2678.HK
Texhong sinks into the red

The company issued its second profit warning in the last seven months, as it fell into the red last year and began selling assets to raise cash

Key Takeaways:

  • Texhong reported it fell into the red with a loss of about 300 million yuan for 2023, reversing a 200 million yuan profit the previous year
  • The yarn maker has begun selling assets to raise cash, as it and its peers suffer from plunging margins due to weak global demand for textiles

 

By Edith Terry

Texhong International Group Ltd. (2678.HK) is trying to convince investors that its shop is well-knitted, after the yarn-making giant issued its second profit warning in a little over six months. In its latest warning just last week, the company forecast a net loss of 300 million yuan ($42 million) for 2023, spinning it into the red after reporting a 200 million yuan profit in 2022.

The latest warning follows a similar one for the first half of 2023, when Texhong ultimately reported its revenue fell nearly 20% and it lost 740 million yuan in the six-month period. The falling revenue was notable because the volume of the company’s yarn sales, its main revenue source, actually rose 8.9% year-on-year to 349,000 metric tons for the period. That dichotomy highlights the dilemma Texhong and its peers now face, as yarn prices tumble due to weak global demand for textiles.

Texhong’s revenue from yarn sales in the first half year of last year fell 12.4% to about 8 billion yuan, while its total revenue fell by 17.1% to 10.8 billion yuan. As its prices came under pressure, its gross margin tumbled to just 2.4% in the first half of 2023 from 19.7% a year earlier. Its gross margin for yarns barely stayed positive at just 0.7%.

Not surprisingly, the market was less-than-impressed with the company’s latest gloomy signals. After briefly rising the first trading day following the latest profit warning, Texhong’s shares fell by 7% from pre-announcement levels over the next two days, resuming a trend that has seen them lose nearly half their value over the last year.

Texhong’s recent downturn reflects changing economics following its bold move to offshore production from its original China base, where cotton prices were relatively high due to domestic price supports, to Vietnam, where lack of such supports meant prices were considerably lower. The move made Texhong a textile superstar, minting a billionaire of founder Hong Tianzhu. But costs in Vietnam have risen substantially with the country’s own recent rise, a trend likely to accelerate as it emerges as a preferred location for global manufacturers looking to diversify beyond China.

Texhong has taken steps to improve profitability by selling assets to reduce its debt. Last August it sold a 250,000-square-meter money-losing factory in Vietnman’s Quang Ninh province to Texwinca Holdings (0321.HK) for $78.6 million. Three months later one of its subsidiaries sold another 975.1 million yuan in assets used for dyeing and electroplating.

Texhong blamed weak global demand for its shriveling revenue and drop into the red in the first half of 2023. But another issue for the company has been its penchant for non-stop investment, particularly in Vietnam. As recently as March 2020, Texhong had pledged to invest $500 million in the Southeast Asian country. At that point it employed 20,000 Vietnamese and supplied 43% of the yarn used for the country’s domestic textile production. Its revenue peaked in 2019, but its profit was already coming under pressure with a 25% decline that year.

Ramping up investment

As it ramped up its new investment, Texhong’s borrowing increased from 7.2 billion yuan to 8.5 billion yuan between 2021 and 2022, far faster than its cash holdings and accounts receivable that rose only slightly from 5.4 billion yuan to 5.5 billion yuan over that period. This means its debt was increasing faster than its ability to cover its short-term obligations. That was fine when everyone expected a post-pandemic rebound to boost global demand for textiles. But such a rebound never really happened, especially for Texhong’s main base of buyers in China.

Reflecting the industry’s sluggishness in China, cotton imports for the country fell 17.6% in the 2022-23 season, according to the China Cotton Association. Higher interest rates abroad and a weak Chinese yuan were factors in the import slowdown. But consumption of domestically grown cotton was also up just 4.1% that season at 7.6 million tons.

Sluggish demand from textile makers put downward pressure on yarn prices. China’s imports of cotton yarn from Vietnam rose by 11% in volume terms to 638 metric tons in the first 10 months of 2023, but the actual value of that yarn fell by 8% to $1.8 billion, according to the US Department of Agriculture.

Most of Texhong’s sales are to China, and China’s share of the total rose from 58.4% to 67.4% between the first half of 2022 and the first half of 2023. But in 2023, yarn prices dropped sharply.

As prices sagged, Vietnam’s export revenues for yarn fell by 11% between January and October 2023 to $3.7 billion, as some producers accepted prices below the cost of production to stay in business. But the pressure claimed at least two Vietnamese mills that were added to the International Cotton Association’s defaulter list. Vietnam’s export revenues from textiles were expected to fall by 5% to 6.3% for all of 2023, according to a Vietnam Textile & Apparel Association forecast in late October.

Costs have also soared in Vietnam, with both wages and rents rising as the country’s standards of living rise. The average daily rent for a factory in Haiphong, Vietnam, ranges from 1 yuan to 1.5 yuan per square meter, according to the manager at Tiansu Machinery and Technology in China’s Zhejiang province, almost identical to similar factories in Zhejiang with better infrastructure. Monthly salaries tripled between 2018 and 2021, to about 3,000 yuan, according to the same source.

Texhong has also had to tackle criticism from Sheffield Hallem University in Britain, which claimed in a 2021 report that one of the company’s Chinese subsidiaries was using forced labor. Texhong responded by saying it had bought the factory in 2016 to be closer to its cotton resources, but added it had sold the subsidiary as of November 2021.

Despite its woes, Texhong certainly isn’t alone in feeling the pain of weak demand for textiles. Its stock currently trades at a price-to-sales (P/S) ratio of 0.15, not far behind peers such as Weiqiao Textile Co. (2968.HK) at 0.23, Texwinca at 0.21, and Fountain Set (0420.HK), which is even lower at just 0.09. Such low ratios aren’t surprising for this kind of old-school sector. What’s more, the group is likely to come under further pressure until prices start to rebound and companies like Texhong can find a way back to profitability.

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