The past few months have been all hype about the textile sector, which has been posting consistently high exports and is in the process of getting a new policy with reportedly favourable terms approved. To better understand what’s ahead for the industry, MG had an insightful chat with Interloop Ltd Chairman Musadaq Zulqarnain.
Interloop is the largest listed textile company in Pakistan by market capitalisation, and in 2019 went public in a spectacular fashion, raising Rs4.8 billion. It has particularly made a name for itself in the production of socks, with a capacity of 700 million pairs of socks and tights annually.
Below are the edited excerpts of the interview.
The company’s full-year profitability plunged by 65% during FY20. Can you explain why?
MZ: Primarily there were two reasons: first we were in an expansion phase and then the last two quarters took a serious hit due to coronavirus as orders got cancelled. Production completely shut down and we had to pay salaries, which costs us anywhere around Rs650-700 million a month and the company didn’t let anyone go.
Another thing happened: every year the rupee depreciates, which results in a windfall in the receivables. This time, it was the opposite as the local currency got stronger, and we had to make accounting adjustments accordingly.
Those are the main reasons and there is nothing fundamentally wrong as you can see from the results of the next two quarters which are phenomenally better, despite no marketing due to our team’s inability to travel.
How sustainable are the renewed profitability and order flows considering two opposing factors: the lockdowns in Europe and the vaccine rollout?
MZ: I can’t really disclose specifically till it’s reported to the Pakistan Stock Exchange but from what we see, it’s getting better and the second quarter’s results appear to beat the first’s.
Generally speaking, in the short term, there will be some delays in orders from Europe as it is in a severe lockdown. Lots of brick and mortar retailers there have relatively smaller online presence than the US players so there will be an impact, but not as bad as the first wave. The vaccine rollout has ignited a hope but nobody knows how long that will take.
Lastly, the orders also depend on the broader macro economy. If the disposable income is shrinking and there is little stimulus then people won’t really be buying clothes so demand might take a small hit due to that in the coming 2-4 months as well. However, good stimulus in the West can result in better disposal incomes and better sales.
There was a marked increase in the company’s trade debts to Rs13.03 billion as of September end, from Rs7.28 billion in June. What explains the jump?
MZ: Due to the lockdowns, our production had taken a serious hit and there was little demand during parts of the April-June quarter, as such our receivables were low. But as the orders resumed, the trade debts went up accordingly. The increase seems bigger because of the low base effect.
Textile exports seem to be finally picking pace after staying flat for the longest time. What exactly has changed?
MZ: First let me clear a general confusion among people as to what comes under textiles. The World Trade Organisation has defined it very clearly. Textiles is defines as yarns, fabric and made-ups. What we do is apparel and garments. Across the globe, textile is reported separately from apparel and garments. Here we even include cotton fibre, a crop, under textiles which is baffling. Yearly growth in textile, how Pakistan defines it, was 8% but if you take apparel and garments, they saw an 18% increase on average.
Now coming to what triggered the latest upward trajectory of exports: the fact that Pakistan operates in a very basic segment, like t-shirts, fleece garments, under wears, socks, jeans etc, proved to be a blessing in disguise. All of these happened to be in high demand during Covid-19 so the orders grew while that of fashionable garments were down. Secondly, consumption of home textiles, which is our strong suit, went up.
There’s another largely unnoticed factor: a huge share of garments and knitwear supply in the US comes from Central and South America and all those countries were badly hit by Covid-19. A fraction of that demand was diverted to Pakistan, which was on top of some orders from India and even China.
Then obviously the exchange rate became reasonably favourable as well, which was coupled with energy rates getting more competitive with the rest of the markets. All of these fueled the export growth in the value added garments.
How much of a net impact does rupee devaluation have on an export unit, considering a major chunk of input costs are for energy, which move along with the exchange rate?
MZ: Quickly devaluing the currency also negatively affects the exports as the buyer immediately asks for a decrease in price. On the other hand, our costs jump since all the commodities go up. If 50% of my costs are raw materials, they automatically adjust. Similarly, energy automatically adjusts. All we benefit from depreciation is a small share of labour costs, and if we have to pass that on to the customer as well, then it’s a loss for us.
There is a thumb rule: the adjustment should be more or less equal to the difference between our and the trading partner’s inflation rate. But it has to be done gradually, not with the State Bank’s interference.
With news of gas shortages surfacing all around, what’s going to be the impact on Interloop and the sector as a whole?
MZ: We have enough alternate routes for our energy so as to avoid any impact on the company’s output but yes, there will be an effect on the cost of production. As for the sector, especially smaller units, there certainly is going to be a hit though quantifying that is tricky.
What’s your view of the upcoming textile policy and how that can boost exports?
MZ: For the first time, the textile sector was taken on board and the commerce adviser created a committee of industry experts and let us make the policy which is yet to be approved. However, policy is worth no more than a piece of a paper; it’s just a political statement from the government. Can I go to the high court on the basis of it to seek any relief? It can be reversed on a single individual’s whim, say, by the new administration.
So in my view, there should be statutory protection for any policy in order to be effective. To make sure the industry also sticks to its end of the bargain, the government can base the incentives on meeting certain key performance indicators. But if I don’t know if it will be implemented or not then how can I make long-term investments?
For apparel and value added garments, the thumb rule is that the asset turnover ratio will be at a maximum 2:1. So if we need to increase exports by $10 billion, then we’ll have to invest $5 billion. Now on that $25bn target, apparel currently occupies around $7bn in the overall textile sector exports and in order to take that to $15-20bn, you will need $8-10bn of investments in technology.
In order to do that, the industry also has to even incur the cost of infrastructure, such as by installing captive plants, roads or different types of boilers. Meanwhile, the alternate ways of making wealth have been made so much easier that it leaves little incentive for anyone to actually make investments.
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