The Hindu Business Line : Textile exports, post quotas

TEXTILE stocks have been in fashion over the past 18 months or so. Expectations that the Indian textile industry would gain from the removal of quantitative restrictions on textiles and clothing from January had led to the re-rating of several stocks, and the share prices of such companies as Arvind Mills, Mahavir Spinning, Indian Rayon and Zodiac Clothing more than doubled over the past year.

Now, nearly six months after the quotas were lifted, the industry appears to have lived up to expectations from it. But it is early days yet. While China is the undisputed leader across almost all categories of textiles and clothing, India has acquitted itself well in several areas, particularly cotton-based products.

Pricing declines, widely expected in the run-up to the abolition of the quota regime, have not been pervasive, with some categories registering an increase in realisations. Keen on reducing their dependence on China, importers appear to be willing to shell out extra for Indian clothing.

If the strong performance over the first couple of months is not reason enough to be optimistic about the industry's prospects, the restoration of quotas on imports from China by the US and the EU on certain categories of textiles and clothing is a further shot-in-the-arm for the textile sector.

Surge in exports

True to expectation, India has come second in the race for market share, post-quota period. Data from the US Office of Textiles and Apparel, shows that imports of cotton apparel products from India surged about 40 per cent in the first four months of 2005. In value terms, imports have risen nearly 45 per cent, indicating gains in pricing as well. Volumes of yarn and fabric imported have also been substantial. For instance, the quantity of knit fabrics imported rose more than 300 per cent during this period. These numbers are significant, considering that the US is our largest market.

They do, however, pale in comparison to that of exports from China. Imports of cotton apparel by the US from China more than doubled during these months; in certain categories, imports shot up 10 times. As China invested in technology on a far larger scale than, and far ahead, of India, this is only to be expected.

Besides, even for the second place in certain categories, India faces stiff competition from its neighbours. While Bangladesh and Sri Lanka appear to have lost ground in these early months, Pakistan has emerged a close competitor. For instance, in the home textiles category, where India was expected to be a major gainer, Pakistan has raced ahead. The import of cotton pillowcases from Pakistan jumped 300 per cent, while that from India grew only about 45 per cent.

In the synthetics segment, the entire sub-continent appears to have lost out to China and some of the other Asian countries, which is to be expected, considering this region's traditional strength has been in cotton.

Coping with pricing pressure

Interestingly, India has scaled up exports in certain categories without succumbing to pricing pressures. The average unit value of imports of cotton apparel products, for instance, has rose by seven cents in 2005. In categories such as cotton pillowcases and sheets, the unit value of imports from India improved; Pakistan witnessed stronger growth in these categories but also took a steeper cut in prices. Cotton shirts and synthetic trousers are the other categories where realisations improved, although marginally.

But, for the most part, a jump in volumes has come only on the back of steep price declines. There has been a price drop of 5-25 per cent depending on the category, China being the main driver of such declines. The average unit value of apparel imports from China has dropped 13 per cent. In categories such as man-made fibre knit shirts and blouses, the average unit value of imports in the first quarter of 2005 fell more than 50 per cent to $71 per dozen from $111 in the corresponding previous quarter.

A similar trend was observed in categories such as cotton knit shirts and blouses and cotton trousers. These are also areas where Indian exporters faced stiff pricing pressure; prices have fallen 20-30 per cent in these categories.

Quotas on China, boost to India

Declining price trends may be worrying for textile exporters, but they have had a more adverse impact on the industry of the US and the EU, as inexpensive Chinese clothing is flooding these markets.

In the above-mentioned categories, imports from China have increased by 300-1500 per cent. China has rapidly gained market share within months of the freeing up of trade barriers. In the first quarter of 2005, China's share of the total imports of T-shirts by the EU shot up to 17 per cent from 7 per cent in 2004.

Not surprisingly, the rapid growth in Chinese imports has triggered protectionist measures from both the US and the EU. Claiming that imports from China have disrupted the domestic market, the EU and the US have chosen to fall back on the "safeguard" clause, which they had introduced at the time of China's accession to the World Trade Organisation.

The dispute with the EU has been sealed on a more conciliatory note, with China agreeing to "manage" (read curtail) the annual growth in exports in nine categories to 8-12 per cent over the next three years. The US, on the other hand, appears to have taken a harder line on the dispute, slapping quotas across seven categories; imports from China in these categories would be allowed to grow only 7.5 per cent every year.

This development has left a small window of opportunity for India, but only till 2008. India is likely to gain market share in categories such as cotton knit shirts/blouses, where volumes have doubled, and in segments such as cotton trousers/slacks. It would, however, face stiff competition in the man-made apparel segment as well as in the innerwear segment.

The companies that are likely to benefit are also largely unlisted players.

Going forward, China is likely to be increasingly viewed as somewhat of a "wildcard" by American importers. International retailers such as Wal-Mart, a big customer, have reportedly not increased their sourcing from China significantly this year. While such players will continue to source a considerable chunk of their merchandise from China, they are likely to diversify their vendor base and India is likely to be a key sourcing destination.

Robust revenue growth...

Doubts remain on India's ability to capitalise fully this situation. Lack of scale among manufacturing units and poor industrial infrastructure might be dampeners. Outfits that have substantial scale may, however, be well placed to absorb the additional demand.

The robust demand on the export front is also likely to encourage outfits that have, so far, been cautious in their expansion plansto ramp up capacity. A fresh round of capacity expansion is underway; and several companies have, in recent months, announced plans to raise money from the public to fund these exercises.

These plans augur well for revenue growth over the long term. Unlisted players are likely togo public to fund their expansions. Investors would, however, have to be selective in investing in these companies. In the past, when a sector was a dominant theme in the market, a majority of the equity offers were from companies with uncertain credentials.

...but tepid earnings growth

While the outlook for the textile industry is positive, it maybe a year or two before the companies begin to record improved performance. The pricing situation is likely to remain volatile.

While the pricing pressure in categories where Chinese imports are restricted is likely to ease, intense competition in other categories may drag down realisations. Several companies are on an expansion drive. While the cost of expansion is likely to strain earnings growth, the market is likely to attach a premium to companies in the investment mode.

The market appears to have priced in most of the benefits that would accrue to textile companies in the near term. Stocks such as Arvind Mills, Raymond, Indian Rayon, Gokaldas Exports and Welspun India now trade at significantly higher levels than they did a year ago. We, however, remain bullish on Arvind Mills, Gokaldas Exports and Mahavir Spinning. Shareholders with a long-term horizon can stay with these stocks.

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