Trade tensions threaten to unravel Texhong turnaround story

The yarn maker has been profitable since the second half of 2023, but its recent turnaround could be threatened by new U.S. tariffs against Chinese exports

Key Takeaways:

• Texhong reported a profit of 580 million yuan last year, extending a recent turnaround as it focuses on its core yarn business and cost controls
• The company sells its yarns and fabrics mostly to textile makers in China, which could expose it to new U.S. tariffs imposed by Donald Trump this week on Chinese goods

By Doug Young

Textile company Texhong International Group Ltd. (2678.HK) has become quite the complex creature these days, pulled in multiple directions by both internal and external factors. The overall picture looked good last year, as the company that derives most of its money from yarn sales returned to profitability after losing money in 2023.

Texhong continued its profitable ways in the second half of last year, based on calculations from a positive profit alert issued in late January. That turnaround owed to both internal and external factors, as Texhong reduced costs and honed its focus on its core yarn business. At the same time, Chinese textile makers that are Texhong’s main customer also saw improving business after a difficult year in 2023.

But having emerged from the earlier downturn, Texhong now stands on the cusp of another potential storm posed by U.S. President Donald Trump’s recent rollout of new tariffs against Chinese imports, which could have a major impact on China’s textile industry. Texhong has yet to comment on Trump’s latest moves which just took effect this week and we’ll detail shortly.

On the whole, investors appear quite sanguine about the situation, at least with regards to Texhong. The company’s stock has been quite stable with only small movements since its positive profit alert on Jan. 24. The lack of movement may owe to indecision as investors try to figure out whether to applaud the company’s return to profitability or worry over the potential impact of Trump’s new tariffs.

Investors may also be looking for clues as to how Texhong’s profit will trend, as the latest signals aren’t very clear. The company fell into the red in the first half of 2023 as it struggled with weak demand from textile makers in China, which account for about 80% of its business. But it returned to the black in the second half of that year with a 488 million yuan ($67 million) profit in the six-month period.

Since then, its profits have been a bit unstable, falling to 270 million yuan in the first half of last year, before rising to 310 million yuan in the second half, based on calculations using the company’s late January announcement that it would record a profit of 580 million yuan for all of last year.

It credited the return to full-year profitability mainly to “the recovery in market demand in the textile industry during the year, such that both the sales volume and capacity utilization rate of the group increased when compared with the year ended 31 Dec. 2023, allowing the product gross profit margin to gradually return to normal levels during the year.”

The company also engaged in its own house-cleaning last year by becoming more efficient, partly by focusing more on its core yarn business, whose share of total revenue rose to 78.4% in the first half of last year from 75% a year earlier. As it did that, its cost of sales dropped to 87% of its revenue in the first half of last year from 98% a year earlier. Its overall revenue also returned to growth in the first half of last year, rising 4.2% to 11.2 billion yuan after falling at a similar rate in all of 2023.

Dividend restoration

As its operations and the broader textile market improved, Texhong’s gross margin also rose sharply to 13.2% in the first half of last year from just 2.4% a year earlier. Squarely back in the black, the company also resumed paying dividends in the second half of last year, after suspending such payments in 2023 while it worked out its problems.

Even after all that turnaround, Texhong’s stock still looks relatively undervalued at a price-to-earnings (P/E) ratio of 5.9, trailing the 7.7 for Texwinca (0321.HK) and 14 for Fountain Set (0420.HK). Texhong’s stock is also relatively unchanged over the past year, up just 6% over that time, showing investors are playing a “wait and see” game to determine if the company’s turnaround is sustainable, especially in the face of the latest trade actions from the U.S.

That leads nicely into the shockwaves that have rattled Chinese exporters over the past week due to actions coming from Washington. Specifically, Trump’s administration imposed a 10% additional tariff on all Chinese goods coming into the U.S. Simultaneously, he also eliminated the so-called “de minimis” exemption that allows packages containing goods worth less than $800 to enter the U.S. duty-free.

Chinese e-commerce companies led by Shein and PDD’s (PDD.US) Temu had been taking advantage of the exemption to flood the U.S. with cheap goods ordered online by U.S. consumers. Shein exclusively sells textiles as a fast fashion e-commerce company, while textiles are also a sizable portion of Temu’s more diverse selection of goods.

Texhong may have anticipated such actions with its decision to diversify its manufacturing base beyond China in recent years, though that probably owed more to lower costs than trade issues. The company now does more than 40% of its yarn production outside China, mostly in Vietnam. But such diversification is unlikely to protect the company now since it still sells most of its Vietnam output back to customers in China, who will be subject to the new Trump tariffs.

China produced a massive 1.13 trillion yuan worth of textiles in the first half of last year, with textile exports equaling the vast majority of that – just over 1 trillion yuan – during that period, according to industry data in Texhong’s midyear report last year. Other data shows that about 14% of China’s $303 billion in textile exports in 2022 went to the U.S., and the amount is likely even higher now due to the rise of Shein and Temu over the last two years.

The bottom line is that there really isn’t a clear bottom line for Texhong right now, at least for investors. The company generally looks slightly undervalued following its recent overhaul and an industry recovery. But Texhong still needs to show investors that its own recovery is sustainable, and also that it won’t get hit too hard by the escalating U.S.-China trade war.

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