Textile companies (or anything but COVID-19)

Markets around the world are falling, 50,000 have been quarantined in Italy, Turkey shut its border to Iran, Trump forced the State department to repatriate Americans off the cruise ship stuck in Japan, which doubled the number of cases in the US. Basically, it’s the end of times!

Source: World Bank

But let’s talk about textiles. Actually, let’s talk about anything else besides COVID-19, and today that something is textiles.

See, I started thinking about textiles after writing about Cambodia (last Wednesday) and Vietnam’s textile exports. Textiles and garments are a big part of the economy, making up 16% of total merchandise exports. They disproportionately employee people, so probably more than 16% of the population works in or with textiles. A bigreason why people move from the countryside to urban areas is to get a job in a place like a textile factory.

But looking at the stock market, there really aren’t many large companies in the textile sector. Looking at the major companies listed in Vietnam, the largest is Vietnam National Textile & Garment Group (VGT), with a market cap of less than $200m. That’s one reason why there aren’t any Vietnamese companies in the VNM ETF that make textiles. There are three foreign companies, and they are definitely larger, but they aren’t that large. Eclat is the largest at $1.7bn market cap.

Beyond just side, the companies trade at very low P/E multiples. The average P/E multiple for the largest Vietnamese companies is just 5.9x, and that’s based on trailing earnings. The foreign companies trade much higher. But then again, they have much higher margins.

Source: Vietecon.com. Share prices and market cap are as of 24 Feb. 2020. *Market cap figures for the foreign companies are in billions of local currency (under Mkt Cap VNDbn). These three figures hadn’t published 2019 full results, so P/E and revenue growth reflect TTM for 2019.

More surprises: revenue growth is not that impressive. For the Vietnamese companies, average growth (2016-19) is just 12%, but the variation is wide from 1% to 35%. And operating margins are very low at 4%.

Source: WTO

My supposition is that the companies are ultimately too small to compete well. That means that they have to take what they can get, which means very low sales prices. They may also struggle to recruit workers, hurting their profits. This will likely only get worse as more companies compete for unskilled laborers.

Gross margins are oftentimes not above 10%, which means that they haven’t really vertically integrated, which would allow them to capture some of that margin from upstream. The export-import data seems to show this as well. Imports of textiles have increased basically in line with the increase in exports. Meaning that the raw materials needed to make cloths are being imported.

If this is true, a roll-up strategy might be interesting. As these companies gain scale, they would be better equipped to invest in more productive machinery, get bigger and better contracts and increase margins. And hopefully they could move up and down the value chain - meaning taking raw materials to make thread and cloth and therefore getting some of that margin. Vietnam really doesn’t have the raw material, so there might be a limit to how much profit they can eventually garner.

Source: WTO

Ultimately, it is hard to say if scale would be enough to fix weak margins in the sector. There aren’t that many large textile manufacturers globally. It may be that there isn’t much benefit to scale, and that the retailers will always go with the lowest cost producer. If so, then scale might not be that great, but it sure couldn’t hurt.

Overall, Vietnam depends heavily on textiles, but it is really not a great business. Exports in the sector are growing at the level of overall exports. So it will probably continue to be an important sector, but not one that will drive future export growth.