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The Path Forward for the Asian Apparel and Footwear Industry

Companies and Markets

By Daniel Cooper  |  August 10, 2022

The global COVID-19 pandemic has had a dramatic impact on the global apparel and footwear industry. This is especially true for Asian producers, responsible for 61% of global export activity. To analyze the pandemic’s effect on this industry, we took public financial data for manufacturers together with customs import and export data at a country level across the globe and tried to understand what has happened over the last two difficult years. We also suggested some priority items that the industry may focus on as it recovers from the turbulence created by the pandemic.

Growing Debt Could Reduce Profits

We considered approximately 1,700 manufacturers as part of this analysis and it covers a broad range of revenue groups. Manufacturers based in China but incorporated in Hong Kong were separated as their financing requirements differ from those incorporated on the mainland.

The first thing that was apparent was these manufacturers have grown debt on their balance sheets faster during the pandemic period than they did in previous years. The manufacturers remain liquid, but this is potentially due to shoring up their balance sheets with cash that was sourced from new debt.

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If this cash was created using corporate bonds, the potential for higher interest rates in the future could make these debt instruments very unattractive to investors on the secondary market. While this isn’t a primary concern of the company itself, bankers may be more nervous about raising large debt in this way if it causes a future distribution challenge.

While sales in 2021 showed signs of significant recovery from the pandemic year, the level of increase is expected to be short lived. The industry projections indicate that while the industry will continue to grow, it will do so in a softer manner than we saw in 2021 and is projected to see in 2022. By the time we get to 2024, balance sheets are potentially going to be overloaded with debt as a percentage of sales. If inflation is not brought under control quickly, or the debt levels are not reduced, the extra interest expenditure could further drag on profitability.

The era of low interest rates where debt is easy to obtain and cheap is now behind us. Excess debt is going to quickly erode margins.

The era of low interest rates where debt is easy to obtain and cheap is now behind us. Excess debt is going to quickly erode margins. How these corporates return to gearing models in line with their strategic goals is going to be hard.

Companies that have not focused on operational efficiency and achieving optimum working capital deployment are going to have to play catchup quickly. There is plenty of low-hanging fruit where significant capital can be created in this area. This capital could be used to help repay some of the increase in debt.

Sustainability and Supply Chains

Manufacturers that are not on track to support the delivery of the United Nations’ Fashion Industry Charter for Climate Action run the risk of losing the support from the buyers that have signed up. Sustainability is no longer an objective you can ignore and those that have and have loaded up their balance sheets with debt trying to survive the pandemic could be in a lot of trouble going forward.

Making supply chains fit for purpose is going to take a long time to complete but nearshoring and geographically spread supply chains are going to be key. Current single points of failure will be addressed by sourcing from many manufacturers, across multiple countries. Nearshoring will potentially break the dominance of Asian supply in this industry and move output to Turkey and North Africa for European buyers, and Central America for buyers located in the United States.

Future supply chains will be a lot more complex and have to consider nearshoring, waste minimization, and the reduction of social and environmental impacts.

Supply chains are complicated beasts. In its current configuration, the supply chain in this industry was designed purely for cost optimization—how buyers could get the lowest possible unit price for their products. Future supply chains will be a lot more complex and have to consider the speed and agility of delivery via nearshoring, the minimization of waste through adoption of new technologies, and the reduction of social and environmental impacts from better equipment and work practices.

Nearshoring could lead to an era of Asian suppliers setting up operations in these new countries and/or looking at mergers and acquisitions to create capacity quickly. The booming population growth in emerging Asia will continue to create significant demand from Asian suppliers, but they will also look to take up the expansion opportunity given their high levels of automation and experience in producing these products in mass volumes.

Manufacturers in the ASEAN region look likely to be the beneficiaries of any de-concentration in China-specific output. Suppliers in the more mature apparel markets of Vietnam and Bangladesh will need to start thinking about injecting capital into capacity expansion to accept new orders.

For Vietnam this is high viable as there is land and people capacity. Many Chinese corporates have already invested in Vietnam so expansion could be relatively simple. However, in Bangladesh many of the existing suppliers may feel they are already at capacity. Land and power resources are scarce and without significant investment in the country’s transport infrastructure, it may struggle to efficiently move increased factory output to overseas buyers.

Conclusion

Is the apparel and footwear industry in trouble? The short answer is no more than any other industry. The waters just charted are unprecedented and no one could have prepared for the events of the last two years. The key priority for many has been survival and, in an environment where sales have collapsed, that either meant scaling back operations, drawing on reserves, selling assets, or taking on more debt—or a combination of all the above.

After the events of the last two years, the challenge for the apparel and footwear industry is how to re-baseline and re-write strategic plans.

The challenge for these corporates is how they re-baseline and re-write strategic plans. Over the next five years, capital expenditure plans may need to be scaled back to give the headroom to correct the balance sheet changes made during the pandemic. We may even see a period of consolidation if suppliers can find acquisition targets that can help bridge their proposition gaps—this could be quicker and cheaper than building out organically.

It seems logical that Chinese suppliers would step up their investments in Vietnam to help protect their buyers from any tariff complications. Another potential partnership would be for Bangladesh suppliers to do the same to help overcome their output capacity constraints.

However, one plan that cannot change is delivering on the sustainability agenda. The commitments made by the big brands are significant and they will look for suppliers to support them. Failure could be terminal for a manufacturer in this industry.

Other articles in this series:

Impact of the COVID-19 Pandemic on the Asian Apparel and Footwear Industry

How Has the Pandemic Impacted the Balance Sheets of Asian Apparel and Footwear Producers?

The Asian Apparel and Footwear Industry Looks to Recovery

This blog post has been written by a third-party contributor and does not necessarily reflect the opinion of FactSet. The information contained in this blog post is not legal, tax, or investment advice. FactSet does not endorse or recommend any investments and assumes no liability for any consequence relating directly or indirectly to any action or inaction taken based on the information contained in this article.

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Daniel Cooper

Founder, Alba Capital

Mr. Daniel Cooper is the founder of Alba Capital, based in Hong Kong, China. In this role, he helps corporates in and around Asia Pacific understand the working capital optimization options from the rarely considered aspect of operations. Prior, Mr. Cooper held various roles during his 24-year tenure at HSBC helping corporates worldwide in their working capital journeys. In the latter part of his career, he was the Global Head of Supply Chain Finance and the Asia Head of Working Capital Advisory. Mr. Cooper earned a Bachelor of Science (BSc) in applied software engineering from UCE (now Birmingham City University).

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The information contained in this article is not investment advice. FactSet does not endorse or recommend any investments and assumes no liability for any consequence relating directly or indirectly to any action or inaction taken based on the information contained in this article.