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PSF: THE GROWING DEMAND

A complement and substitute for cotton

By SHABBIR H. KAZMI
Nov 24 - Dec 07, 2003

At present earnings of Polyester Staple Fibre (PSF) manufacturers are under pressure due to a number of reasons, the most important factor being glut of supply. The over supply is mainly due to capacity expansion undertaken by the leading manufacturers simultaneously in the recent past. However, it is interesting to note that one of the manufacturers is busy in doubling the plant capacity. The additional capacity is expected to come online in year 2006.

The depressed profitability of the sector was evident from the financial results. Profitability of the sector is expected to remain depressed in the near future unless the demand-supply equation improves. According to industry sources, the PSF sector is going through a unique phase. Ibrahim Fibres has attained the position of price leader and others players have no option but to follow the market leader. Other manufacturers are forced to sell their product either at marginal profit or at cost, in some cases, even below cost. Analysts attribute this power of Ibrahim to conversion cost efficiency leading to a relatively bigger margin to sustain price cuts. There are three major manufacturers in the PSF sector, namely Dewan Salman Fibres, Ibrahim Fibres and ICI Pakistan, whereas, Pakistan Synthetics and Rupali are the smaller manufacturing units. DSF is the largest unit with a market share of 40% followed by Ibrahim. However, Ibrahim commands the position of price leader in the domestic market due to having lower cost of production and proximity to consumers of PSF located in Faisalabad. According to Murad Ansari of KASB Securities, "The PSF sector faces over-supply situation due to expansion undertaken by the major players. While most of the analysts continue to give more weight to the regional situation, they tend to ignore the fact that the local dynamics overshadow any positive trend in the regional markets. At the time, domestic PSF manufacturers were expecting an upward price revision one of the major players deciding to keep its product price stable and others were forced to follow the market leader."

With the competition heating up in the domestic market, local PSF manufacturers are making efforts to sell their products in the global markets. However, some analysts do not consider export of PSF from Pakistan a profitable business. They say, "Any attempt to improve profit margin through export is a futile effort export can only help in keeping inventories at lower level and attaining higher capacity utilization. With the Asian region already experiencing glut of PSF supply, Pakistani PSF manufacturers are forced to look at European and American markets."

The present profit margin of domestic PSF manufacturers is mainly due to the protection enjoyed by the industry. Therefore, the profits are virtually non-existent in export markets. Local manufacturers have to sell their product at the prices prevalent in those markets, which barely covers the cost and freight cost is also high. It is understood that freight costs to European markets is almost 10 times higher than the charges for the Asian markets.

COTTON PRICES

Cotton prices in the domestic market have registered an upward trend, partly due to contradictory estimates of cotton output in the country and, partly, due to forecast of a potential shortfall in cotton production globally. Textile spinners fear that they will not be able to pass on the increase in cost of cotton to the buyers. The rupee appreciation against dollar has already started affecting the profit margins of exporters of textiles and clothing. Therefore, they are trying to convince the GoP to take measures that can improve cotton supply as well as contain PSF prices to avoid erosion of their profit margins.

It is necessary to recognize the fact that the cotton prices are expected to remain high due to potential shortfall in its supply globally, Pakistan cannot be an exception. Similarly, unless crude oil prices come down, any reduction in PSF prices should not be expected. If the hike in cotton and PSF prices in universal, the hike in the prices of textiles and clothing is inevitable. Saying this, one must also keep the fact in mind that it will not be easy for the local exporters to negotiate higher price for the already signed export orders, at the best they may succeed in acquiring new orders at higher prices.

Textile industry had two outstanding demands, i.e. the GoP should withdraw duty applicable on the import of PSF and its inclusion in Duty Tax Remission for Export (DTRE) scheme. In the federal budget for year 2003-04, the GoP has accepted the second demand and expressed its inability to even lower the duty rate on imported PSF. The inability of the GoP to reduce the duty on PSF is due to the guarantees extended to the sponsors of Pakistan PTA. This unit has substantial equity stake of foreign investors.

Textile industry is of the opinion that if the GoP had any agreement with any foreign investor why should the local industry be penalized. The GoP should compensate the investor from its own resources. However, some analysts do not agree with this rationalization. They say that textile industry in Pakistan has survived and flourished only because of protection. If protection of textile industry for over half a century was justified, the protection to the sole manufacturer of PTA for a specified period is also justified.

According to some analysts, "The GoP critics do not recognize two important achievements made in the recent past, i.e. establishment of a PTA manufacturing plant and massive investment by PSF manufacturers to expand installed capacity in the country. Both the targets have achieved only because protection was offered to investors. The strategy was aimed at achieving self-sufficiency in PSF to insulate its domestic consumers from volatility of prices of man-made fibre in the global markets."

At present five PSF manufacturers are operating in the country. Collectively they have installed capacity to produce 618,000 tonnes PSF annually. Till year 2002, they had an installed capacity to produce 445,000 tonnes PSF annually. This increase was mainly due to addition of capacity by ICI Pakistan and Ibrahim Fibre. Currently Dewan Salman (after the merger of Dhan Fibre) has the largest installed capacity, followed by Ibrahim Fibre and ICI Pakistan.

INSTALLED CAPACITY

(Tonnes/annum)

DEWAN SALMAN

270,000

IBRAHIM FIBRES

208,600

ICI PAKISTAN

109,000

PAKISTAN SYNTHETICS

28,000

RUPALI POLYESTER

23,000

The local spinners often complains that the local PSF manufacturers are selling their product at prices higher than the landed cost of fibre. However, analysis of prices of locally manufactured PSF indicates strong correlation between domestic prices and its global prices. Since the prices of two basic raw materials, PTA and MEG, are dependent on the movement of crude oil prices, local manufacturers also have to adjust prices accordingly. Therefore, blaming the local PSF manufacturers for profiteering may not be correct.

Some sector experts say that local spinners have been over-playing the importance of PSF prices for attaining higher exports. Historically bulk of Pakistan's exports comprised of 100% textiles and clothing. It is also evident from another fact that while textile industry has been consuming about two million tonnes of cotton, the consumption of PSF has been around 400,000 per annum. It was only recently that exports of synthetic textile attained any significant share in Pakistan's total exports.

INDUSTRY DYNAMICS

PSF is a man-made synthetic fibre used in the textile industry for blending with cotton and other man-made fibres to produce blended yarn. The major raw material used in for the manufacturing of PSF are Pure Terephthalic Acid (PTA) and Mono Ethylene Glycol (MEG). Both PTA and MEG are petrochemical derivatives made from Naphtha.

PSF started gaining importance in Pakistan in eighties as a complement to cotton for the manufacturing of blended yarn. For considerably long time spinners, prime choice was cotton due to its easy availability and low price. PSF was not made locally and entire demand had to be imported. However, the subsequent increase in cotton prices and shortfall in production for a number of years coupled with gradual shift towards blended fabrics created demand for PSF locally.

Synthetic fibre is essentially a commodity and manufacturers are exposed relatively high volatility in production, revenue and profitability. Domestic prices of PSF normally move in tandem with its international prices. Whereas, prices of PTA and MEG are linked with the international prices of crude oil. The domestic demand for PSF has been driven by global as well as domestic demand for blended textiles and clothing. Uniform quality and availability throughout the year reinforces the use of PSF in blended yarn.

KEY PLAYERS

Dewan Salman Fibre (DSF) is part of the Dewan Group having diversified interest. Besides, having stake in PSF the Group has stake in sugar, automobile and textile spinning. DSF is the Group's flagship company and has been the market leader in the PSF since its inception. The company has four PSF manufacturing units with a cumulative production of 270,000 tonnes per annum and one unit of acrylic fibre with an installed capacity of 25,000 tonnes per annum.

DSF is the only company that manufacturers acrylic fibre, primarily used in woollen mills. Due to local climatic conditions there is little domestic demand for blended woollen yarn. The major market is exports of woollen yarn, fabrics and made-ups. However, Pakistani exporters are not very active in these products.

The recent past has been a nightmare for DSF for two reasons. A price-setting competitor had surplus capacity and geopolitical uncertainties kept raw material prices high. However, the declining trend of interest rates allowed the company to reprofile its debt, helping in reducing financial charges substantially. The future looks promising because of robust domestic demand for PSF and any improvement in capacity utilization will yield additional benefits.

The company has reprofiled its debt and the average financial cost has declined by 700 bps as a result financial charges are expected to be 37% lower for the year 2004. Another factor contributing to reduction in manufacturing cost is gradual conversion of its plant from furnace oil to natural gas. After the full conversion the company will be able to save over one billion rupee or 25% of its fuel cost. If PSF prices remain stable in the domestic market, DSF is expected to achieve about 10% increase in its gross profit.

One of the major issues facing the company is high inventory level, needing higher working capital requirement. This also exposes the company to inventory losses, due to any decline in domestic prices of PSF. The company is making efforts to reduce inventory levels by exporting part of its surplus production. DSF is probably the only exporter of PSF. While the margins on exports may be negligible its helps in achieving higher economies of scale and reducing average cost per kilogram of fibre.

Ibrahim Fibres is the flagship company of Ibrahim Group. The Group started with trading of cloth and gradually diversified into manufacturing of textiles and finally into PSF manufacturing. The Group has merged all its textile units and its captive power plant into Ibrahim Fibres. The company is a well-run entity and is well entrenched in the market.

It is the second largest producer of PSF in the country with an installed capacity of 208,600 tonnes per annum. The biggest advantage enjoyed by the company is its strategic local, in close proximity of the hub of textile industry in Faisalabad. This gives the company an advantage over other manufacturers through low transportation cost and just-in-time inventory. The group also owns textile units, which consume about 1% of its current production.

The company has acquired its plants from Lurgi Zimmer AG, Germany, one of the top companies in the world. Lurgi has also provided the technological know-how for the manufacturing of PSF. Ibrahim is currently the lowest cost producer in the country. The basic raw materials are entirely imported against long-term supply contracts. The supply glut kept capacity utilization low, around 70%. However, lately the plant has been operating at full capacity, which will also improve the average capacity utilization for the full year.

Ibrahim is currently working on the expansion plan, which will double its installed capacity from present 208,600 to 417,200 tonnes per annum. The additional capacity is expected to come online in year 2006. Keeping in view the growth in PSF consumption, the new capacity will come online at a time when the demand is expected to surpass the production from existing installed capacity.

ICI Pakistan pioneered PSF technology in Pakistan through its investment in a 12,000 tonnes per annum PSF manufacturing plant commissioned in 1982 in Sheikhupura, near Lahore. Successive expansions and de-bottlenecking in the late1980s and a major expansion in 1996, costing US$ 100 million, have enabled it to retain its strong position in the industry. Arrangements for off balance sheet financing, through the establishment of an industrial modaraba have successfully increased PSF manufacturing capacity from 65,000 tonnes to 109,000 tonnes per annum

The plant has achieved record production, which was possible as a result of utilizing the incremental capacity made available following the de-bottlenecking as well as improvement in raw material conversion efficiencies and higher plant availability compared to previous years. The production record is now equal to or even better than those in competitive plants in the region using DuPont technology. As the focus of textile industry shifts from lower value addition to niche products, ICI has exploited the availability of batch line technology to strategically develop and produce variant fibres. While some of these variants have already been launched, development continues on other fibres aimed at providing spinners with a distinct edge over their competitors.

OUTLOOK

Ever since the import duty on PSF is reduced, the local manufacturers have been saying, "The duty structure in Pakistan does not fully support PSF manufacturing in the country." To be able to make a prudent decision, economic managers of Pakistan must not ignore their outcry. The fact is that the GoP reduced the import duty on PSF but did not make any corresponding reduction in import duty on PTA and MEG. Therefore, the PSF manufacturers are right in demanding that either the GoP should reduce the import duty on PTA and MEG or take some measures that can keep local production of PSF a viable business.

It has been often alleged that a cartel prevails in PSF industry. Under the cartel, production quota of each manufacturer is fixed, on the basis of installed capacity and prices are also be fixed by the cartel. The spinners are the biggest opponents of such a cartel. If the presence of a cartel is accepted, it was aimed at ensuring decent profit for each manufacturer. The cartel was said to be necessary due to over supply. However, the oversupply seems to be a temporary phenomenon. Consumption of PSF is expected to take a quantum leap due to enhanced textile quota allocation by the European Union and signing of Trade and Investment Framework Agreement (TIFA) with the United States of America.

It appears that prices of crude oil will remain high in the near future and continue to keep margins of local PSF manufacturers under pressure. The induction of PSF in DTRE scheme has provided an opportunity to exporters of textiles and clothing to contain their cost without going through the hassle of filing refund claims. Therefore, duty on PSF has become of no consequence for them. One may argue that it still pose problems for those who are not registered under DTRE scheme. The solution is simple, get registered under the scheme to qualify for the benefit.

Local textile manufacturers must also keep the fact in mind that global demand for PSF is expected to surpass the supply in the near future. This may resulted in higher global prices of PSF. At a time when cotton prices are high they must take the best advantage of indigenous availability of PSF by entering into long-term supply agreements with the local manufacturers. PSF is not a substitute for cotton it rather complements cotton.