Textile: Is it different this time?

Indian textile companies, across product categories (apparels, denim, home textiles) are today
seeking to build scale, extend their footprint and access global markets. While their attempts are
not without several hiccups, there is certainly a sort of rejuvenation in the sector, which was once
written off as an old economy debt-ridden sector. This was primarily so when most companies in
the sector sought refuge in the BIFR in the late 90s. With the textile majors today once again
talking of expanded capacities and inorganic growth, we analyse whether the scenario is different
this time.

The pros...
Yet to reap the fruits of capex: Most companies in the sector timed their expansion plans FY04
onwards, so as to avail themselves of the funding under TUF (Technology Upgradation Fund,
offering loans at 6% subsidy) - due to expire in March 2007. This led to the capex-spending
phase in the textile sector peaking in the last two fiscals. Against this backdrop, we believe most
of the capex in the sector has already been incurred or is in the last leg of completion. We believe
that the benefits of these expansions should start filtering in from FY08 onwards, once the new
capacities stabilise and the utilisation levels get normalised.

Overseas alliances to help move up the chain: Several Indian textile companies have formed
alliances with their global counterparts, particularly those with strong front-end capabilities, in a
bid to access global markets, tap technological know-how, design skills and branding and retailing
ability. The alliances have been struck in most cases by way of JVs or stake acquisition. The
strategic rationale for the alliances could be as outlined below.

 Branding and retailing capabilities: While Indian textile companies have the advantage
of a cost competitive manufacturing base, they lack global branding and retailing
capabilities. Tying up with overseas companies will help them move up the value chain
and focus on the more lucrative branding and retailing business (Welspun India's stake
acquisition in Christy).

 Market access: Overseas alliances give Indian companies direct access to the US and
European markets where their overseas partners have a distribution channel in place
(Raymond's JVs with overseas partners).

 Technology transfer: Transfer of technology and know-how for manufacturing the

premium end products will become a possibility. Raymond through its JV with Gruppo
Zambaiti has entered into a new line of business - high-value cotton shirting fabric. While
 Raymond will provide the low-cost manufacturing base in India, while its overseas JV
partner will supply the technological know-how.

 Designing capability: Overseas alliances will help Indian companies acquire

international design capabilities and product development skills. This is true for all the
three JVs entered into by Raymond in the recent past.

Overseas alliances
Indian
Overseas entity Profile of overseas entity Nature of alliance
company
Raymond UCO NV, Belgium Market leader in high-end denim in Europe JV (50:50)
Gruppo Zambaiti, Amongst Italy's top 3 high fashion cotton textile
JV (50:50)
Italy companies
Lanificio Fedora, Italy Largest producer of carded wollen fabrics in the world JV (50:50)
VF Corp owns popular denim and apparel brands
including JV (40% stake of
Arvind Mills VF Corporation, US
Lee, Wrangler, Vanity Fair, Nautica, JanSports and Arvind)
Kipling
Welspun India Christy, UK UK's largest towel brand Acquisition (85% stake)
Alok Industries Teviz, Portugal Manufacturer of high end shirting fabric JV

Source: Company, Equitymaster research

Retail footprint: Most large textile companies in India, realising the growth potential in domestic
retailing, have drawn up aggressive strategies to expand their footprint in the domestic market
(see table below). These include companies like Welspun and Himatsingka, which were
traditionally export-oriented, as also Raymond, which has been the pioneer in domestic textile
retailing. While Raymond has been reasonably successful with most of its domestic brands, its
brand Color Plus is pegged as the most profitable apparel brand. Home textile (furnishing)
companies like Himatsingka and Welspun have also taken steps in this direction with their outlets
Atmosphere and Spaces respectively.

Seeking global footprint

Company Product category Brands No. of stores Owned Franchised
Raymond Apparel Raymond, Park Avenue, Parx, Manzoni 395 52 343
Worsted suiting Color Plus, Zapp
Welspun India Home furnishings Spaces, Home Mart 46 23 23
Himatsingka Seide Home furnishings Atmosphere 11 11 0
Arvind Mills Apparel Tommy Hilfiger, Arrow, Lee, Wrangler, 211 NA NA
Flying Machine, Excalibur, Newport

NA - Not available

And the cons...

Home textiles-Over-supply concerns: Although home textile companies have recently been
aggressive on the capacity expansion front, realisations have remained stable. But as new
capacities come on-stream and utilisation levels pick up, this is unlikely to continue. This is
because although India continues to feature amongst the lowest cost producers for the US and
 EU markets, competitors like Pakistan and Turkey are cannibalising its market share. Moreover,
with the possibility of slowdown in the western economies looming large, a slowdown in demand
cannot be ruled out.

Apparel-Rigid labor laws: India's inflexible labor laws have been a hindrance to investments in
this segment. Unlike in home textiles, garment capacities are highly fragmented and leading
Indian textile companies have been slow to ramp up their apparel capacities, despite strong order
flows from overseas buyers who are trying to diversify out of China.

Denim-Excess capacity: Total denim capacity in India has nearly doubled over the past 12 to 15
months, resulting in a prolonged slump in the domestic market. Most new entrants (largely
catering to the unorganised market) are incapable of producing export-quality denim and have
resorted to dumping their produce in the domestic market resulting in nearly 15% drop in prices
within a few months.

Firming cotton prices: As per the data for cotton production shown by the textile ministry of
respective countries, cotton production is expected to rise by 2% globally. However, the new
capacities in the textile industry seem to have to be falling short of sufficient raw material. While
India continues to remain in surplus, the demand for cotton from across the globe is expected to
keep cotton prices firm for the rest of the fiscal, thus impacting the operating margins of textile
companies.

Cotton demand supply scenario

Production (m bales) Closing stock (m bales)
FY06 FY07E Change FY06 FY07E Change
World 114 116 1.8% 52 48 -7.7%
US 24 20 -16.7% 6 5 -16.7%
India 19 21 10.5% 9 10 11.1%
China 26 28 7.7% 13 11 -15.4%
Pakistan 10 11 10.0% 3 3 0.0%

Source: Office of Textile Commissioner and OTEXA

The scenario is...

...no different this time! Excess capacity, pressure on realisations and raw material costs are as
much of a concern today as it was half a decade back. In fact, dependence on exports for
vending a large part of turnover has cost the companies foreign exchange losses (in their hedging
account) with the rupee depreciation. Nonetheless, what needs to be acknowledged is that
several companies in the sector have been pro-active in taking advantage of the regulatory and
market opportunities (TUF, retail outlets, overseas JVs), which we believe will stand them in good
stead in times to come.
Textiles: Is MFA a boon or a bane?

After Multi Fiber Arrangement (MFA) is phased out, the textile industry of developing economies
like India will have a reason to be optimistic about the long-term growth opportunity. The textile
manufacturers will have a chance to increase the share of exports to the European Union (EU)
and US markets. This development will have a positive impact not only on the textile sector of the
country, but also on the economy as a whole. In this report, let’s try to understand as to how MFA
actually works and how will Indian textile companies benefit, post 2005.

Before going any further, the importance of the textile sector on the overall growth prospects of
the economy over the long term cannot be understated. Currently, the textile industry is providing
employment to 18% of the India’s work force and contributes to around 6% to the country’s GDP
and around 22% of the India’s exports. So, is MFA a boon or a bane?

MFA is an agreement through which a particular country is restricted to export its textile products
beyond a certain level to European and US markets. So, a particular quota is fixed for each
country (in terms of quantity, say 1-m shirts etc.), and no country can exceed the quantity
assigned. Thus, the motive behind this agreement can be either to provide a window of
opportunity for the under developed and developing economies or it can be to save the interest of
the domestic textile industry of European Union (EU) and the US.

After a particular quota has been assigned, the interested exporters have to contact the textile
ministry (in India, for example) and bid for the quantity to be exported. The government assigns
the quantity that a particular company can export on the basis of certain parameters like past
performance, new investor entitlement (in order to promote investments) on a first come first
served basis. The selection criteria for different categories like garments, yarn and fabrics are
different. For example, in garments, 70% of the quota is granted on the basis of past track record,
15% for new entrants, 10% on the first come first serve basis and only 5% as non-quota
entitlement. However, a company can buy a quota from another company in the market by paying
some premium. For example, if a company X has a quota to export only 10 mm of cloth, it can
buy the quota of company Y at a premium and increase the total quantity that can be exported.
Just to put things in perspective, inspite of having capacity and capability, currently, India’s share
in the international garment market is just 3%, due to quota restrictions. Let’s have a look at the
size of the opportunity post 2005.

Denim: The total denim production capacity of India is 220 million meters (mm), whereas the
current global denim consumption is around 3.9 bn meters and is growing at 4% per annum. The
consumption pattern chart given below shows that European and the US together constitute
around 69% of the total global denim consumption.

Shirting: The total domestic shirting capacity is around 65 mm whereas the global shirting
consumption stands at around 1.3 bn meters. The high value (superior quality) global shirting
demand is growing at around 6% per annum. The major consumers of high value cotton shirting
are European countries, Japan and the US. The current export quota for Indian shirts stands at
around 30 m pieces, which is marginal.

Thus, looking at the global demand size, we can say that the potential of Indian companies is
huge. Consider the cost competitiveness of the Indian sector now.

The textile chain can be broken in three stages. At the end of first stage, the fabric is
manufactured. The second stage can be identified as garmenting (i.e. converting fabric into
garments) and the third stage will be branding and retailing. The first stage begins with spinning
and continues till the grey fabric is ready. Raw material forms the major chunk of cost in the first
stage (around 50%). Cotton is the most important raw material for the denim and shirting industry.
Here, India is the third largest cotton producer in the world and the cotton prices are
comparatively cheaper in India as compared to international markets. So, we are at the
advantage.

The second stage involves processing and garmenting of the fabric produced. India has a major
advantage in this segment, as this stage is highly labour intensive. As evident from the graph
below, labor cost as percentage of total cost in India is very low as compared to other countries.
Apart from cheap labour, India has skilled labour too, which also gives an edge over other
countries.
The third stage can be recognised as branding and retailing of the garments produced. This is the
higher end of the textile chain, but it takes time for a brand to gain market share. Indian textile
majors have already started entering this segment but we believe the process is time-consuming
post the MFA scenario.

The government has set an ambitious textile export target of US$ 50 bn by 2010 as compared to
US$ 11 bn currently. However, the government is putting in efforts at lending a helping hand to
the textiles industry, which has been in doldrums for quite a few years now. In order to achieve
the growth target, a few important initiatives have been taken by the government. The
government has already set up a textile reconstruction fund to help reduce the effective interest
burden on viable textile companies. This fund targets reduction in interest rate for all borrowers in
range of 8%-9%. Banks and financial institutions have burnt fingers in the past by lending to this
sector. Hence, advances have been costly. This move by the government will benefit the sector a
long way.

We would like to conclude by saying that there is a huge opportunity lying ahead for Indian textile
manufacturers in post MFA era, as the markets will no longer be restricted. But there will be
competition from countries like China, Sri Lanka, Bangladesh, in terms of cheap availability of
products. But when it comes to fashion trends, we believe Indian companies will have an
advantage. As far as cost competitiveness is concerned, the larger players in the Indian textile
sector are well placed to compete.

But the Indian textile sector has a long way to go to achieve a sustainable competitive advantage.
The industry is very fragmented and access of finance and technology has been affecting growth
prospects of the smaller manufacturers. In terms of technology and the ability to produce
products in the large-scale, we still lag behind others and to that extent, investors to remember
that there are only few companies in this league. Impractical labour laws also restrict large
players to lay off redundant workers to improve competitiveness. Therefore, the risk profile of the
sector is also higher, despite the growth opportunity, on account of lack of control over input
costs. Overall, it is a balanced scenario and it remains to be seen how Indian companies tap this
opportunity

he textile industry holds significant status in the India. Textile industry provides one of
the most fundamental necessities of the people. It is an independent industry, from the
basic requirement of raw materials to the final products, with huge value-addition at
every stage of processing.

Today textile sector accounts for nearly 14% of the total industrial output. Indian fabric is
in demand with its ethnic, earthly colored and many textures. The textile sector accounts
about 30% in the total export. This conveys that it holds potential if one is ready to
innovate.

The textile industry is the largest industry in terms of employment economy, expected to
generate 12 million new jobs by 2010. It generates massive potential for employment in
the sectors from agricultural to industrial. Employment opportunities are created when
cotton is cultivated. It does not need any exclusive Government support even at present to
go further. Only thing needed is to give some directions to organize people to get enough
share of the profit to spearhead development.

Segments

Textile industry is constituted of the following segments

• Readymade Garments

• Cotton Textiles including Handlooms (Millmade / Powerloom/ Handloom)

• Man-made Textiles

• Silk Textiles

• Woollen Textiles

• Handicrafts including Carpets

• Coir

• Jute

The cottage industry with handlooms, with the cheapest of threads, produces average
dress material, which costs only about 200 INR featuring fine floral and other patterns. It
is not necessary to add any design to it. The women of the house spin the thread, and
weave a piece in about a week.
It is an established fact that small and irregular apparel production can be profitable by
providing affordable casual wear and leisure garments varieties.

Now, one may ask, where from the economy and the large profit comes in if the lowest
end of the chain does not get paid with minimum per day labour charge. It is an irony of
course. What people at the upper stratum of the chain do is, to apply this fabric into a
design with some imagination and earn in millions. The straight 6 yards simple saree,
drape in with a blouse with embroideries and bead work, then it becomes a designer¡¦s
ensemble. For an average person, it can be a slant cut while giving it a shape, which can
double the profit. Maybe, the 30 % credit that the industry is taking for its contribution to
Indian economy as good as 60 % this way. Though it is an industry, it has to innovate to
prosper. It has all the ingredients to go ahead.

Current Scenario

Textile exports are targeted to reach $50 billion by 2010, $25 billion of which will go to
the US. Other markets include UAE, UK, Germany, France, Italy, Russia, Canada,
Bangladesh and Japan. The name of these countries with their background can give
thousands of insights to a thinking mind. The slant cut that will be producing a
readymade garment will sell at a price of 600 Indian rupees, making the value addition to
be profitable by 300 %.

Currently, because of the lifting up of the import restrictions of the multi-fibre

arrangement (MFA) since 1st January, 2005 under the World Trade Organization (WTO)
Agreement on Textiles and Clothing, the market has become competitive; on closer look
however, it sounds an opportunity because better material will be possible with the
traditional inputs so far available with the Indian market.

At present, the textile industry is undergoing a substantial re-orientation towards other

then clothing segments of textile sector, which is commonly called as technical textiles. It
is moving vertically with an average growing rate of nearly two times of textiles for
clothing applications and now account for more than half of the total textile output. The
processes in making technical textiles require costly machinery and skilled workers.

The application that comes under technical textiles are filtration, bed sheets and abrasive
materials, healthcare upholstery and furniture, blood-absorbing materials and thermal
protection, adhesive tape, seatbelts, and other specialized application and products.

Strengths

. India enjoys benefit of having plentiful resources of raw materials. It is one of the
largest producers of cotton yarn around the globe, and also there are good resources of
fibres like polyester, silk, viscose etc...

. There is wide range of cotton fibre available, and has a rapidly developing synthetic
fibre industry.
. India has great competitiveness in spinning sector and has presence in almost all
processes of the value chain.

. Availability of highly trained manpower in both, management and technical. The

country has a huge advantage due to lower wage rates. Because of low labor rates the
manufacturing cost in textile automatically comes down to very reasonable rates.

. The installed capacity of spindles in India contributes for 24% share of the world, and it
is one of the biggest exporters of yarns in the global market. Having modern functions
and favorable fiscal policies, it accounts about 25% of the world trade in cotton yarn.

. The apparel industry is largest foreign exchange earning sector, contributing 12% of the
country's total exports.

. The garment industry is very diverse in size, manufacturing facility, type of apparel
produced, quantity and quality of output, cost, requirement for fabric etc. It comprises
suppliers of ready-made garments for both, domestic or export markets.

Weakness

Massive Fragmentation:

A major loop-hole in Indian textile industry is its huge fragmentation in industry

structure, which is led by small scale companies. Despite the government policies, which
made this deformation, have been gradually removed now, but their impact will be seen
for some time more. Since most of the companies are small in size, the examples of
industry leadership are very few, which can be inspirational model for the rest of the
industry.

The industry veterans portrays the present productivity of factories at half to as low as
one-third of levels, which might be attained. In many cases, smaller companies do not
have the fiscal resources to enhance technology or invest in the high-end engineering of
processes. The skilled labor is cheap in absolute terms; however, most of this benefit is
lost by small companies.

The uneven supply base also leads barriers in attaining integration between the links in
supply chain. This issue creates uncontrollable, unreliable and inconsistent performance.

Political and Government Diversity:

The reservation of production for very small companies that was imposed with an
intention to help out small scale companies across the country, led substantial
fragmentation that distorted the competitiveness of industry. However, most of the sectors
now have been de-reserved, and major entrepreneurs and corporate are putting-in huge
amount of money in establishing big facilities or in expansion of their existing plants.
Secondly, the foreign investment was kept out of textile and apparel production. Now, the
Government has gradually eliminated these restrictions, by bringing down import duties
on capital equipment, offering foreign investors to set up manufacturing facilities in
India. In recent years, India has provided a global manufacturing platform to other multi-
national companies that manufactures other than textile products; it can certainly provide
a base for textiles and apparel companies.

Despite some motivating step taken by the government, other problems still sustains like
various taxes and excise imbalances due to diversification into 35 states and Union
Territories. However, an outline of VAT is being implemented in place of all other tax
diversifications, which will clear these imbalances once it is imposed fully.

Labour Laws:
In India, labour laws are still found to be relatively unfavorable to the trades, with
companies having not more than ideal model to follow a 'hire and fire' policy. Even the
companies have often broken their business down into small units to avoid any trouble
created by labour unionization.

In past few years, there has been movement gradually towards reforming labour laws,
and it is anticipated that this movement will uphold the environment more favorable.
Distant Geographic Location:
There are some high-level disadvantages for India due to its geographic location. For the
foreign companies, it has a global logistics disadvantage due the shipping cost is higher
and also takes much more time comparing to some other manufacturing countries like
Mexico, Turkey, China etc. The inbound freight traffic has been also low, which affects
cost of shipping - though, movement of containers are not at reasonable costs.

Lack of trade memberships:

India is serious lacking in trade pact memberships, which leads to restricted access to the
other major markets. This issue made others to impose quota and duty, which put scissors
on the sourcing quantities from India.

Opportunities

It is anticipated that India's textile industry is likely to do much better. Since the
consumption of domestic fibre is low, the growth in domestic consumption in tandem is
anticipated with GDP of 6 to 8 % and this would support the growth of the local textile
market at about 6 to 7 % a year.

India can also grab opportunities in the export market. The industry has the potential of
attaining $34bn export earnings by the year 2010. The regulatory polices is helping out to
enhance infrastructures of apparel parks, Specialized textile parks, EPZs and EOUs.

The Government support has ensured fast consumption of clothing as well as of fibre. A
single rate will now be prevalent throughout the country.
The Indian manufacturers and suppliers are improving design skills, which include
different fabrics according to different markets. Indian fashion industry and fashion
designers are marking their name at international platform. Indian silk industry that is
known for its fine and exclusive brocades, is also adding massive strength to the textile
industry.

The industry is being modernized via an exclusive scheme, which has set aside $5bn for
investment in improvisation of machinery. International brands, such as Levis, Wal-Mart,
JC Penny, Gap, Marks & Spencer and other industry giants are sourcing more and more
fabrics and garments from India. Alone Wal-Mart had purchased products worth $200mn
last year and plans to increase buying up to $3bn in the coming year. The clothing giant
from Europe, GAP is also sourcing from India.

Anticipation
As a result of various initiatives taken by the government, there has been new investment
of Rs.50,000 crore in the textile industry in the last five years. Nine textile majors
invested Rs.2,600 crore and plan to invest another Rs.6,400 crore. Further, India's cotton
production increased by 57% over the last five years; and 3 million additional spindles
and 30,000 shuttle-less looms were installed.

Forecast till 2010 for textiles by the government along with the industry and Export
Promotion Councils is to attain double the GDP, and the export is likely attain $85bn. The
industry is anticipated to generate 12mn new jobs in various sectors.

How to uphold textile Industry

Weak infrastructure may be a hindrance which can be overcome with better network and
with the willingness to share profit by loyalty bottom up and patronization from above
downwards.

. By putting more retail outlets,

. With better value added products,

. By taking the lowest end of the chain into confidence and building their capability to
innovate more and more.

. By upholding the market knowledge at every level that happens at higher-end that lifts
the chain.

. By building on the expertise for technical textiles that include bed sheets; filtration and
abrasive materials; furniture and healthcare upholstery; thermal protection and blood-
absorbing materials; seatbelts; adhesive tape, etc which need skilled workers who are not
easy to find in an Indian market.

. By keeping a regular research and development department with regards to the industry
. By building up the peripheral market with regular update of new accessories.

. By integrating the disorganized sectors into one segment that is functionally

independent of each other's unwanted stranglehold

. By putting affiliated efforts into the sector

. By creating a state owned cargo-shipping mechanism : with rationalizing fiscal duties;

upgrading technology through the Technology Up-gradation Fund Scheme (TUFS);

. By setting up of Apparel Parks

. By clearing off bottlenecks in the form of regulatory practices

. By replacing the indirect taxes with a single nationwide VAT

. With liberalization of contract norms for textile and garments units

. By controlling export of raw materials

. By curtailing the drawback claims falsely boosted invoice value of exports

. By effectively installing a price discovery mechanism to track market trend to take

effective measures before hand a slump

How to promote textile exports

For promotion of exports the measures which should be taken up are

. Up gradation of textiles sector

. Policy level decision to achieve export target

. Woven segment of readymade garment sector and knitwear have been de-reserved

. Technology Up-gradation Fund Scheme to be pursued till next five years

. Liberalization of FDI Policy with up to 100 per cent foreign equity participation

. Import of capital goods at 5% concession rate of duty with appropriate export obligation
under

Export Promotion Capital Goods (EPCG) Scheme and clearly laid out EXIM policy

. Advance Licensing Scheme with standard input-output norms

. Prescribed Duty Exemption Pass Book (DEPB) Scheme credit rates

. Duty Drawback Scheme wherein the exporters are allowed refund of the excise and
import duty loss on raw materials

. Construction of Apparel International Mart by Apparel Export Promotion Council to

provide a world class facility to the apparel exporters to exhibit products and built
international reputation

. Setting up of quality checking laboratories

. Apparel Park for Exports Scheme to invite international production units along with in-
house production floors.

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Strengths:

• Indian Textile Industry

is an Independent & Self-Reliant industry.

• Abundant Raw Material availability that helps industry to control costs and reduces
the lead-time across the operation.
• Availability of Low Cost and Skilled Manpower provides competitive advantage to
industry.
• Availability of large varieties of cotton fiber and has a fast growing synthetic fiber
industry.

• India has great advantage in Spinning Sector and has a presence in all process of
operation and value chain.
• India is one of the largest exporters of Yarn in international market and
contributes around 25% share of the global trade in Cotton Yarn.
• The

Apparel Industry

is one of largest foreign revenue contributor and holds 12% of the country’s total
export.

• Industry has large and diversified segments that provide wide variety of products.
• Growing Economy and Potential Domestic and International Market.
 • Industry has Manufacturing Flexibility that helps to increase the productivity.

Weaknesses:

• Indian Textile Industry is highly Fragmented Industry.

• Industry is highly dependent on Cotton.
• Lower Productivity in various segments.
• There is Declining in Mill Segment.
• Lack of Technological Development that affect the productivity and other
activities in whole value chain.
• Infrastructural Bottlenecks and Efficiency such as, Transaction Time at Ports and
transportation Time.
• Unfavorable labor Laws.
• Lack of Trade Membership, which restrict to tap other potential market.
• Lacking to generate Economies of Scale.
• Higher Indirect Taxes, Power and Interest Rates.

Opportunities:

• Growth rate of Domestic Textile Industry is 6-8% per annum.

• Large, Potential Domestic and International Market.
• Product development and Diversification to cater global needs.
• Elimination of Quota Restriction leads to greater Market Development.
• Market is gradually shifting towards Branded Readymade Garment.
• Increased Disposable Income and Purchasing Power of Indian Customer opens
New Market Development.
• Emerging Retail Industry and Malls provide huge opportunities for the Apparel,
Handicraft and other segments of the industry.
• Greater Investment and FDI opportunities are available.

Threats:

• Competition from other developing countries, especially China.

• Continuous Quality Improvement is need of the hour as there are different
demand patterns all over the world.
• Elimination of Quota system will lead to fluctuations in Export Demand.
• Threat for Traditional Market for Powerloom and Handloom Products and forcing
them for product diversification.
• Geographical Disadvantages.
• International labor and Environmental Laws.
• To balance the demand and supply.
• To make balance between price and quality.