. AN OVERVIEW Industry estimated to be worth USD4.4 trillion 1 The global textile and clothing industry is estimated to be worth approximately US$ 4,395 bn with global trade totalling US$ 600 bn 1. The US market is the largest and continues to grow estimated at 5% per year. In combination, the US and EU nations account for 64% of global clothing consumption. TEXTILES Textile manufacturing is capital intensive and therefore relatively slow to move and adjust > Textile production is more capital intensive than clothing manufacturing and therefore tends to have higher exit barriers and longer establishment lead times. > The cost structure of the industry and the capital intensity of the manufacturing approach means that minimum orders are relatively large. Manufacturers have limited ability to swiftly adjust production to consumer tastes. > The capital intensity of textile manufacturing has risen significantly over the past 20 years, as has firm concentration. However capital intensity is still generally much less than that of manufacturing as a whole. GARMENTS Garment production traditionally has had a very high dependence on cheap labour > Garment manufacturing is a classic labour intensive activity that, along with similarly labour intensive manufacturing industries such as toys, travel goods and shoes, many low wage developing countries have established a comparative advantage in, as exporters to the world market. Source: WTO, D&B, Economist and ANZ Analysis Note 1: Dun & Bradstreet

3 TEXTILE & GARMENT INDUSTRY 1-2 CHASING CHEAP LABOUR A HISTORY OF SIGNIFICANT CHANGE The industry has a history of dramatic geographical shifts Driven by the importance of cheap labour to the competitiveness of industry participants, the search for low wages underpins a history of dramatic geographic shifts in the primary production base for the Textile and Garment industry. Three such shifts have occurred to date (see the timeline below) and recent events in China, the world s largest producer and exporter of textile and garments, have led to speculation that we are at the early stages of another. Will the shift from China to other South Asian countries accelerate? TIMELINE AND GEOGRAPHICAL SHIFTS Late 18 th century 1950 s and early 1960 s 1970 s and early 1980 s 1980 s and early 1990 s 2012 Origin The modern form of textile manufacture using factories with machinery driven by artificial motive power dates from the first revolution started in Britain in the late 18 th century and was based on imported cotton. First Shift From North America and Western Europe to Japan Initially based on imported cotton & British spinning machinery and later (post world war II) based on its own indigenously developed state of the art equipment, Japan became the most preferred destination. Second Shift Japan to Hong Kong, Taiwan and South Korea The second shift was from Japan to Hong Kong, Taiwan and the Republic of Korea. These countries dominated textile and clothing exports in the 1970 s and early 1980 s. Third Shift Hong Kong, Taiwan & South Korea to other South Asian countries The third migration was a move to other developing countries in Asia. In the 1980 s production moved principally to mainland China, but also to Indonesia, Malaysia, the Philippines, Sri Lanka and Thailand. Fourth Shift??? China to Vietnam, Indonesia and Cambodia?? Rising labour costs, appreciation in Chinese currency and increasing shipping costs may be pointing towards another geographical shift as China potentially begins to lose its competitive advantage in this industry. Three geographical shifts so far fourth shift underway? Shifts are buyer driven based on cost reduction strategy Historically, this shifting globalisation of production has largely been buyer-driven by pressure from retailers such as Wal-Mart, Sears and JC Penny, and fashion-oriented apparel companies like Liz Claiborne, Gap, and The Limited. The cost-reduction strategies of these companies has shaped the industry they have retained design and marketing functions but largely contracted out the production of their apparel to firms in low-wage countries. In effect these companies and those that have mirrored them have became manufacturers without factories. This globalisation of production has resulted in a complex set of commodity chains. Many of the largest clothing companies have most of their products manufactured through arrangements with different independent suppliers, with no one supplier producing more than a fraction of the company s output. Most globalised industry in the world These manufacturers, though concentrated in Asia, are scattered throughout the world, making the clothing industry one of the most globalised of all manufacturing activities. Source: WTO, Economist and ANZ Analysis

4 TODAY S TEXTILE AND GARMENT INDUSTRY Developing countries produce half the world s textile exports and nearly three-quarters of the world s clothing exports The global Textiles and Garments industry forms an important component of world trade flows, particularly for some developing and emerging countries where clothing accounts for a large proportion of total exports. In 2010, world textiles exports were valued at $251bn and clothing at $351bn, representing 1.7% and 2.4% respectively of total world merchandise trade. Today, developing countries produce half the world s textile exports and nearly three-quarters of the world s clothing exports. TEXTILE AND CLOTHING TRADE AT A GLANCE EUROPE ASIA AMERICAS Significant intra region trade ~ 80% of total trade Largest exporter of textile and garments in the world Significant intra region trade ~ 81% of the total trade $140 $120 $100 $80 $60 $40 $20 - Textiles Exports % of global exports Garments 35% 34% 33% 32% 31% 30% $250 $200 $150 $100 $50 - Textiles Exports % of global exports Garments 59% 58% 57% 56% $18 $15 $12 $9 $6 $3 - Textiles Exports % of global exports Garments 8% 6% 4% 2% - KEY COUNTRIES Textiles Clothing In USD Bn Exports Exports Total 78 5 Intra Europe Asia 5 5 Africa 5 1 CIS 4 5 North America 4 3 Middle East 2 2 South & Central America 1 0 KEY COUNTRIES Textiles Clothing In USD Bn Exports Exports Total Intra Asia Europe North America Africa 10 5 Middle East 9 8 South & Central America 8 7 CIS 5 KEY COUNTRIES Textiles Clothing In USD Bn Exports Exports Total 16 Intra Americas Asia 2 0 Europe 1 0 Africa 0 0 Middle East 0 0 CIS 0 0 In USD Bn Europe China India United States South Korea Taiwan Turkey Pakistan Japan Indonesia GLOBAL TEXTILE INDUSTRY -TRADE STATISTICS Top 10 Textile Exporters 2010 (Value) Share in Global Trade 31.1% 30.7% 5.1% 4.9% 4.4% 3.9% 3.6% 3.1% 2.8% 1.7% In USD Bn Europe China United States Japan Turkey Vietnam Mexico Bangladesh South Korea Indonesia Top 10 Textile Exporters 2010 (Value) Share in Global Trade 25.1%.6% 8.8% 2.7% 2.5% 2.3% 1.9% 1.9% 1.8% 1.6% In USD Bn China Europe Bangladesh Turkey India Vietnam Indonesia United States Mexico Thailand GLOBAL TEXTILE INDUSTRY -TRADE STATISTICS Top 10 Textile Exporters 2010 (Value) Share in Global Trade 43.9% 34.5% 4.5% 3.6% 3.2% 3.1% 1.9% 1.3% 1.2% 1.2% In USD Bn Europe United States Japan China Canada Russia Switzerland Australia South Korea Turkey Top 10 Textile Exporters 2010 (Value) Share in Global Trade 71.8% 22.3% 7.3% 4.8% 2.3% 2.0% 1.4% 1.3% 1.2% 0.8% Source: WTO, 2010 Asia accounted for 56.6% of world textiles exports in While a net exporter, China is also a major importer of textiles Trade patterns in Textiles and Garments are similar although variations do arise, largely driven by differences in capital and labour intensity (textile manufacturing tends to be a capital-intensive, garment making labour-intensive). Overall, Asia accounted for 56.6% of world textiles exports in The EU and the US are the biggest importers of textiles, followed by China, which needs fabric for its large garments industry. EU, USA & Japan are the leading importer of garments For clothing, China is the biggest exporter, followed by the European Union (including intra-eu trade) with a 35% share of world garments exports. Overall, Asia accounted for 57% of world clothing exports in The major importers of clothing are the EU and the US, with Japan trailing in third place. Source: WTO, Economist and ANZ Analysis

5 TEXTILE & GARMENT INDUSTRY 3-4 CHINA IS THE MARKET LEADER LOOSING ITS SHINE? China dominates textile and apparel manufacturing and for years has exported deflation to the benefit of western consumers Over the past two decades or so, China has gained a dominant position in textile and apparel manufacturing at the expense of manufacturers in more developed countries those based in nations such as U.S. and Canada in particular have suffered a long period of decline. To consumers in Europe and North America however, the dominance of China as an exporter of low cost but competitive quality goods as meant lower inflation, lower costs of living and higher living standards. Long the manufacturing base for the developed world, Chinese businesses are now being squeezed from many angles. Costs, particularly wages, are rising quickly while the appreciation of the Yuan has reduced profitability. Though shipping costs are well off their highs, factor in the impact of rising oil prices on freight costs, and China appears to be fast loosing its competitive advantage. Squeezed from many angles, China may be loosing its competitive advantage. China retains many advantages however There is some evidence of increased interest in moving production to other Asian countries. It is a long time since China offered merely wage arbitrage, however it far exceeds its competition in providing supply chain and scale benefits, has a huge domestic market and is increasingly investing in productivity. For many of these reasons, China remains a preferred destination for Textile and Garment production. The seeds of change, though, may be in the air. CHINESE CHALLENGES I: CURRENCY APPRECIATION Yuan appreciated by almost 8% in the last 3 years The Yuan has appreciated by almost 8% in the last three years with Chinese goods becoming more expensive in international markets as a result. Currency exposure is an important consideration for the Chinese industry. Despite the size of it s domestic market it remains highly dependent on export demand. In addition, the industry is fragmented; comprised of many small and medium sized manufacturers that together lack significant bargaining. The tolerance range for currency appreciation is not wide. As a rule of thumb, it has been suggested that for every 1% appreciation of the RMB, textile industry profits decrease by between 2% and 6% A recent report published by the China Banking Research Centre suggested that a rapid appreciation of the RMB, paired with a deteriorating external environment, would pose an enormous challenge for China s export enterprises. The report suggested that less than 30% of export enterprises can withstand a 4% appreciation or more while in the textiles, apparel, shoes and hats space only 44.5% can withstand a 2% appreciation; 6% would test all players. As a rule of thumb, it has been suggested that for every 1% appreciation of the RMB, textile industry profits decrease by between 2% and 6% CNY / USD last 3 years CNY / USD forecast Mar 09 Jul 09 Nov 09 Mar 10 Jul 10 Nov 10 Mar Jul Nov Mar Sep 12 Dec 12 Mar 13 Jun 13 Sep 13 Dec At present, exchange rates are forecast to remain steady in the near future Source: WTO, Economist, Bloomberg and ANZ Analysis

6 CHINESE CHALLENGES II: RISING LABOUR COST Twenty-one local governments have recently hiked their minimum wages: labour costs have risen by almost 20% a year for each of the past 4 years Wage inflation in China has raised questions over the country s future as the preferred outsourcing destination for multinationals in search of cheap labour. Factories have historically clustered in coastal provinces and, it is in these areas where costs have been climbing relentlessly. Labour is the key driver of this increase though taxes, land prices, and stricter regulation have all had an impact. Unlike in other countries, cities and provinces in China set their own minimum wages. Twenty-one local governments have recently hiked their minimum wage, some by double digits. Labour costs have on an average surged by 20% a year for the past four years. China s coastal provinces are losing their power to attract workers out of the hinterland and are also facing issues in retaining workers. As reported by The Economist Magazine 1, Joerg Wuttke, a veteran industrialist with the EU Chamber of Commerce in China, predicts that the cost to manufacture in China could soar twofold or even threefold by Should this trend continue China s position as the world s most preferred outsourcing destination will be under threat Also, AlixPartners, a consultancy, offers this intriguing extrapolation: if China s currency and shipping costs were to rise by 5% annually and wages were to go up by 30% a year, by 2015 it would be just as cheap to make things in North America as to make them in China and ship them there. 1 While it is probably not realistic to expect that China will cost as much as the US by 2015, China is not getting any cheaper. As the gap narrows more companies will look seriously at alternatives. Source: Note 1: The Economist, Manufacturing: The end of cheap China, 10th March 2012 Source: WTO, Economist and ANZ Analysis

7 TEXTILE & GARMENT INDUSTRY 5-6 AS CHEAP CHINA PROGRESSIVELY DISAPPEARS, WHAT WILL REPLACE IT? DOES SOUTH EAST ASIA OFFER CHEAPER ALTERNATIVES? Firms making clothes and shoes have already started to shift to other low cost nations Small and high-tech companies appear to be weighing the pros and cons of moving out of China. None-the-less, a number of firms especially those making clothes and shoes have relocated their business and moved to Bangladesh, Cambodia, Indonesia or Vietnam. Nike is a prime example. Nike used to make most of their trainers in China, but many of its big suppliers have moved elsewhere and in 2010 Vietnam became the company s biggest production base worldwide. Unless a new way of making shoes and clothing without manual labour emerges (ie with the use of technology), these businesses will move again in the future; Myanmar looks tempting, provided that reforms there continue. China faces intense competition from very low cost nations in Africa as well as from Vietnam, Malaysia, Bangladesh, Pakistan and the Philippines. However, China offers many advantages not currently available in other countries labour may be cheap but other factors make China hard to leave: Many benefits available in China still outweigh rising costs and thus China remains as an attractive destination 1. Booming domestic market. 2. Increasing productivity. 3. Sophisticated supply chain. 4. Large and flexible labour pool to meet seasonal demand. An alternative to leaving China, is to seek lower costs elsewhere on the mainland. While many labour intensive businesses are now moving from coastal regions to relatively less expensive inland China, inland infrastructure remains significantly behind its coastal equivalents on par with other South East Asian countries. Additional moving costs are very significant and logistics networks are under developed currently coastal supply chains are unrivalled. Moving inland in China, China plus one strategy and re-shoring are other initiatives followed by companies So what options exist for a firm that decides it is not yet time to leave coastal China? Many firms are adopting a China plus one strategy, usually putting an additional production base in a lower-cost country in Asia. This idea is in fact now being extended to the repatriation of some manufacturing facilities to rich countries. Diversification is one driver - a string of natural disasters in recent years has shown that lean supply chains can snap all too easily. One of the more interesting recent developments in apparel manufacturing has been a return of some of the business to manufacturing plants based in America. Some designers and retailers find that their orders are not of sufficient size to interest major offshore plants, or their need for fast delivery makes it impossible to use overseas manufacturers. As wages continue to rise in emerging nations and shipping costs remain sensitive to fuel price spikes, some portion of clothing manufacturing will continue to re-shore. Growing productivity from better manufacturing technology will add to this trend. Source: WTO, Economist and ANZ Analysis

8 BENCHMARKING THE MAJOR PLAYERS: Asian companies dominate the textile industry with 65.5% of companies in the sample are domiciled in Asia GLOBAL COMPANIES RECEIVABLE DAYS ASIAN COMPANIES Working capital performance have been relatively stable during the last 4 years except for 20 where significant movement was felt for both Global as well as Asian companies INVENTORY DAYS Median inventory days peaked in FY20 particularly for Asian companies due to ongoing financial turmoil in Europe the largest importer of textile & garment in the world PAYABLE DAYS Notes > Statistics shown are sourced from Capital IQ database for companies that have revenues between USD 15m to USD 150m per year based on the latest financial report. > The sample size considered for the analysis includes 800 Global companies out of that 527 are Asian companies. > The Asian geographical split is based on country of domicile.

9 BENCHMARKING 7-8 Working capital performance have been relatively stable during the last 5 years for both Global as well as Asian companies GLOBAL COMPANIES ASIAN COMPANIES CASH CONVERSION CYCLE NWC / SALES 39.3% 39.7% 40.0% 39.5% 39.0% 38.1% 37.6% 34.1% 35.3% 38.0% 26.4% 26.8% 26.6% 26.2% 25.4% 26.0% 26.5% 23.6% 23.8% 23.9% 15.7% 15.5% 15.2% 15.4% 15.9% 15.5% 15.0% 14.4% 14.8% 15.6% Conclusions > As the industry evolves, infrastructure improves, supply chains develop, those players with flexible strategies, including moving further inland and/or pursuing a China plus one strategy stand to benefit. > Despite competition from cheaper South East Asia locations, China maintains a significant advantage due to the size of the domestic market, supply chain concentration and scale benefits accumulated over 30 years. > RMB appreciation coupled with rising labour, materials, land and regulatory costs will make it increasingly important for China based players to seek alternative competitive advantages in order to differentiate themselves in the global marketplace. > Although working capital has been relatively stable over the last five years, inventory days peaked in FY20 and credit appears to have been tightening as suppliers demand quicker payments. Prudent WC management and access to financing will become an increasingly important driver of profitability and success, especially if the European financial crisis worsens. > Smaller firms are more at risk from current market dynamics including RMB appreciation, China plus one, credit tightening and access to financing which inherently favour, players with scale. Source: WTO, Economist and ANZ Analysis

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