Navigating The Asian Textile and Garment Supply Chain - Screen - April 2015

POSITIONING FOR PROFIT
NAVIGATING THE ASIAN TEXTILE & GARMENT SUPPLY CHAIN

APRIL 2015
CONTENTS
EXECUTIVE SUMMARY
EXECUTIVE SUMMARY
KEY INSIGHTS
THE TEXTILE AND GARMENT MARKET IS NOT LOCAL ANYMORE
UNDERSTANDING THE ASIAN SUPPLY CHAIN
12
WHAT HAVE CHINESE COMPANIES BEEN DOING TO COMPETE?
18
DIRECT SOURCING IN A LOWER AUD ENVIRONMENT
38
KEY CONTRIBUTORS
48
ABOUT CLIENT INSIGHTS & SOLUTIONS
48
IMPORTANT NOTICE
50
ANZ ASIA RETAIL
Effective supply chain execution has had a major impact

on profits for the Australian textile and garment industry
(manufacturers through to retailers) over the last five years,
as retailers have used a shift in product sourcing to reduce
costs in a low growth environment, at the expense of
manufacturers and wholesalers.
Supply chain efficiency covers two key themes, (1) getting
the right product at a lower price at a comparable level
of quality and (2) getting it to market as quickly as possible.
Having a better understanding of the supply chain provides
management with the information to make informed
sourcing decisions. Direct sourcing has had a structural
and positive impact on the cost base, and therefore
profitability, of Australian clothing and footwear retailers.
But this may not last.
Two major themes have emerged that will heavily influence

the future profitability of Australian retailers:
1. The focus on China as a major source of product has been
extremely successful, but there has been and continues
to be significant change in the upstream legs of the
supply chain. We examine the four key strategies that
Chinese textile and garment manufacturers are adopting
to recapture falling profits, and we assess the impact for
Australian retailers in the context of the entire value chain.
2. The continued move to direct sourcing for Australian
retailers has made foreign exchange risk management more
important than ever. Following on from our November 2013
report: The Migration to Direct Source Retailing: Opportunities
from a lower exchange rate, in a volatile AUD environment we
examine the profit implications and potential winners and
losers from a further fall in the currency.
KEY INSIGHTS
RISK MANAGEMENT IS NOW A SOURCE OF COMPETITIVE ADVANTAGE
China accounts for more than 40% of global textile and

garment exports. Australia accounts for around 2% of global
consumption. Chinese manufacturers are typically global
and larger, while Australian businesses are largely domestic
and smaller. The power in the supply chain is skewed towards
Chinese manufacturers and this directly and negatively
impacts the cost of capital for Australian retailers.
Due to increasing costs, low value textile and garment
manufacturing has been progressively moving away
from China to other markets such as Bangladesh,
Vietnam and Cambodia since 2007.
There are four key components in the upstream Chinese
supply chain for textiles and garments: (1) sourcing raw
materials, (2) fibre processing, (3) fabric production,
and (4) garment manufacturing. On average, operators
in all four parts of this supply chain are generating returns
at or below their cost of capital, as there has been
a downward trend in profitability.
The three key reasons for declining profitability in Chinas
upstream supply chain are: (1) average wages have increased
by 14% per annum since 2006, (2) being categorised as a low
cost source of production, many manufacturers have limited
capacity to pass on price increases to larger customers in the
US and Europe specifically, and (3) the move to just in time
and fast fashion has increased the working capital burden
for manufacturers. This has strained the operators capital base
without the associated increase in earnings, thereby diluting
return on equity (ROE).
Chinese manufacturers are implementing four key strategies
to improve profitability, which will have varying effects
on Australian retailers.
ANZ ASIA
OPPORTUNITY
RETAIL CHINA
1. Relocation of facilities to lower cost countries:

The aggregate cost benefits to manufacturers can
be significant, however, risks can be higher. Many
Chinese manufacturers are adopting a China +1
strategy and this can lead to both positive and negative
implications for Australian retailers. While lower prices
may be passed through, there may be brand and quality
risk. Furthermore, there may be lengthened sourcing
times due to employee unrest.
2. Increasing focus on fast fashion: Characterised by
the likes of Zara and H&M, fast fashion is influencing
the Chinese garment making sector due to the associated
expedited product cycles. Chinese manufacturers are
following these key clients into new markets but this
focus can come at the expense of smaller Australian
retailers that may be considered non-core.
3. Manufacturers shifting to higher margin products:
Low value add manufacturing is leaving China as
manufacturers shift their focus to higher margin products
to arrest falling margins. Australian retailers may need
to find new suppliers or choose suppliers from other
countries for low value garments, which can increase
business complexity and risk.
4. M
anufacturers are becoming more vertically integrated:
Vertically integrated manufacturers can achieve profit
margins more than 10% higher than specific parts of the
upstream supply chain. Furthermore, there have been cases
of manufacturers moving downstream into retail markets
such as Hong Kong listed Win Hanverky and locally Pacific
Brands has also adopted this strategy. Becoming more
vertically integrated can improve profitability for Chinese
manufacturers, however, this is unlikely to have a material
impact on Australian retailers in the medium term.
In FY2013, around 60% of discretionary retailers in Australia

were direct sourcing products from overseas. By FY2014,
ANZ estimates that this share had increased to 65-70%.
The primary focus for Australian retailers direct sourcing
has been Asia, and China in particular.
The move to direct sourcing has been the main driver
of gross profit margin gains for Australian retailers over
the last five years, but it has also increased their exposure
to foreign exchange volatility (see Fig 1). With more retailers
direct sourcing, the industry will now do much better in an
appreciating AUD environment and much worse in a lower
AUD environment.
Risk management is now more important than ever.
Interestingly, analysis of ANZ retail clients reveals that
the average hedging tenor declined from 6.5 months
in FY2013 to 5 months by early 2015. In a falling exchange
rate environment this is a negative trend.
Modelling a base case AUD/USD average exchange rate
of 0.75c during FY2016, more than 70% of direct sourcing
retailers are expected to exhibit a negative EBIT prior to
price increases or other cost saving initiatives. This share
will represent an increase from the 17% that are presently
EBIT loss making.
FIGURE 1. THE CHANGING IMPACT ON GROSS MARGINS

FROM DIRECT SOURCING
Source: CIQ, ANZ
FY09
Limited retailers direct sourcing
Average exchange rates drop significantly
Wholesaler gross profit margins more af fected
1.033
1.027
0.990
0.896
0.918
0.882
0.870
0.747
47.5%
38.4%
48.1%
39.8%
48.3%
37.1%
49.3%
50.5%
52.1%
50.5%
49.2%
39.7%
39.2%
39.4%
39.9%
37.3%
FY14
65% - 70% retailers direct sourcing
Average exchange rates drop by 10%
Both retailer and wholesaler gross prof it margins af fected
FY07
FY08
FY09
AUD/USD (Avg)
FY10
FY11
FY12
Retailers
FY13
FY14
YTD
Wholesalers
It is not all bad news as there are two identified tailwinds

for retailers that can help offset pain in a lower exchange
rate environment: (1) tariffs on textiles and garments fell
from 10% to 5% on 1 January 2015, which will make imports
cheaper and can help to partially offset higher FX induced
costs, and (2) The China-Australia Free Trade Agreement
will lead to nil tariffs from China from late December 2015,
when the agreement is expected to come into force.
China is Australias largest source for textiles and garments.
THE TEXTILE AND GARMENT MARKET

IS NOT LOCAL ANYMORE
THE GLOBAL GARMENT MANUFACTURING INDUSTRY
IS WORTH IN EXCESS OF USD $600 BN
The rise of online shopping is just one example of the

increasing globalisation of Australian retail. Online shopping
has led to increased competition, as foreign companies
have competed for the local dollar, while local retailers
have incorporated online as an omni-channel business
strategy to capture more of the customer wallet.
Another example of increased globalisation within the
industry, and specifically within the textile and garment
industry, is on the supply side. More and more Australian
clothing and footwear retailers are sourcing products
directly from the overseas manufacturer or overseas agents.
As highlighted in ANZs November 2013 report, The migration
to direct source retailing: Opportunities from a lower
exchange rate, the move to direct sourcing has been
the primary driver of retailer gross margin expansion,
as opposed to the widely held belief that retailers simply
got lucky due to a higher Australian dollar (AUD).
The move to direct sourcing has also provided retailers
with the option of sourcing products from a greater range
of manufacturers and wholesalers from more geographies.
Anecdotal customer feedback suggests that retailers may
not be fully aware of the dynamics, opportunities or issues
that may exist upstream in the supply chain.
The global garment manufacturing industry is worth in excess
of USD $600 bn (Fig 2). Capacity is largely driven by consumer
demand and like many discretionary related industries,
its highly correlated to economic growth and per capita
disposable income.
FIGURE 2. GLOBAL GARMENT MANUFACTURING

Source: Global Apparel Manufacturing, IBISWorld, December 2014
USD
604 bn
North Asia 35.8%
North America 5.0%
Europe 29.6%
South America 5.0%
South East Asia 15.1%
Africa & Middle East 1.9%
India & Central Asia 7.1%
Oceania 0.5%
Australia compares extremely favourably in per capita

spending on garments against major Western markets,
as well as key emerging markets. In 2013, Australians spent
USD $1,131 per person on garments, which is expected
to rise to USD $1,790 by 2025, implying an increase
in USD nominal terms of 3.9% per annum.
FIGURE 3. PER CAPITA SPEND ON GARMENTS
High disposable incomes and increasing wealth are

two key reasons why the Australian retail industry will
outperform other geographies in demand terms. Its also
one of the primary reasons why many foreign retailers
have been entering Australia, as the demand fundamentals
compare favourably against their home markets.
1,500
Despite the strong existing and forecast spend on clothing,

Australia still only accounts for around 2% of global
consumption. This is particularly important in the context
of the relationship between Australian retailers and their
global suppliers. The globally small share of the Australian
market has meant that many Australian retailers lack
bargaining power with their major suppliers, as their
volume is low compared to orders from major US and
European customers. This is particularly relevant for
many Australian retailers and Chinese manufacturers.
Source: India International Textile Machinery Exhibitions Society

In USD
2,000
1,000
500
0
2013
Europe
USA
China
Japan
India
Russia
Canada
Australia
Brazil
FIGURE 4. GARMENT CONSUMPTION BY COUNTRY

Source: India International Textile Machinery Exhibitions Society
USD m
600
450
300
150
0
ANZ ASIA RETAIL
2025F
2013
2025F
Europe
USA
China
Japan
Brazil
India
Russia
Canada
Australia
RoW
AUSTRALIAN RETAILERS MAY NOT HAVE THE POWER IN THEIR SUPPLY CHAIN
Further examination between Australian retailers and

Chinese manufacturers highlights a material difference
in size from a sales perspective. Based on ANZs clients
servicing the China-Australia textile and garment corridor,
the median Chinese clothing and footwear manufacturer
generated sales of AUD $225m and AUD $280m respectively
in 2014. This compares to AUD $157m and AUD $50m for
Australian clothing and footwear retailers. Furthermore,
the latter includes the major department stores,
which skew the figures to the upside.
Chinese firms tend to have global networks and are well
versed in dealing with companies across different continents
and regions. However, Australian retailers, as a whole, are still
relatively early into their journey of being more connected
into a regional supply chain and overseas customer markets.
FIGURE 5. GLOBAL GARMENT TRADE (2013)
FIGURE 6: AUSTRALIAN VS CHINESE TEXTILE & GARMENT COMPANIES
Source: WTO
Source: CIQ, ANZ
Exports (USD bn)
Revenue Growth (Latest FY)
Size of the bubble represents the median AUD revenue

of companies within our sample universe
300
18
250
16
200
150
14
100
12
50
0
(50)
10
0
50
100
150
Imports (USD bn)
200
8
6
Africa, 1.82%
Asia (Ex China), 14.48%
This difference in experience and relative size has two key

financial impacts:
China, 43.3%
North America, 2.53%
Australia, 0.05%
Europe, 21.36%
1. The volumes demanded of Chinese manufacturers

by Australian firms, on a per business basis is small
compared to larger customers domiciled in the US
or Europe. This can limit volume discounts, potentially
leading to a higher unit price compared to other
larger retailers, which flow through to retail prices
and ultimately market share. Furthermore, some
major Chinese manufacturers will not deal with
low volume orders.
South America, 2.84%
4
2
0
(2)
Represents percentage of total global exports
(4)
%
0
10
12
14
16
EBIT Margin (Latest FY)
CHI - Apparel Manufacturing, 225
AUS - Clothing Retailing, 157
AUS - Clothing Wholesaling, 48
CHI - Footwear Manufacturing, 280
AUS - Footwear Retailing, 51
AUS - Footwear Wholesaling, 42
2. Given that the power in the Australia-China supply chain

may in fact be with the global Chinese manufacturers,
Australian retailers may be limited in their ability to negotiate
favourable trade terms. Accelerated or short payment terms
to Chinese manufacturers increases the working capital
intensity for a retailer. That comes at a cost, as the increase
in working capital needs to be funded via debt and/or
equity and acts as an anchor on returns.
ANZ ASIA RETAIL
CHINA IS THE UNDISPUTED GARMENT

MANUFACTURING CENTRE OF THE WORLD
FIGURE 7: GARMENT EXPORT INDEX: 2007 = 100
China remains the king, but there are challengers
Source: WTO
China is the undisputed garment manufacturing centre

of the world. According to the China National Garment
Association, Chinas garment industry employs more than
10 million people and generates annual exports of almost
USD 200bn.
275
250
225
World Trade Organisation data indicated that the next

four largest exporters were Italy, Bangladesh, Germany
and Vietnam, whose collective garment exports were
only 42% of Chinas in 2013.
200
175
150
125
100
75
50
Bangladesh
Cambodia
China
2008
India
2009
Indonesia
2010
2011
Sri Lanka
2012
Taiwan
2013
Vietnam
However the growth momentum is clearly shifting.

Despite all of Chinas Asian competitors only accounting
for approximately one third of what China exports,
the growth rates of some of Chinas neighbours are
significantly higher. From 2007 to 2013, garment exports
from Bangladesh and Vietnam grew at 18% and 15%
respectively while China grew at 7% per annum.
Factors such as wage inflation, the appreciation of the RMB,
and rising domestic cotton prices have significantly dented
Chinas competitiveness, opening the door for those other
countries to win new business based on a lower cost
of doing business.
Despite the impacts of rising costs, China maintains
advantages such as political stability, infrastructure and
logistics, and is expected to remain the worlds largest
exporter of garments for a considerable period of time.
ANZ ASIA RETAIL
11
UNDERSTANDING
THE ASIAN SUPPLY CHAIN
WHAT HAPPENS UPSTREAM HAS A MAJOR EFFECT
ON CONDITIONS DOWNSTREAM
Client feedback suggests that a knowledge gap still remains

amongst Australian retailers regarding the key issues and
trends upstream in their supply chain. Put simply, many
Australian retailers may not know or have the visibility to
understand the key parts of their supply chain. Highlighting
these trends is a key objective of this report.
Due to factors such as competition, changing consumer
preferences and technology, the garment supply chain is
becoming increasingly more complex. Today there are many
more options available along the supply chain, from which
raw materials are used, to what channel is used to sell to a
customer a retail store or via the internet?
When taking a deeper look at the garment supply chain,
ANZ split the supply chain into two parts; upstream
and downstream, noting that each leg is supported
by transport and logistic services.
1. Upstream:
Sourcing raw materials
FIGURE 8. CHINA AND INTERNATIONAL COTTON PRICE
A. The sourcing of raw materials such as cotton,

wool and synthetics
Traditionally garments have been made from natural fibres

such as wool or cotton. Cotton has long been the main
raw material used in making garments. In China, cotton for
manufacturing is mostly sourced domestically.
Source: Bloomberg
5000
2. Downstream:
Recent changes to Chinas cotton policy, and an emerging

glut in global supply, have resulted in cotton prices steadily
declining since 2011.
D. Garment wholesaling, either locally in Australia

or direct from the manufacturer or overseas agent
It is estimated that a US 30 cent decline in cotton fibre prices

is expected to save 6%-7% of total sourcing costs.
B. The manufacturing of textiles fibre processing

and fabric production
C. Garment making
E. Retailing within Australia

Its worth noting that textile manufacturing and garment
making are quite different in terms of labour and capital
intensity. Textile manufacturing requires specialised
machinery, while garment making is significantly more
labour intensive. For this reason, ANZs analysis splits
these into separate business types.
Global
Sourcing
Raw Materials
Fibre
Processing
Local (Australia)
Fabric
Production
A. Sourcing Raw Materials

R
aw materials used in garment production are either natural fibres such
as cotton, wool or silk, or synthetic fibres such as nylon or polyester

R
aw materials typically account ~80% of fibre production costs
B. Fibre Processing

Yarn is produced by spinning raw materials into long strands
which can then be used to make fabrics

S pinning is mostly done using machines and is capital
intensive for businesses

B
efore being processed into yarn, the fibres are washed
to remove impurities such as oils and wax

Fabric Production
T hrough processes such as weaving knitting and pressing,
individual yarns (i.e. the strands of yarn are turned into fabrics)
ANZ ASIA RETAIL
Garment
Making
Garment
Wholesaling
Retailing
C. Garment Making

Garment making is a labour intensive process involving cutting
fabric into shapes and stitching using sewing machines

Fabric consists of ~30% of garment production costs
while wages account for ~20%
Declining cotton prices have helped improve the

environment for the textile and garment industry, however
other cost pressures are impacting profitability.
Synthetic fibres, most of which are a by-product of oil, have
grown in popularity over natural fibres. Within the fibre
market, synthetics accounted for 70% of fibre production in
2013. Synthetics are also expected to contribute 98% of total
fibre consumption growth through to 2025.
USD/Metric Ton
6000
4000
3000
2000
1000
0
2009
2010
2011
China Cotton 328
2012
2013
2014
Cotlook A Index
Global overcapacity and falling crude oil prices have also led
to a drop in the price of synthetic fibres, thereby narrowing
the price differential with cotton.
Asia is very competitive for producing synthetic fibres and as
of December 2014, local prices were more than 22% below
the world average, making it an attractive place to produce
garments from these materials.
Even at the very start of the value chain, it is evident that
the supply side can be subject to considerably more volatile
conditions than what drives changes in demand.
D. Garment Wholesaling

60-70% of Australian retailers direct source
from the manufacturer or overseas agent

The balance source local product or imported
products via local wholesalers
E. Retailing

The cost of sourcing garments accounts
for about 40-50% of retailers revenue
13
LABOUR INTENSIVE GARMENT MANUFACTURERS GENERATE HIGHER

MARGINS THAN FIBRE PROCESSORS AND FABRIC PRODUCERS
FIGURE 9. GROWTH IN SYNTHETIC FIBRE CONSUMPTION
FIGURE 10: SYNTHETIC FIBRES SOUTH EAST ASIA INDEX
Source: Tecnon Orbichem
Source: Bloomberg
Metric Ton
Chinese textile manufacturing

and garment making
The financial performance and profile of yarn producers and
fabric manufacturers are influenced by very similar industry
pressures. Many textile companies are vertically integrated
and undertake both processes. Hence, from a financial
analysis perspective, ANZ has grouped them as textiles.
1,600
140,000
1,200
120,000
100,000
800
80,000
400
60,000
0
40,000
Jan
10
May
10
20,000
Sep
10
Jan
11
May
11
Sep
11
Jan
12
May
12
Sep
12
Jan
13
PTA CFR South East Asia Index
May
13
Sep
13
Jan
14
May
14
Sep
14
Jan
15
MEG CFR South East Asia Index
0
1980
1983
1986
Wool
1989
Cotton
1992
1995
Cellulosic
1998
2001
2004
Polypropylene
2007
2010
2013
2016
Polyamide
Acrylic
2019
2022
Polyester
2025
Despite the rapid increase in wages within China, labour

intensive garment manufacturers still generate higher margins
compared with fibre processing and fabric production (grouped
as textile manufacturers). The primary reason for this is that
textile manufacturers provide a relatively commoditised input
into the production process, whereas garment manufacturers
are aligned to the end product and brand.
Although the alignment to the brand may not be strong,
it does enable these businesses to generate higher margins
relative to companies further upstream in the supply chain.
Garment makers are also the final part of the production process
and the most direct source of product for Australian retailers.
FIGURE 11: PCI SYNTHETIC FIBRES INDEX BY REGION

Source: Bloomberg
400
300
200
100
0
Jan
10
May
10
Sep
10
Jan
11
World
Wool
Cotton
Cellulosic
Polypropylene
Acrylic
Polyamide
May
11
Sep
11
Jan
12
Asia
May
12
Sep
12
Jan
13
USA
May
13
Sep
13
Jan
14
May
14
Sep
14
Jan
15
Western Europe
15
ANZ ASIA RETAIL
CHINESE MANUFACTURERS ARE NOT COVERING THEIR COST OF CAPITAL
FIGURE 12: REVENUE GROWTH
FIGURE 13: MARGINS
Source: CIQ, ANZ
Source: CIQ, ANZ
CHINESE TEXTILE MANUFACTURERS
%
30
25
20
15
10
5
0
-5
2010
2011
2012
2013
LTM
18
16
14
12
10
8
6
4
2
0
Detailed analysis of textile and garment supply chain

participants in China suggests there are three key themes
impacting profitability:
2010
2011
2012
Gross Margin
CHINESE GARMENT MANUFACTURERS
Despite the favourable margin differential between textile

manufacturers and garment manufacturers, both industries
as a whole have generated returns below their cost of capital
for at least the last two years. For textile manufacturers, these
businesses as a whole have not covered their cost of capital
since at least 2010 and possibly longer.
2013
LTM
Net Margin
2. Chinese manufacturing has for many years competed

on cost and scale. It is for that reason that Chinese
manufacturers have limited power across their supply chain
to put up prices, primarily against large US and European
customers. This creates additional pain when costs are
increasing, which explains the downward trend in returns
for garment manufacturers in particular.
40
25
35
20
30
15
25
3. The just in time stock covering model from retailers has

forced garment-makers to hold more stock and therefore
fund increased working capital. This increase in the invested
capital base has contributed to lower returns.
20
10
15
5
0
10
2010
2011
2012
2013
LTM
5
0
2010
2011
2012
Gross Margin
Financial trends are based on a sample of public companies based

in Greater China generating more than USD 100m in revenue.
Sample sizes are 77 for Textiles and 40 for Garments.
1. Despite the reduction in domestic cotton and synthetic

prices, key parts of the production process remain highly
labour intensive. Average manufacturing sector wages
increased by 14% per annum between 2006 and 2013,
which have led to increases in operating costs.
2013
FIGURE 14: RETURNS

Source: CIQ, ANZ

8
7
6
5
4
3
2
1
0
2010
2011
2012
Return on Assets
2013
LTM
Return on Equity

18
16
14
12
10
8
6
4
2
0
2010
2011
2012
Return on Assets
LTM
2013
LTM
Return on Equity
Net Margin
LTM = Last Twelve Months
LTM = Last Twelve Months
ANZ ASIA RETAIL
17
WHAT HAVE CHINESE COMPANIES

BEEN DOING TO COMPETE?
WAGE DIFFERENTIALS BETWEEN PROVINCES ARE AN IMPORTANT
CONSIDERATION WHEN DECIDING WHERE TO LOCATE A FACTORY
Increasing operating costs, a higher working capital burden and a limited ability to pass on price increases to all customers has
weighed on Chinese textile and garment manufacturing returns in recent years. To arrest this decline and meet the increasing
customer demand for fast fashion and just-in-time, manufacturers have and are implementing a range of strategic responses.
These changes could provide additional risk and opportunities to Australian retailers.
Upstream Response
Summary
Importance
Impact for Australian Retailers
1.
Relocation of
manufacturing
facilities towards
lower-cost geographies
To lower costs, Chinese garment makers

are increasingly looking for lower wages
domestically and abroad. This is also resulting
in textile manufacturers relocating to be
closer to their customers.
Potential favourable pricing due to lower upstream

costs; Relocation may require new suppliers to be
found; Relocation may also increase exposure to
business and social risk for retailers (i.e. safety),
and potential changes in quality.
2.
Increasing popularity
of fast fashion
The emergence of large global garment brand

such as Zara, H&M and The Gap has resulted in
increased price competition amongst low value
garment suppliers. Success by these companies
has also altered the competitive landscape of
in-country or local garment retailing.
3.
Migration of textile and
garment players towards
higher margin products
Due to increasing costs (i.e. wages) and

competition, Chinese garment makers are
looking to move away from low-value
garments in favour of higher margin products
such as chemical fibres used in sportswear.
Potential requirements to find new suppliers as

existing manufacturers change their product lines/mix.
4.
Increased vertical
integration
To create synergies and reduce costs, textile

and garment companies are increasingly
looking to vertically integrate.
Vertical integration of manufacturing may lead to

cost savings being passed through but this is unlikely.
This can be done through combining production

processes such as fibre processing and fabric
production, or move closer to the consumer
with some garment companies creating their
own brands and opening retail stores.
ANZ ASIA
OPPORTUNITY
RETAIL CHINA
Fast fashion brands are becoming larger and more

influential in garment supply chains. Australian
importers may find they need new suppliers
as existing manufacturers focus more on key
customers. ANZ has observed that revenue is
becoming increasing concentrated toward key
customers for some garment makers.
A major Chinese garment retail presence in Australia

would increase competition, but this is also unlikely
to occur in the medium term.
Upstream trend #1 - Relocation
FIGURE 15: MANUFACTURING WAGES IN CHINA (RMB)
More and more textile and garment producers are relocating

their supply chains to take advantage of lower costs found
outside their traditional manufacturing locations. Most
commonly, players are choosing to relocate domestically
or to South East Asia.
Source: National Bureau of Statistics of China
Its all about Chinese wages

Average manufacturing sector wages in China have
increased from RMB 15,757 in 2006 to RMB 46,431
in 2013, an annual increase of 14%. However beneath
this, wages by province vary significantly.
Although manufacturing sector wages by province in China
are not published, minimum wages can be used as a proxy.
Anecdotally, manufacturing sector wages are 60-70% above
minimum wages (the minimum wage in Guangzhou is USD
$300 per month against the minimum manufacturing sector
wage of around USD $550), however the two trend in much
the same way.
RMB 000's
50
45
40
35
30
25
20
15
10
5
0
2006
2007
2008
2009
2010
2011
2012
2013
2014
Some manufacturers are also required to provide

accommodation, meals and transportation to attract
employees which significantly increases their cost base.
Minimum wages in inland provinces such as Chongqing
and Hubei can be up to 50% less than east coast provinces
such as Guangdong and Zhejiang.
Wage differentials between provinces are therefore
an important consideration when deciding where to
locate a factory. Also, as wage rates are rapidly changing,
manufacturers are continually opting to relocate or add
additional capacity in lower cost regions to manage or
maintain margins.
19
THE WAGE DIFFERENTIAL BETWEEN CHINA AND GREATER

ASIA CAN MAKE RELOCATION EXTREMELY ATTRACTIVE
FIGURE 16: MINIMUM WAGES IN CHINA BY PROVINCE
The lure of South East Asia
Source: China Labour Bulletin Article Wages in China dated 10 June 2013
Despite the attractiveness of inland regions in China,

relocating to South East Asian countries can lead to even
lower costs. While there are many factors to consider,
such as regulation, safety, proximity, and political stability,
when it comes down to cost and wages, many South East
Asian countries are extremely competitive.
Increasing labour costs have meant that companies with
production facilities located in Chinas traditional industrial
areas have found themselves to be increasingly less
competitive compared to their regional peers.
Beijing
Tianjin
As of 2013, Chinas average manufacturing sector wage

was USD 550 per month. This compares to Thailand
at USD 270 and Vietnam at only USD 100.
This differential has motivated manufacturing companies
to relocate. Given garment making is highly labour intensive,
this sub sector has been the first-mover in relocating to take
advantage of lower wages, as the savings can be substantial.
Chongqing
1,000 - 1,150 yuan

1,151 - 1,300 yuan
1,301 - 1,450 yuan
FIGURE 17: AVERAGE MONTHLY MANUFACTURING WAGES

IN USD (2012)
*Textile and garment employees only
**State employees only
Sources: National Bureau of Statistics of China, National Statistical Office
of Thailand, Philippine Statistics Authority (Bureau of Labor and Employment
Statistics, Statistics Indonesia, General Statistics Office of Vietnam
500
489
400
322
300
216
208
200
113
100
0
China
Thailand
Philippines*
Indonesia
Vietnam**
Relocation in action
Several large Chinese textile and garment manufacturers
have relocated portions of their production capacity into the
Mekong region in recent years. ANZ has sought to ascertain
the impact of this relocation by analysing a sample of large
Asian textile and garment manufacturers that also form part
of the Australian retail supply chain.
1,451 - 1,600 yuan

1,601 - 1,750 yuan
1,750 - 1,900 yuan
ANZ ASIA RETAIL
21
MANY CHINESE MANUFACTURERS HAVE ADOPTED A CHINA +1 STRATEGY
FIGURE 18: MAJOR CHINESE TEXTILE & GARMENT MANUFACTURERS
FIGURE 19: CHANGE IN GEOGRAPHICAL LOCATION OF ASSETS
Financials are the 12 months to June 2014. Data sourced from CIQ
Source: CIQ, ANZ
Indicates the Company operates in this part of the value chain
Company
Revenue
EBIT Margin
In 2011, Eagle Nice embarked

upon aggressive relocation into Indonesia,
and into the lower-cost Jiangxi in China
Capabilities
Yarn
Fabric
Garment
Retail
Shenzhou International
AUD 2,130m
18.7%
Win Hanverky
AUD 569m
5.2%
Eagle Nice
AUD 251m
4.8%
Yue Yuen
AUD 9,098m
3.0%
Fountain Set Holdings
AUD 957m
1.2%
Addchance Holdings
AUD 216m
1.6%
Recent industrial action in Yue Yuens China factories has

meant that the Company is now more focussed on relocating
(rather than just expanding) its capacity into SE Asia
Shenzhou has been a relatively

late mover, having only off-shored
~8% of its production base up until 2013
%
100
90
80
70
60
The companies in Fig 18 are amongst the largest garment

makers in the world, with many also forming part of the
supply chain for Australian garment retailers.
Despite the relocation strategy being commonplace
for garment makers given their reliance on labour, some
companies started moving earlier than others. Some
companies chose to relocate within China instead of
offshore, while companies like Fountain Set Holdings Ltd
have had an overseas presence for almost 20 years.
Notwithstanding this, all of the companies highlighted in

Fig 18 now have a China + 1 structure, with some firms
now being based in up to 4 countries outside of China.
Most of this relocation has occurred over the last five years,
but as highlighted in Fig 19, a large portion of manufacturing
remains in China.
50
40
30
20
10
0
2007
2015
Shenzhou
2008
2013
Win Hanverky
China
ANZ ASIA RETAIL
2009
2014
Eagle Nice
Vietnam
Cambodia
2008
2013
2009
Yue Yuen
Indonesia
2013
Fountain Set
Other
2008
2014
Pacific Textiles
Sri Lanka
23
RELOCATION CAN LEAD TO COST REDUCTIONS FOR

AUSTRALIAN RETAILERS, BUT IT CAN ALSO LEAD TO INCREASED RISK
Upstream trend #1
Relocation: Impact for Australian Retailers
The impacts of relocation on Australian Retailers are mixed.
Essentially lower labour costs provide for lower garment costs,
however sourcing garments from other locations also has
additional risks.
Impact 1 Lower purchase costs (positive)
Cost plus business models are common amongst players
in the textiles and garments supply chain, thereby allowing
retailers to benefit from upstream labour cost savings.
One example is that of Yue Yuen, the worlds largest original
equipment manufacturer of athletic shoes. The Companys
gross margins typically experience short-term fluctuations
based on changes in labour costs, but then revert back
to medium-term averages.
FIGURE 20: YUE YUENS GROSS MARGINS
Impact 2 Lengthened sourcing times

due to employee unrest (negative)
Source: CIQ
25
Socio-political volatility in South East Asian nations can

increase supply chain risks. A prominent example is that
of Cambodia, where the garment industry provides one
third of the countrys GDP and employs ~600,000 people,
who are mostly women.
Margin dropped then

recovered, in part, due to
higher raw material and
China labour costs
24
23
Margin dropped then

recovered on the back
of Indonesia labour
cost advantages
22
21
20
FY10
FY11
FY12
FY13
FY14
For years garment industry employees have been striking

in search of higher wages. According to the Garment
Manufacturers Association in Cambodia, 888,527 days were
lost in 2013 due to industrial action, resulting in complaints
of disrupted production by H&M, The Gap, Puma and Inditex
(Zara), and a cut back in orders from Levi Strauss and Target.
On January 5 2015, the minimum wage in Cambodia was
raised to USD 128 per month1, however this fell well short
of the USD 140 asked for by workers and unions, and remains
a small portion of what employees are paid in China.
Impact 3 Potential impact on quality (negative)
Australian retailers have been required to recall almost
208,000 items of clothing due to high levels of azo dye.
Azo dyes are known to break down to carcinogenic
compounds called aromatic amines, although this is only
considered to be possible above certain concentration levels.
While the use of azo dye can also be found in China,
its use is more prevalent in other developing countries.2
As manufacturers source from emerging ASEAN countries,
exposure to risks such as product recalls can increase.
Impact 4 Reputation damage (negative)

In 2013, a factory in Rana Plaza in Bangladesh collapsed
resulting in the death of 1,138 people. The factory was
used by many major companies including Zara, H&M,
Tesco and The GAP.
Since the collapse more than 150 global brands have
signed the Accord on Fire and Building Safety in Bangladesh
which enables staff to stop working if their safety is being
compromised. Some companies who have refused to sign
the agreement have been publicly criticised for their inaction.
Going forward global brands are going to be increasingly
held responsible for the behaviours undertaken by their
suppliers. Sourcing garments from clothing makers in
emerging countries is less transparent than local sourcing,
thereby increasing reputational risk and time required in
understanding end-to-end supply chains.3
Upstream trend #2
Large brands and the impact of fast fashion
The last decade has seen the emergence of some large global
clothing retailers such as H&M, Inditex, The GAP, Topshop,
Benetton, Espirit and Uniqlo. The success of these brands has
had considerable influence along the textile and garment
supply chains. They have positioned supply chains to react
very quickly to emerging fashion trends at competitive prices,
which have led significant gains in market share.
Many of the larger garment makers have forged stronger ties
with these larger retailers. They have followed their customers
into new markets, which has led to increased geographic
diversification. As this relationship has strengthened it has
also meant that these manufacturers do not need to partner
with as many customers. While this can create some customer
concentration risk for the manufacturer, it also impacts other
customers or potential customers.
1. Source: Leonie Barrie, Aroq Ltd, Sharp fall in Cambodia garment strikes in 2014,
January 2015
2. Source: ACCC
3. Source: Cleanclothes.org
ANZ ASIA RETAIL
25
LARGE GLOBAL RETAILERS ARE NOT ONLY COMPETING AT THE RETAIL LEVEL.
THEYRE ALSO COMPETING AT THE SUPPLIER LEVEL
Upstream trend #2
Large brands and the impact of fast fashion
Impact for Australian retailers
FIGURE 21: REVENUE MIX FOR SELECTED CHINESE MANUFACTURERS

Source: CIQ
Eagle Nice
Win Hanverky
11%
21%
14%
31%
9%
10%
13%
-31%
10%
North American
Europe
7%
10%
4%
Hong Kong
Europe
Mainland China
13%
30%
38%
-17%
43%
Mainland China
Japan
54%
23%
15%
26%
Other
Rest of Asia
5%
13%
Other
10%
Eagle Nice manufactures sportswear for companies such as Nike, the North Face and Puma.
The Companys two largest customers account for ~70% of total revenue. Mainland Chinas
share of revenue has declined by 31% as sales to Europe and North America have increased
North America
Win Hanverky is an OEM for major sporting brands like Reebok and Puma. Its China revenue took
a hit through the discontinued distribution of the loss-making Diadora and Umbro lines, however
a rebound in its US and European business has enabled the Company to grow by over 30% in FY2014
The globalisation of garment retailing has two main impacts

on Australian retailers.
1. Australian clothing importers become comparably
smaller than other customers of their suppliers
The globalisation of clothing retail has resulted in more
concentrated customer bases for garment makers as they
create strategic relationships with large global brands.
This also means that Australian clothing importers are
becoming relatively smaller compared to the other
customers of their garment suppliers.
This can potentially cause pricing and sourcing issues
as garment makers lose focus on Australian importers.
Mainland Headwear
Shanghai Dragon
17%
17%
35%
16%
35%
-18%
49%
65%
China
-35%
US
Europe
Globalisation of clothing retail has resulted in some major

clothing names entering the Australian market. These
companies have very different cost structures to Australian
retailers and can ultimately compete at a lower price point.
Taking Inditex, H&M, The Gap and Uniqlo as global names
that have entered the Australian market and comparing
them to eight publicly listed Australia clothing retailers,
there are noticeable differences in both margins and
balance sheet strength.
Australian retailers achieve stronger gross margins than
their global competitors, however, global retailers generate
higher EBIT margins, which is largely a function of scale.
Furthermore, global retailers generate, on average, a higher
return on equity.
This poses a threat as the higher gross margins are
attractive to new market participants. Furthermore, their
scale, efficiency and balance sheet strength implies they
may have the capacity to undercut domestic competitors,
who will disproportionately wear more pain if retail prices
fall given that their group cost structures may be higher
than the foreign retailer.
Non-China
100%
66%
As one of the largest casual headwear makers in the world, Mainland Headwears
key partnerships with the likes of New Era, Warner Bros and Under Armour has
allowed it to increasingly source more of its revenue from outside of China
China
2. Cost structure advantage
Partnerships with global brands like Guess, Lacoste and Target have allowed Shanghai Dragon to
go from a domestically focussed business to sourcing 35% of revenue from overseas in just 5 years
FY08
5 year change in home country
(Mainland China or Taiwan) %
FY13
ANZ ASIA RETAIL
27
GLOBAL RETAILERS GENERATE LOWER

GROSS MARGINS, BUT FAR HIGHER NET MARGINS
FIGURE 22: RETAILER COMPARISON

Source: CIQ, ANZ
Australian median based on the 8 major publicly (or recently listed) listed garment
retailers in Australia and New Zealand: David Jones, Country Road, Myer, Noni B,
Oroton Group, RCG Corporation, Specialty Fashion and Kathmandu
GROSS PROFIT MARGINS

%
70
60
50
40
30
20
10
0
FY10
H&M
FY11
Inditex
FY12
The Gap
FY13
Uniqlo
FY14
Australian Median
ROE
Case Study: Crystal Group (private company)
Case Study: TAL Group (private company)
Case Study: Abercrombie & Fitch
Revenue: USD $1.6 bn

Market Cap: Private
Revenue: AUD $1 bn
Market Cap: Private
Revenue: USD $3.7 bn

Market Cap: USD $1.4 bn
Crystal Group is one of the largest Hong Kong-based

apparel manufacturers with 48,000 workers and a turnover
of USD $1.6 bn during 2013. The company is a supplier to
global retail brands such as Levis, Uniqlo, Victorias Secret,
H&M, The Gap, JC Penney and Marks & Spencer.
TAL Group is a Hong Kong based garment maker with

over 25,000 employees and has operations in Hong Kong,
China, Taiwan, Malaysia, Indonesia, Thailand and Vietnam.
Attracted by high margins, well known US apparel

retailer Abercrombie & Fitch (A&F) announced in
2012 that they were to enter in the Australian market.
This came at an interesting time in Australia garment
retailing as A&F decided to enter when David Jones,
Myer and Billabong were experiencing sharply
declining profitability.
Andrew Lo, the CEO of the group, commented in an

interview with just-style, an online news and research
company focusing on the apparel and textile industry,
our top ten customers account for around 85% of our
business, and most of our customers have been working
with us for 15 20 years or even longer. Building a
strategic relationship to our scale takes a good ten years,
so we cant afford to have ever-changing customers.
The Company has taken on the expanding role
of manufacturers in the value chain:
24
20
I. Crystal Group has set up a quality assurance

team which work on behalf of the customer
to monitor production.
16
12
8
II. Increased focus on product design and development

as customers are demanding value added activities.
4
0
FY10
H&M
FY11
Inditex
FY12
The Gap
FY13
Uniqlo
FY14
Australian Median
NET MARGINS
%
50
III. The Company has also collaborated with leading IT

vendors to promote technological advancement
(including SAP ERP, RFID and an electronic document
exchange portal) to boost competitiveness,
productivity and collaboration with business partners.
The company has strengthened its position with

customers through logistics management and by taking
on broader supply chain responsibilities. Of which, a key
example was the partnership established between TAL
Group and JC Penney.
In order to reduce the lead time to market for a new series
of garments, TAL assumes the responsibility of market
testing and design (partnerships involving design are
likely to be more commonly observed for brands with
products that are of lower value and lesser complexity).
Also, after analysis of JC Penneys sales data, TAL used
their knowledge to make recommendations on the
volume of shirts to be made in appropriate size and
colour. Additionally, TAL leveraged their own forecasting
technology and JC Penneys sale data to directly assist JC
Penney in managing inventory. Due to limited resources,
such strategic partnerships are usually not available to
smaller customers.
Source: Asian firms and the restructuring of global value chains
by 23 (2014), TAL Group sustainability report 2012 and Shirt tales
from TAL, an apparel powerhouse by Financial Times (Dec 2013)
Abercrombies strategy was to open two Hollister stores:

Doncaster (Melbourne) and Bondi (Sydney). Hollister
is a lower price point than the traditional A&F brand,
thereby better positioning the company to compete
against TopShop and Zara who had also entered the
Australian market. The Hollister stores opened in April
and May 2013.
However in March 2015, A&F announced that they were
closing the two stores and withdrawing from Australia.
The company cited disappointing results and increasing
competition from major fast fashion labels.
This example highlights the speed at which the
garment retailing in Australia is changing and how
it is increasingly important retailers ensure effective
deployment of scarce capital.
Source: Asian firms and the restructuring of global value chains

by International Business Review 23 (2014) and Crystal Group
sustainability report 2014
45
40
35
30
25
20
As garment suppliers continue to invest and build strategic relationships with key global customers, it may prove to be difficult
for Australian retailers to adequately source garments as suppliers continue to focus on the bigger retailers.
15
10
5
0
FY10
H&M
ANZ ASIA RETAIL
FY11
Inditex
FY12
The Gap
FY13
Uniqlo
FY14
Australian Median
29
MANY TEXTILE AND GARMENTS PLAYERS

ARE SEARCHING FOR HIGHER MARGIN PRODUCTS
Upstream trend #3
The migration of textile & garment
players towards higher margin products
Due to margin compression in lower value garments, many
textile and garments players are searching for higher margin
products. This theme applies along the supply chain, from
yarn spinners to garment makers.
Evidence of this change can be found in the types of
machinery thats imported into China. According to the
China Textile Machinery and Accessories Association,
between 2000 and 2012, the portion of imports of chemical
fibre machinery increased from 6% to 22% of total imports.
At the same time, imports of traditional equipment
(i.e. weaving, dyeing and knitting) significantly declined.
Products made with chemical fibres include sports or active
wear as well as lingerie and are typically of higher value than
traditional garments.
Production facilities in Mainland China are increasingly focusing on differentiated and higher value-add products.
Case Study: Texhong

Revenue: AUD $1.8 bn
Market Cap: AUD $960 m
Yarn manufacturing is a relatively low value-add
segment within the textiles value chain.
Core-spun yarn, where fibres are twisted around an
existing yarn to enhance its durability and stretch,
commands higher gross margins which are on par
with downstream fabric makers.
During 2013, the average selling price for cotton
core-spun yarn was USD 4.45 per kilogram against
USD 4.10 for 100% cotton yarn. This highlights the
difference created by the differentiated value-add
products and also the appeal of moving up the
value chain.
Texhong has focused on core-spun yarn which
has increased its share of total revenue from
79% to 94%. During FY2013, the Company has
also managed to increase margins in core-spun
yarn from 17.7% to 22.4%.
REVENUE BY SEGMENT FOR TEXHONG

%
100
75
50
25
0
FY08
FY09
Yarn
FY10
FY11
Grey Fabrics
FY12
FY13
Garment Fabrics
GROSS PROFIT MARGIN FOR TEXHONG BY PRODUCT

%
24
18
12
0
Core-Spun Yarn
Other Yarns
FY12
ANZ ASIA RETAIL
Fabrics
FY13
31
AUSTRALIAN RETAILERS MAY FIND THAT THEY NEED TO LOOK

TOWARDS MANUFACTURERS IN LOWER-COST COUNTRIES
Upstream trend #3
The migration of Textile & Garment players
towards higher margin products: Impact on
Australian retailers
Given the focus by large Chinese garment makers on highermargin products, Australian retailers may find that they
need to look towards manufacturers in lower-cost countries
to source low value garments. For many years garment
makers have been relocating low value manufacturing
to countries such as Vietnam, Bangladesh and Cambodia
to take advantage of lower costs. Often it is no longer
profitable to continue to make basics in China.
For example, H&M now sources 45% of their basic clothes
from Bangladesh where labour costs for basic garments are
~10% of China (source: SCMP). H&M have also stated that
they can get better clothes produced under higher ethical
standards in Bangladesh than what they have experienced
in China. As a result, garment makers in Bangladesh are
experiencing the highest growth across the region,
followed closely by those in Vietnam.
Given this change, Australian retailers who also sell low value
garments might have to follow H&Ms strategy in sourcing
from countries outside China, as garment makers relocate
or pricing differentials become attractive.
ANZ ASIA RETAIL
Case Study: Lululemon

Market Cap: AUD $12 bn
High-end athletic apparel retailer Lululemon has
carved out a competitive advantage, partly a result
of their technology-enhanced sportswear fabrics.
The patented nature of these fabrics, however,
has resulted in relatively high supplier concentration.
Furthermore, all of Lululemons signature Luon
fabric, which represents ~30% of the fabric used
in the Lululemons products, is manufactured solely
by a single Taiwanese supplier.
Notwithstanding this, improvements in Asias textile
and garment suppliers manufacturing capabilities
have enabled Lululemon to gradually expand its
supplier base. With more money being increasingly
put into textile and garment research in China,
the expectation is that companies in Lululemons
situation will eventually be able to dilute the
percentage sourced from their top suppliers.
LULULEMONS SUPPLIER BASE

%
No. of Suppliers
40
80
30
60
20
40
10
20
0
FY10
FY11
No. of Suppliers
FY12
FY13
% supplied by top supplier
Source: CIQ and Company Annual Reports
33
VERTICALLY INTEGRATED MANUFACTURERS

GENERATE HIGHER MARGINS THAN PURE-PLAY FIRMS
25
Vertically Integrated Garment + Yarn/Fabric Producers
18.8%
20
17.1%
13.5%
15
20.5%
18.1%
Shenzhous integrated business model allows the company

to achieve (1) lower production costs, (2) shorter lead times,
(3) improved research and development capabilities, and (4)
the ability to broaden its product categories to better cater
for customers needs.
9.2%
10
5
19.7%
Shenzhou is the worlds largest vertically integrated

knitwear manufacturer which accounted for 13% of
Chinas knitwear exports in 2012. The company is also the
largest apparel supplier of Nike, Puma, Adidas and Uniqlo.
14.1%
4.2%
Youngor Group
Shenzhou International
Best Pacific
Eclat Textiles
Pacific Textiles
0
Ningxia Zhongyin Cashmere
There is a clear margin differential within the upstream

supply chain between diversified and pure play firms.
This differential highlights the value that can be captured
within the supply chain and how margins are highest for
businesses that are integrated to spin yarn, produce fabric
and make garments.

Market Cap: AUD $7.1 bn
Note: Yarn + Fabric Producers are based on a sample of 77 Chinese yarn

and fabric producers, and Garment Producers are based on a sample
of 40 garment producers
Black Peony (Group)
Pure play firms are increasingly moving towards vertically

integrated business models as a way to secure their supply
chain, reduce costs, boost margins and improve efficiency.
Case Study: Shenzhou International
Source: CIQ, ANZ analysis
Garment Prducers
Some textile and garment companies are vertically

integrating to capture upstream synergies in yarn
and fabric production, while there are also examples
of manufacturers moving further downstream into retail.
FIGURE 23: VERTICALLY INTEGRATED EBIT MARGINS

VS PURE-PLAY MARGINS
Yam + Fabric Producers
Upstream trend #4
Increased vertical integration
Weaving & knitting
Dyeing & finishing
Cutting
Sewing
Packaging
Source: Shenzhou broker reports by Bank of America Merrill Lynch (Feb 2013) and Kim Eng (Jan 2013)
Case Study: Eclat

FY13 EBIT Margin
Revenue: AUD $824 m

Market Cap: AUD $3.5 bn
Eclat is an integrated manufacturer engaged in the weaving, knitting,
dyeing, and finishing of fabrics and garments. The company specializes
in functional flexible circular knitted fabrics and ready-to-wear garments.
Eclat supplies to some very large and well-known brands demonstrating
the value-add of Eclats integrated supply chain.
Through Eclats proven business model, the company has been able
to partner with key clients to create patented materials. This has driven
strong financial performance with growth and margins averaging
~29% and ~16% respectively from 2011-2013.
Fabric Customers:
Nordstrom, Jockey, Macys, Fila, Calvin Klein,
JC Penney and The Gap
Garment Customers:
Adidas, Nike, Fila, Lululemon, Athletica, Reebok, Chicos and The Gap
Vertical Integration
Knitting
Dyeing
Finishing
Garment making
Source: Company website and CIQ
ANZ ASIA RETAIL
35
A NUMBER OF CHINESE MANUFACTURERS

HAVE SOUGHT TO VERTICALLY INTEGRATE
Upstream trend #4
Increased vertical integration
Impact on Australian retailers
To date, vertical integration amongst Chinese manufacturers
has been further upstream, as upstream consolidation can lead
to higher margins and cost efficiencies. This is mildly positive
for Australian retailers, as these efficiencies could lead to lower
prices, however, this will be partially offset by lower negotiating
power, as the manufacturer is likely to be much larger in scale.
This could impact trade terms and volume discounts.
There has been some evidence of Chinese textile and
garment companies moving downstream into retail
(See Win Hanverky case study). Clearly any new competitor
into the Australian market would not be positive, however,
in the context of the Australian market this poses little
to no threat in the medium term. The basis for this view is:
Case Study: Win Hanverky

Revenue: AUD $562 m
Market Cap: AUD $233 m
Win Hanverky is an integrated sportswear manufacturer
and distributor for international sports and fashion
brands. The company has diversified into the high-end
fashion retail business to capitalise from increasing
disposable incomes in China.
The companys gross profit margin increased from ~26%
in FY2013 to ~29% in June FY2014, which was primarily
driven by the incorporation of their retail business
(Shine Gold Group) since 1 November 2013. Their EBIT

margin, however, declined from 5.9% to 5.2% due
to an increase in other operating costs.
While it might still be relatively early to determine whether
the vertical integration will be a success, the company
believes it can grow revenue and improve margins as
they realise synergies from the new business model
and improve the efficiency of existing shops.
1. Most Chinese manufacturers do not have a brand following

in Australia or design capability.
2. Unlike other foreign retailers entering the Australian market,
these businesses are first and foremost manufacturers,
and not retailers. Few have demonstrated a capability
to succeed downstream in retail markets.
3. The domestic retail market in China is large and is likely
to be far more attractive compared to a developed and
extremely competitive Australian market. There is little
rationale to expand overseas when opportunities
at home are stronger.
ANZ ASIA RETAIL
37
DIRECT SOURCING IN A LOWER

AUD ENVIRONMENT
THE FALL IN THE AUD/USD IS STARTING TO HAVE A MORE NOTICEABLE
EFFECT ON PROFITS AND PRICES
In ANZs November 2013 report, the migration to direct source

retailing: opportunities from a lower exchange rate, it was found
that nearly 60% of retailers were direct sourcing products.
This implied that these retailers were not using Australian
agents or distributors and were instead going to overseas
agents, distributors and directly to manufacturers, primarily
in Asia. This structural shift in product sourcing was the
primary reason for gross margin gains during the five years
to FY2013, as opposed to the widely held belief that
it was AUD appreciation that helped improve margins.
If margins were simply driven by the change in exchange
rates, then there would be more volatility in the gross
profit margin of wholesalers, which are even more exposed
to FX volatility than retailers.
Using latest available financial information from FY2014
shows that gross margins for Australian retailers have
declined by around 300 basis points since FY2012. This is in
line with the average AUD/USD exchange rate decline of over
10%. Retailers have enjoyed capturing the benefit of direct
sourcing, but it has increased their exposure to FX volatility
both up and down. As such, the fall in the AUD/USD is starting
to have a more noticeable effect. For example, when the
average exchange rate fell more than 15% in FY2009, gross
margins actually increased for retailers. This was because the
vast majority of retailers sourced product locally and did not
have a direct exposure to FX rates. In that year, wholesalers
bore the brunt of the weaker AUD, as highlighted by a gross
profit margin decline of 170 basis points.
FIGURE 24: AUSTRALIAN RETAILER & WHOLESALER

GROSS MARGINS
Source: CIQ, ANZ
0.896
0.786
48.1%
38.4%
39.8%
FY07
1.027
0.918
0.882
0.870
0.747
47.5%
FY08
48.3%
37.1%
FY09
49.3%
50.5%
52.1%
50.5%
49.2%
39.7%
39.2%
39.4%
39.9%
37.3%
FY10
FY11
FY12
AUD/USD (avg)
Retailers
FY13
FY14
In this 2015 update, based off FY2014 financial information,

ANZ believes that the proportion of retailers with revenue
greater than AUD $10 million that direct source has now
increased to between 65% and 70%.
YTD
Wholesalers
Review and recap.

What we said, and what happened
Our November 2013 report provided a what if perspective at a
time when the average AUD/USD exchange rate for the FY2013
year was over USD 1.00. The analysis modelled the financial
impact on Australian retailers in a lower AUD environment and
was viewed over a two-year forward period out to the end of
FY2015. Our base case average exchange rate scenario of
AUD/USD 0.85 represented 15% depreciation at the time.
Although spot rates have fallen past USD 0.80, the average year
to date AUD/USD exchange rate as at mid-March 2015 was
USD 0.86, which is broadly in line with our base case scenario.
This structural change is significant. It has resulted in

increased direct FX exposure for retailers, as opposed to
an indirect exposure if they were to purchase from local
wholesalers. Consequently, risk management strategies have
become a critical driver of profitability and a potential source
of competitive advantage for many, if executed correctly.
FIGURE 25: AUSTRALIAN RETAILER & WHOLESALER

EBITDA MARGINS
Source: CIQ, ANZ
1.033
0.990
0.896
0.786
8.1%
7.5%
7.1%
FY07
1.027
0.918
0.882
0.870
0.747
6.6%
FY08
7.7%
6.5%
FY09
7.2%
7.3%
7.2%
6.5%
FY10
7.2%
6.3%
7.8%
AUD/USD (avg)
ANZ ASIA
OPPORTUNITY
RETAIL CHINA
1.033
0.990
In our subsequent discussions with over 120 retail and

wholesale businesses in late 2013 and 2014, there was strong
conviction about direct source retailing. In fact, more than
90% of attendees were direct sourcing some products from
overseas and irrespective of potential AUD weakness, were
seeking to do more or wanted to direct source more but
couldnt for a variety of reasons. Despite AUD depreciation,
there is no indication that this is starting to unwind.
FY11
5.7%
FY12
Retailers
4.2%
5.2%
FY13
FY14
YTD
Wholesalers
39
A NUMBER OF PUBLICLY LISTED RETAILERS HAVE HAD TO INCREASE PRICES
FIGURE 26: AUD/USD EXCHANGE RATE
The primary contention of the migration to direct source

retailing: opportunities from a lower exchange rate was that
FX risk management will provide a strategic advantage
for savvy retailers in the midst of a falling AUD. External
conditions will affect all businesses with a direct or indirect
exposure, however, the extent and timing of that affect
can be influenced. Utilising hedging and other risk
management solutions, retailers could have protected
themselves against AUD depreciation for longer. This
protection provides the ability to maintain prices when
competitors are increasing prices, or increase prices with
the market to capture increased profits.
Source: CIQ, ANZ

As at 18 March 2015
1.15
1.10
1.05
1.00
0.95
0.90
0.85
0.80
0.75
Mar-10
Aug-10
Jan-11
Jun-11
Nov-11
Apr-12
AUD/USD
Sep-12
Feb-13
Model Forecast
Jul-13
Dec-13
May-14
Oct-14
FY15 YTD
Mar-15
What has been the impact on profits?

Our base case modelling of an average exchange rate of
AUD/USD 0.85 during FY2015, which is broadly in line
with the actual exchange rate, implied that before strategic
initiatives, only 55% of direct sourcing retailers would be
profitable on an EBIT basis from around 20% that were
already unprofitable at the time.
Although FY2015 data wont be available until later this year,
there is already evidence that businesses have had to react
and position themselves accordingly. A number of publicly
listed retailers have stated that they had to increase prices
as a result of a lower AUD. This will create winners and losers,
as price rises can lead to loss of market share, particularly
if competitors are able to maintain their prices.
As opposed to FY2014, which was partially protected via
hedging, exchange rate cover has fallen in average tenor
during FY2015 (Fig 32). Also, the cover has been at a lower
rate suggesting that profits will be more impacted.
FIGURE 27: PERCENTAGE OF COMPANIES MAKING AN EBIT LOSS UNDER EACH SCENARIO (NOV 2013 PREDICTION)
%
100
90
80
70
60
50
40
30
20
10
0
Direct Sourcing Retailers
Current
ANZ ASIA RETAIL
Local Sourcing Retailers

@0.950
@0.900
@0.850
Wholesalers
@0.800
@0.750
41
MORE BUSINESSES WILL BE EXPOSED TO AUD VOLATILITY
ANZ forecasts to FY2016

Updated modelling to the end of FY2016 highlights the potential profit impact for the industry under a range of FX scenarios.
Scenarios are based on average exchange rates and our base case of AUD/USD 0.75 during FY2016 represents an average
decline of 18% from FY2014.
FIGURE 28: FX FORECAST SCENARIOS
FY 2015
FY 2016
Decline from FY2014

avg. (0.918)
Forecast FX rate Scenario 1
0.884
0.850
7%
0.859
0.800
13%
0.834
0.750
18%
0.809
0.700
24%
0.784
0.650
29%
FIGURE 29: PERCENTAGE OF COMPANIES MAKING AN EBIT LOSS UNDER EACH SCENARIO (APRIL 2015 PREDICTION)
Source: ANZ
Group - Negative EBIT Margin
%
100
90
80
70
60
With the share of direct sourcing retailers increasing, more

businesses will be exposed to AUD volatility. In our base case
scenario, before strategic initiatives such as price increases,
more than 70% of direct sourcing retailers will generate a
negative EBIT. This is a significant percentage and highlights
the extent of price increases that are likely to occur for many
of these businesses to avoid losses. The extent of these price
rises and the associated impact on consumer demand and
market share will be dependent on the company, sub-sector
and market in which the company operates in.
For Australian wholesalers, theres likely to be more pain in
a lower AUD environment as cost of goods sold represents
a larger portion of total expenses relative to retailers. Profit
margins are also thinner for wholesalers. A silver lining though
has been that balance sheets for wholesalers have improved
considerably. Cashflow leverage and balance sheet leverage
has declined to their lowest levels since at least FY2006
(Fig 30 and Fig 31). This provides increased financial flexibility
to offset some exchange rate pain.
In addition to price increases, retailers and wholesalers can
continue to reduce the cost of doing business. The primary
focus has been on the physical supply chain (i.e. direct
sourcing), but businesses should also consider the benefits
of streamlining their financial supply chain, which can help
to improve liquidity and lower the cost of capital (See Supply
Chain case study). In a low growth environment, physical
and financial strategic supply chain initiatives can provide
an opportunity and/or advantage to retailers.
FIGURE 30: WHOLESALER CASHFLOW LEVERAGE

Source: ANZ
Total financial indebtedness (TFI) / EBITDA
3.4x
3.3x
3.1x
2.3x
2.2x
2.9x
1.9x
3.0x
3.0x
2.8x
2.1x
1.9x
1.9x
1.2x
1.1x
1.9x
1.5x
1.4x
1.1x
1.3x
1.3x
1.2x
0.6x
FY07
FY08
FY09
FY10
Top Quartile
FY11
Median
FY12
FY13
FY14
Bottom Quartile
FIGURE 31: WHOLESALER BALANCE SHEET LEVERAGE

Source: ANZ
Total financial indebtedness / Capital + operating leases
68%
71%
71%
70%
71%
69%
62%
55%
55%
54%
54%
50
42%
40
3.1x
43%
51%
53%
49%
45%
40%
30
37%
35%
34%
33%
37%
20
17%
10
0
Retailers
Direct Sourcing
Current
Scenario 1
Local Sourcing
Scenario 2
Scenario 3
Scenario 4
Wholesalers
Scenario 5
FY07
FY08
FY09
Top Quartile
ANZ ASIA RETAIL
FY10
FY11
Median
FY12
FY13
FY14
Bottom Quartile
43
THE AVERAGE HEDGING TENOR HAS DECLINED SINCE JANUARY 2013
Case Study: Supply Chain (ABC Retail)

Solution:
Supply Chain Considerations:

A large Australian retailer (ABC Retail) has been
expanding in Australia and throughout Asia. The majority
of their sourcing is derived from China, however, many
of their Chinese suppliers are exposed to the volatile
cost of debt locally. At the same time, ABC Retail has
been seeking to improve their working capital efficiency
by extending payment terms, however, this would
place an additional capital burden on their suppliers.
ABC Retail implemented a Payables Finance solution.

This solution enables ABCs suppliers to not only request
early payment for invoices, which enhances liquidity and
improves working capital, but also to finance this at ABCs
credit rating, which provides a lower cost of debt.
In exchange for this benefit, ABC Retail is able to negotiate
an extension in payment terms, which enhances their
liquidity and working capital. By providing liquidity, this
solution helps to support suppliers, which can reduce
operational risk.
The changing dynamic of risk management
FIGURE 32: ANZ RETAIL SECTOR HEDGING TRENDS
Analysis of ANZ internal data for retailers at various points in

time reveals that risk management practices have changed.
Despite forecasts of a lower AUD, the average hedging
tenor has declined since January 2013. This is surprising and
suggests that there has been a focus on short term trends,
rather than planning for longer term exposures, especially
given long lead time from design to store.
Source: ANZ
In a falling AUD environment, this trend will negatively affect

retailers. It will lead to new cover at lower average rates and
possibly to businesses increasing prices and/or lower profits
due to higher costs.
0.940
0.930
0.920
0.910
0.900
0.890
0.880
0.870
0.860
Jan-13
Dec-13
Mar-14
Tenor (Months)
Sep-14
Dec-14
AUD/USD
1. Purchase order
2. Deliver goods/services and invoice
Anchor/Buyer
Supplier
6. Send early payment

at discounted value
3. Send approved invoices

7. Pay invoice amount
on invoice due date
ANZ ASIA RETAIL
Supply Chain Finance

Provider/ Financial
Institution
4. Option for early

payment of invoice
5. Request for early payment
45
AUSTRALIAN RETAILERS HAVE TWO MAJOR FACTORS IN THEIR FAVOUR
Two tailwinds
Case Study: Risk Management
Its not all bad news. Australian retailers have two major
factors in their favour that will provide major tailwinds
to a potential decline in the AUD.
Risk Management Considerations:
For the Retail Sector:
Before entering into a currency hedge, it is important

to identify the key risks and opportunities.
Should the AUD/USD depreciate, protection is

paramount. This can help to protect your margins
and can be a competitive advantage should any
competitors be unhedged.
How much risk can the business tolerate?

How important is certainty of cash flows?
Should the AUD/USD appreciate, participation in

some form is desirable. This allows for the possibility
to achieve some cost savings and again you can
potentially outperform peers where they may have
entered into less flexible hedging arrangements.
What are the budgeted exchange rates?

What tenor of hedging suits the business?
What are competitors doing?
Risk Management Benefits:
By structuring hedging arrangements appropriately,
clients can select their desired level of protection and
participation. In doing this, businesses can have comfort
that their margins are protected if the AUD/USD falls,
however should the AUD/USD rise, businesses are able,
in varying degrees, to share in the upside.
Firstly, on the 1st of January 2015, tariffs on imported textiles

fell to 5% from 10%. The extent of this cost pass through
benefit will vary by industry sub-sector and company,
but it will provide an opportunity for direct sourcing
retailers and wholesalers to partially offset cost increases
via currency depreciation as a result of lower tariffs.
The other major benefit will start to take effect at the end of
2015. In November 2014, China and Australia signed a Free
Trade Agreement (ChAFTA), which is expected to come into
force in December 2014. The ChAFTA will mean that Chinese
textile imports will be tariff free, providing a further 5% fall
from the 1 January 2015 reduction. This change is significant
for Australia as China is Australias largest source for all textiles.
Both these factors will provide a much needed cost shield
against a falling currency.
The future path of exchange rates is uncertain.

You cant control what exchange rates do, you cant
control what your competitors do, but you can control
your own risk management.
FIGURE 33: AUD/USD WHERE TO FROM HERE?

Source: ANZ
AUD/USD Exchange Rate

0.95
Your hedging strategy needs to work for you
under the two following scenarios
If AUD/USD trends higher - it is

important to maintain a degree of
market relevance with your hedging
0.90
0.85
ANZ OPPORTUNITY CHINA
AUD/USD has exhibited both

stability and volatility over the past 12 months
THE CHAFTA AND IMPLICATIONS FOR AUSTRALIAN BUSINESSES
0.80
MARCH 2015
0.75
If AUD/USD trends lower
- you want protection
0.70
Jan-14
Apr-14
Jul-14
Oct-14
Jan-15
today
Apr-15
Jul-15
Oct-15
ANZ Opportunity China

The ChAFTA and implications for Australian businesses
http://insites.anz.com/chinagateway
Jan-16
K15179_ANZ_Business in Asia_Brochure_CCB_v2.indd 1
ANZ ASIA RETAIL
6/03/2015 10:02 am
47
Key Contributors
About Client Insights & Solutions
Mark Ganz
Client Insights and Solutions (CIS) is at the forefront of

developing and disseminating intellectual capital for the
benefit of ANZs Institutional and Corporate Banking clients.
Director, Client Insights & Solutions

Mark.Ganz@anz.com
Andrew Howard
Associate Director, Client Insights & Solutions
Andrew.Howard@anz.com
Lisa Zhong
Associate, Client Insights & Solutions
Lisa.Zhong@anz.com
ANZ ASIA RETAIL
The team utilises corporate finance, industry analysis,

and big data techniques to develop tailored capital
structure, risk management, and working capital solutions.
Additionally, our industry, market event and regulatory
analysis provide predictive analysis and associated solutions
across all industry sectors.
With an on the ground presence in Australia, New Zealand,
Singapore, Hong Kong, London, New York and India,
CIS is resourced to identify and meet our clients needs.
49
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POSITIONING FOR PROFIT

NAVIGATING THE ASIAN TEXTILE & GARMENT SUPPLY CHAIN

THE TEXTILE AND GARMENT MARKET IS NOT LOCAL ANYMORE

UNDERSTANDING THE ASIAN SUPPLY CHAIN

WHAT HAVE CHINESE COMPANIES BEEN DOING TO COMPETE?

DIRECT SOURCING IN A LOWER AUD ENVIRONMENT

ABOUT CLIENT INSIGHTS & SOLUTIONS

ANZ ASIA RETAIL

Effective supply chain execution has had a major impact

Two major themes have emerged that will heavily influence

RISK MANAGEMENT IS NOW A SOURCE OF COMPETITIVE ADVANTAGE

China accounts for more than 40% of global textile and

1. Relocation of facilities to lower cost countries:

In FY2013, around 60% of discretionary retailers in Australia

FIGURE 1. THE CHANGING IMPACT ON GROSS MARGINS

It is not all bad news as there are two identified tailwinds

THE TEXTILE AND GARMENT MARKET

The rise of online shopping is just one example of the

FIGURE 2. GLOBAL GARMENT MANUFACTURING

North Asia 35.8%

North America 5.0%

South America 5.0%

South East Asia 15.1%

Africa & Middle East 1.9%

India & Central Asia 7.1%

Australia compares extremely favourably in per capita

FIGURE 3. PER CAPITA SPEND ON GARMENTS

High disposable incomes and increasing wealth are

Despite the strong existing and forecast spend on clothing,

Source: India International Textile Machinery Exhibitions Society

FIGURE 4. GARMENT CONSUMPTION BY COUNTRY

ANZ ASIA RETAIL

THE TEXTILE AND GARMENT MARKET IS NOT LOCAL ANYMORE

Further examination between Australian retailers and

FIGURE 5. GLOBAL GARMENT TRADE (2013)

FIGURE 6: AUSTRALIAN VS CHINESE TEXTILE & GARMENT COMPANIES

Source: CIQ, ANZ

Exports (USD bn)

Revenue Growth (Latest FY)

Size of the bubble represents the median AUD revenue

Imports (USD bn)

Asia (Ex China), 14.48%

This difference in experience and relative size has two key

North America, 2.53%

1. The volumes demanded of Chinese manufacturers

South America, 2.84%

Represents percentage of total global exports

EBIT Margin (Latest FY)

CHI - Apparel Manufacturing, 225

AUS - Clothing Retailing, 157

AUS - Clothing Wholesaling, 48

CHI - Footwear Manufacturing, 280

AUS - Footwear Retailing, 51

AUS - Footwear Wholesaling, 42

2. Given that the power in the Australia-China supply chain

ANZ ASIA RETAIL

THE TEXTILE AND GARMENT MARKET IS NOT LOCAL ANYMORE

CHINA IS THE UNDISPUTED GARMENT

FIGURE 7: GARMENT EXPORT INDEX: 2007 = 100

China remains the king, but there are challengers

China is the undisputed garment manufacturing centre

World Trade Organisation data indicated that the next

1. Relocation of facilities to lower cost countries:

1. The volumes demanded of Chinese manufacturers

2. Given that the power in the Australia-China supply chain

A. The sourcing of raw materials such as cotton,

D. Garment wholesaling, either locally in Australia

B. The manufacturing of textiles fibre processing

2. Chinese manufacturing has for many years competed

3. The just in time stock covering model from retailers has

1. Despite the reduction in domestic cotton and synthetic