IMPROVED PROFIT MARGIN REQUIRED FOR EXPANSION TO MEET ENHANCED DEMAND

By SHABBIR H. KAZMI
Oct 12 - 18, 1998

The polyester staple fibre (PSF) sector in Pakistan is at the crossroads. It has to make a crucial decision regarding expansion of present installed capacity. Current glut of supply of PSF, declining profit margins of local manufacturers and cheap imports are the major impediments for the plans of further expansion. But the increase in domestic consumption of man-made fibre, a forecast that the demand for PSF will exceed domestic production by the end of 1999, persistent higher price of cotton and commencement of production of PTA in the country, suggest expeditious increase in the installed capacity. Only those companies will be able to exploit the opportunity which have better cash flow. However, they have to make swift move to achieve financial close and place order for plant and machinery to capture the expected shortfall in supply by the year 2000.

According to some sector specialists, it is the right time to make such a crucial decision. Though the sector faces reduced profit margins — mainly due to cheap imports falling under 'dumping' — the domestic demand for man-made fibre is expected to surpass supply by the end of next year. Their forecast is based on massive increase in consumption of PSF for the production of blended yarn and fabrics. They even say that though the consumption has increased significantly, it is still much below the global level. The shift from production of 100 per cent cotton yarn to blended yarn in the recent years was mainly due to persistent high prices of cotton in the country and a large number of spinning units were revamped to produce blended yarn.

SECTOR FUNDAMENTALS

Demand vs supply

A closer look at the sector indicates that there has been a massive increase in the installed capacity for PSF manufacturing during the last five years. New units were established and existing units expanded their production capacities. Two large size units, Ibrahim Fire and Dhan Fibres, with a total installed capacity of over 160,000 tonnes per annum, commenced production. ICI Pakistan, Dewan Salman and Pakistan Synthetics also expanded production capacities.

Theoretically, such a massive expansion should have created a glut of supply but in the mean time some of the spinning units were also busy in modifying the plants. With the availability of enhanced production of PSF, its local consumption increased and imports declined. The PSF manufacturers having in-house consumption, were better off. These were Dewan, Dhan and Ibrahim. They were also less affected from declining trend in PSF prices. But, the Chakwal Group, facing serious financial problems and delay in construction of its cement plant, was not able to overcome problems faced by Dhan Fibres. The level of distress is evident from a fact that the Group was forced to sell its stake in Prime bank.

According to textile industry sources, the local consumption of PSF was estimated around 350,000 tonnes in 1998-99. It is expected to exceed 400,000 tonnes in next financial year as more spinning units will complete the conversion. The demand for blended yarn and fabrics is constantly increasing in the global markets mainly due to less stringent quota restrictions.

Prices

During last three years the prices of PSF in the country were slashed to around half. This was mainly due to reduction in prices of PTA and MEG, two major raw materials, and local supply of PSF exceeding demand. This was despite the fact that the sector was heavily import based and Pak rupee also went through significant devaluation. The reduction in international prices of PSF was more than the corresponding reduction in prices of raw materials. The overseas manufacturers, facing a glut of supply, were forced to curtail prices to achieve higher volume and, at times, recover the fixed costs.

Dumping by overseas suppliers

Local PSF manufacturers, during the last two years, have been complaining about sale of commodity to Pakistani importers at a price, which may fall under dumping, creating a justification for imposition of anti-dumping duties. However, such duties cannot be imposed as there is no such law in the country. But, the local manufacturers, having a large foreign investment, were able to convince the government of Pakistan (GoP) to impose regulatory duty on import of PSF and also keep the tariff high. The move has come under severe criticism by the spinners. They have been demanding from the GoP to reduce the tariff on import on the fibre and lately added demand to include PSF in 'No Duty No Rebate regime'. Though, they have not been able to get the duty abolished, but were able to put pressure on PSF manufacturers and get the prices reduced lately. It is expected that once arrival of cotton from new crop gains momentum, the PSF manufacturers will be forced to slash the prices further to maintain current volume of sales.

Opposing the demand of spinners, textile sector experts say that most of the spinning mills, having financial capability, have already revamped their facilities to produce blended yarn and even if the prices of PSF are slashed by 50 per cent, the increase in demand will be marginal only. Further switch over is restrained because, the country in general and spinners in particular, face serious liquidity crunch. Acquisition of fresh loans for conversion of spinning units is not possible in the presence of existing prudential laws. In their views the spinners are demanding reduction in tariff on imported PSF to put pressure on local manufacturers of man-made fibres. Such a move is aimed at improving profit margins of spinners. However, the sector specialists support continuation of higher tariff to keep the local manufacturers of PSF immune from dumping by overseas suppliers for the time being. But, they also say that local manufacturers of PSF should keep the prices of fibre at realistic level.

Expansion

There is a forecast that the demand for PSF will surpass local production by the end of next year and therefore there is a need to increase installed capacity in the country latest by the year 2000. With the increase in consumption and aging of plants, the need to shut down the plants for repair and service is expected to become more pressing and it will not be possible to run the plants at full capacity for a longer period. The sector experts also say that since Dhan has not been able to overcome its technical problems, its capacity cannot be added to arrive at dependable capacity. Dhan has not been able to attain the confidence of quality-oriented buyers. In their views the companies which could possibly go for expansion, are Dewan, ICI Pakistan and Ibrahim.

Dewan, after doubling its capacity, has decided to diversify. It is establishing an acrylic fibre unit. The probability of ICI Pakistan, going for another expansion, is low as it has recently made heavy investment in PTA plant. It is not expected that the parent company may be interested in expanding its exposure in Pakistan — though it will have the advantage of in-house supply of PTA. According to sector experts the probability of Ibrahim going for an expansion is the highest.

The sector experts attribute the following reasons for this belief: the Company already enjoys high capacity utilisation due to its location in Faisalabad — the centre of yarn consumption. The cost of production at the unit is relatively low and the Company enjoys a strong and stable cash flow. The expertise of the Group to negotiate lower project cost was evident when the plant was established. Technical services agreements with leading process marketing companies and high acceptance of its finished products give it an edge over other PSF manufacturers.

But securities analysts say that in case the Group decides to go for expansion, the shareholders of the company will be deprived of cash dividend. The unit is equity based and if it once again decides to do the same way, it will have to retain bulk of earnings. However, one cannot ignore the fact that low debt equity ratio, good cash flow and a strong track record will attract any lender to conclude the deal at lower interest rate. Many DFIs and investment banks are sitting on hard cash only because the fresh applications for financing are visible by their absence.

Sector Profile

Local

At present there are six major producers of PSF in the country. These are Dewan Salman, Dhan Fibres, Ibrahim Fibres, ICI Pakistan, Rupali and Pakistan Synthetics. These manufacturers have a total installed capacity to produce about 380,000 tonnes of fibre per year. Besides these, National Fibre has an installed capacity of 12,000 tonnes per annum. During post privatisation era, the unit faced problems. National Development Finance Corporation has lately taken over the control of the project. The demand for fibre has been increasing due to strong demand by the spinners. The production and export of blended yarn and fabrics is on a constant increase due to declining trend of PSF prices and higher price of cotton.

The PSF price in Pakistan has come under pressure as a result of the regional over-supply. Korea, Thailand and Indonesia, affected by the current Asian currency crisis, have resorted to dispose of their production at lower prices to generate cash to keep their plants running. The PSF manufacturers in Pakistan have come under severe pressure due to, a sort of, dumping by these countries. It was observed that while the selling price of PSF in Korea is around US$ 0.91/kg, the offers, received by the Pakistani importers from the Korean manufacturers, were as low as US$ 0.60/kg. This works out to Rs. 48.00/kg at prevailing exchange rate.

International

Globally there is an over-supply in both PSF and filament yarn. In 1998, the global demand for PSF was estimated around 7 million tonnes as against an installed capacity of 8.3 million tonnes. At present the industry is operating at around 84 per cent capacity utilisation.

During the last two years there was a significant increase in PSF production capacity in Asia due to easy availability of dollar financing at extremely attractive interest rates and buoyant demand. The major chunk of demand originates from China which was estimated at over 1.6 million tonnes for 1998. The demand for Asia Pacific was estimated at 4.3 million tonnes with the balance of 2.7 million tonnes, attributed to rest of the world. The major PSF exporting countries are Korea, Taiwan, Indonesia and Thailand. The global demand has grown around 6% per annum.

Sector Outlook

Commencement of production of PTA in Pakistan ensures availability of one of the crucial raw materials locally. The indigenous production is expected to facilitate local producers of PSF in reducing their working capital requirement, financial charges and carrying large inventory of the fibre. According to sector experts Pakistan has not achieved the capability to produce exportable surplus. This limitation is due to enhanced local consumption of the fibre and continued dependence on imported MEG. The probability of exports also becomes low as China is expanding installed capacity which will result in reduced import of PSF by the country.

The decline in PTA and MEG prices is not sufficient to compensate for the reduction in PSF prices. The short-term outlook for PSF sector in Pakistan will continue to be bearish due to reduced margins. However, the forecast for local consumption exceeding supply, offers an opportunity to expand the existing capacities. Besides, there is a forecast that there will be capacity rationalisation in Asia over next couple of years particularly in Korea, Indonesia, Taiwan and Thailand as availability of capital dries up and these countries are obliged to comply with IMF conditionalities. It is expected that prices of PSF will start improving by the end of next year. Therefore, the increase in local production has become all the more important amidst a forecast for devaluation of Pak rupee by 15 to 20 per cent in the near future.

The GoP must promulgate anti-dumping law immediately to protect the local PSF manufacturers from alleged dumping by the overseas suppliers. In the absence of this law the local manufacturers cannot be protected. The investment in the sector is estimated around US$ 500 million in assets and it contributes around Rs. 6 billion per annum to national exchequer. The PSF sector has been playing a catalyst in the revival of local spinning sector. It has a stronger role to play in the near future if the spinners decide to improve capacity utilisation and profit margins by producing more of blended yarn and fabrics.

Installed Capacity

Tonnes

Dewan Salman

108,500

Dhan Fibres

91,000

Ibrahim Fibres

70,000

ICI Pakistan

60,000

Pakistan Synthetic

23,000

Rupali

12,000

National Fibre

12,000

 



Import of PSF

Tonnes

1991-92

33,475

1992-93

24,685

1993-94

25,176

1994-95

32,815

1995-96

19,629

1996-97

17,960

1997-98

12,656

(July-May)



Consumption of Fibre

Tonnes

1991-92

105,775

1992-93

125,525

1993-94

182,077

1994-95

192,152

1995-96

192,691

1996-97

236,692

1997-98

317,449

Source:APTMA

 


 

Production of Polycotton Yarn

Tonnes

1991-92

109,973

1992-93

81,621

1993-94

120,107

1994-95

135,314

1995-96

134,784

1996-97

192,960

1997-98

242,270

Source:APTMA

 


 

Production of Blended Fabrics

Tonnes

1991-92

66,256

1992-93

67,344

1993-94

59,835

1994-95

51,907

1995-96

61,293

1996-97

57,198

1997-98

56,996

Source:APTMA