IPO candidate Pacific Textiles pushes growth story

The company's focus on complex fabrics keeps margins high and gives it an edge over Hong Kong-listed peers.
Pacific Textiles Holdings has kicked off the official roadshow for a Hong Kong initial public offering that aims to raise up to HK$1.97 billion ($250 million). The Chinese fabrics manufacturer will be trying to persuade investors with its growth story, arguing promising prospects for ChinaÆs cotton knit manufacturing industry following the expiration of trade quotas in 2005.

The company is offering 25% of its enlarged share capital, or 358 million new shares, at a price between HK$4.15 and HK$5.50. A 15% greenshoe could boost the total proceeds to about $290 million. The deal is jointly arranged by Citi and Morgan Stanley.

According to analysts, the textile manufacturer, which offers fabric knitting, dyeing and finishing services and produces knitted fabric products from raw or dyed yarns, has an edge over its closest comparables in the mid-stream of the textile supply chain in that it makes more complex and higher-value products. One example is its production of higher margin fabrics for inner wear and swimwear, which made up approximately 30% of its revenues in the fiscal year ending March 2006.

Other Hong Kong-listed Chinese cotton knitted fabric manufacturers such as Fountain Set, Texwinca and Victory City, mainly focus on fabrics for leisure wear, which is less difficult to make and commands lower margins.

Higher sales will be the key growth driver for Pacific Textiles, according to sources close to the company, and syndicate research forecasts sales increases ranging from 20% to 30% between fiscal 2007 and 2008. The company reported a net profit growth of 30% to HK$459 million in the year to March 2006 and by fiscal 2009 its bottom line is expected to exceed HK$800 million ($102 million), equivalent to a compound annual growth rate of around 20%.

In addition to its dyeing and knitting of fabrics for apparel production, Pacific Textiles is also trying to boost its earnings by moving into the manufacturing of more niche fabrics. In 2005 it entered into a joint venture with Suminoe Textile and Marubeni Corporation to produce fabrics for Japanese auto makers in China. One syndicate analyst estimates that the production cost for auto fabrics is 50%-80% higher than for apparel fabrics, but average selling prices should also be significantly higher. Pacific Textiles owns 33% of the JV, which started production in 2006 and is expected to bring in profits from fiscal 2008.

When the quota system was removed in 2005, the sharp escalation of Chinese garment exports resulted the adoption of anti-surge measures by both the US and the EU. The uncertainties posed by these measures disturbed the purchasing pattern of apparel distributors and hence adversely affected the capacity utilisation of fabric producers such as Pacific Textiles.

China has since reached export agreements with the EU and the US and the anti-surge restrictions will expire in 2008/2009. It is generally agreed that the quota removal should be positive for ChinaÆs garment industry over the long term, and that the Chinese garment producers will grasp the chance to increase their market share.

Meanwhile, fabric producers are less vulnerable to competition as entry barriers, including capital requirements, are higher in this part of the supply chain than they are for the garment producers further down stream. Also, it isnÆt a given that the entire production must be exported.

ôAlongside the trade agreements signed between China, the EU and the US, one shouldnÆt neglect ChinaÆs domestic demand for fabrics,ö says an analyst covering textile companies.

ChinaÆs apparel retail industry generated total revenues of US$61.2 billion in 2005, attributing 7.4% to the global apparel revenue, according to Datamonitor. The online database provider forecasts ChinaÆs retail sales revenue will increase at a CAGR of 6% to US$81.8 billion in 2010, which will account for 8.6% of total sales in the global apparel retail industry.

However, Pacific Textiles ships about 30%-35% of its fabrics to garment factories in China, but estimates that garments sold in the US account for around 75% of the fabrics it produces. China currently accounts for less than 1%.

ôThe valuations of textile companies are also relatively cheaper than Chinese companies in other sectors with growth potential,ö the analyst notes.

According to syndicate research, the Hong Kong listed fabric manufacturers currently trade at between five and 10 times their 2007 earnings on a calendarised basis, while the garment producers trade at seven to 11 times. This compares with price-to-earnings multiples of 30 to 40 times for Chinese retail stocks, which are highly popular among investors.

The price range values Pacific Textiles at 8.6 to 11.4 times its projected earnings in fiscal 2008, which at the top end pitches it at a slight premium to its Hong Kong-listed peers. According to Bloomberg data, Texwinca and Victory City International, which both have fiscal years ending in March, trade at fiscal 2008 P/E multiples of 10.4 times and 5.6 times respectively. Fountain Set, which has a fiscal year ending in August, trades at a P/E multiple of 7.9 for fiscal 2008 and 6.5 for fiscal 2009.

Fountain SetÆs share price has gained 26% this year, while Victory City has climbed 15%. Texwinca has been more volatile, but it too has recovered in recent days and yesterday finished 4% up on the year, marginally above the 2.1% year-to-date gain in the Hang Seng Index.

Among the potential risks, a significant deterioration in overseas consumer spending and sharp fluctuations in cotton prices could affect Pacific TextilesÆ earnings, given that 70% to 75% of its fabrics are made into garments sold in the US and 80% of its yarn requirement is cotton yarn. As the US economy is expected to slow this year and some industry reports estimate the cost of cotton yarn could rise 3% to 5% this year, the China textile industry as a whole could be plagued by shrinking exports and escalating production costs.

The textile industry in China is also fragmented and competitive and significant fixed-asset investment in the industry has raised concerns over excess capacity. With the rise of India, Pakistan and other low-cost producing countries, China fabric producers are going to face more intense competition from abroad, while the appreciation of the renminbi and tightening government environmental regulations could undermine their profit growth, according to one research report.

Pacific TextileÆs share offering has the usual structure with 90% going to the institutional tranche and 10% earmarked for retail investors. There is also a clawback mechanism that could increase the retail tranche to as much as 50% in case of heavy oversubscriptions.

The company is going to use the majority of the IPO proceeds to repay outstanding bank loans and to expand and upgrade its production facilities in Panyu in Guangdong Province. Part of the money will also go towards other corporate purposes. The company increased its bank borrowings significantly in fiscal 2006 to fund a dividend distribution of HK$941 million to shareholders.

Pacific Textiles was founded in 1997 by Wan Wai Loi, who was previously an executive director of Fountain Set. In fact, no fewer than four of the companyÆs executive directors previously held the same role at the rival firm, including Choi Kin Chung who was a co-founder and vice chairman of Fountain Set.

The management and other co-founders of Pacific Textiles will control close to 63% of the company after the IPO. These include The Capital Group, one of the worldÆs biggest funds, which has been holding shares in the company for years. The fund currently owns 11.5% of the company and will not be selling any shares as part of the IPO.

The final price is expected to be determined on May 11 and the trading debut is scheduled for May 18.
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