Textiles garment industry update

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

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> 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

Industry estimated to be worth USD4.4 trillion1

The global textile and clothing industry is estimated to be worth approximately US$ 4,395 bn with global trade totalling US$ 600 bn1 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

AN OVERVIEW

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

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

TEXTILES AND GARMENTS –

AN INDUSTRY TRANSFORMATION IN THE MAKING

Source: WTO, D&B, Economist and ANZ Analysis

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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?

CHASING CHEAP LABOUR – A HISTORY OF SIGNIFICANT CHANGE

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

TIMELINE AND GEOGRAPHICAL SHIFTS

Three geographical shifts so far … fourth shift underway?

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 18th century and was based on imported cotton

Late 18 th

century

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

1950’s and

early 1960’s

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

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

1980’s and

early 1990’s

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

2012

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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

Asia accounted for 56.6% of world textiles exports in 2010 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 2010 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 2010 The major importers of clothing are the EU and the US, with Japan trailing in third place

TODAY’S TEXTILE AND GARMENT INDUSTRY

TEXTILE AND CLOTHING TRADE AT A GLANCE

7 8

South & Central America

200 142

Total

Clothing Textiles

KEY COUNTRIES

In USD Bn Exports Exports

Intra Asia 65 41

7 8

South & Central America

200 142

Total

KEY COUNTRIES

Intra Asia 65 41

2 2

Middle East

115 78

Total

KEY COUNTRIES

Intra Europe 58 98

2 2

Middle East

115 78

Total

KEY COUNTRIES

Intra Europe 58 98

11 16

Total

KEY COUNTRIES

Intra Americas 12 10

11 16

Total

KEY COUNTRIES

Intra Americas 12 10

-$50

$100

$150

$200

$250

Textiles Garments 56%

57%

58%

59%

Exports % of global exports

-$20

$60

$100

$140

Textiles Garments

30%

31%

32%

33%

34%

35%

-$3

$9

$12

$18

Textiles Garments

-2% 4% 6% 8%

GLOBAL TEXTILE INDUSTRY -TRADE STATISTICS

Top 10 Textile Exporters

2010 (Value) Global Trade Share in

In USD Bn

Top 10 Textile Exporters 2010 (Value) Global Trade Share in

In USD Bn

1.7%

4 2.8%

3.1%

3.6%

3.9%

4.4%

4.9%

5.1%

30.7%

31.1%

7 8 9 10 11 12 13 77 78

Indonesia

Japan

Pakistan

Turkey

Taiwan

South Korea

United States

India

China

Europe

4 5 5 5 6 7 7 23 29 100

Indonesia

Europe China United States Japan Turkey Vietnam Mexico Bangladesh South Korea

1.6%

25.1%

11.6%

8.8%

2.7%

2.5%

2.3%

1.9%

1.8%

1.2%

1.3%

1.9%

3.1%

3.2%

3.6%

4.5%

34.5%

43.9%

4 4 5 7 11 11 13 16 121 154

Thailand Mexico United States Indonesia Vietnam India Turkey Bangladesh Europe China

3 4 5 5 7 8 17 27 82 252

Turkey

Europe United States Japan China Canada Russia Switzerland Australia South Korea

0.8%

71.8%

22.3%

7.3%

4.8%

2.3%

2.0%

1.4%

1.3%

1.2%

GLOBAL TEXTILE INDUSTRY -TRADE STATISTICS

In USD Bn

Source: WTO, 2010

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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%

At present, exchange rates are forecast to remain steady in the near future

0.140

0.144

0.148

0.152

0.156

0.160

Mar

09 Jul09 Nov09 Mar10 Jul10 Nov10 Mar11 Jul11 Nov11 Mar12

0.155 0.160 0.165 0.170 0.175 0.180

Sep

12 Dec12 Mar13 Jun13 Sep13 Dec13 2014 2015 2016

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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 Magazine1, 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 2020

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: http://www.businessweek.com/articles/2012-03-07/china-boosts-the-minimum-wage

Note 1: The Economist, “Manufacturing: The end of cheap China”, 10th March 2012

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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

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Median inventory days peaked in FY2011 particularly for Asian companies due to ongoing financial turmoil in Europe the largest importer

of textile & garment in the world

Asian companies dominate the textile industry with 65.5% of companies in the sample are domiciled in Asia

Working capital performance have been relatively stable during the last 4 years except for 2011 where significant movement was felt for both Global as well as Asian companies

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.

BENCHMARKING THE MAJOR PLAYERS:

RECEIVABLE DAYS

FY2007 FY2008 FY2009 FY2010 FY2011

1st Quartile Median 3rd Quartile

39

59

FY2007 FY2008 FY2009 FY2010 FY2011 1st Quartile Median 3rd Quartile

INVENTORY DAYS

101 102 98 99 104

153 157 156 156 163

FY2007 FY2008 FY2009 FY2010 FY2011

91 93

132 137

123 128

140

PAYABLE DAYS

FY2007 FY2008 FY2009 FY2010 FY2011

60 58

28 32

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Conclusions

further inland and/or pursuing a “China plus one” strategy stand to benefit

domestic market, supply chain concentration and scale benefits accumulated over 30 years

based players to seek alternative competitive advantages in order to differentiate themselves in the global marketplace

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

access to financing which inherently favour, players with scale

Working capital performance have been relatively stable during the last 5 years for both Global as well as Asian companies

CASH CONVERSION CYCLE

108 109 105 104 102

168 170 167 164 171

FY2007 FY2008 FY2009 FY2010 FY2011

104 105

159 153

140 148 155

NWC / SALES

15.7% 15.5% 15.2% 15.4% 15.9%

26.4% 26.8% 26.6% 26.2% 25.4%

39.3% 39.7% 40.0% 39.5% 39.0%

FY2007 FY2008 FY2009 FY2010 FY2011

15.5% 15.0% 14.4% 14.8% 15.6%

26.0% 26.5%

23.6% 23.8% 23.9%

38.1% 37.6%

34.1% 35.3%

38.0%

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