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

POSITIONING FOR PROFIT
APRIL 2015
NAVIGATING THE ASIAN TEXTILE & GARMENT SUPPLY CHAIN

CONTENTS
EXECUTIVE SUMMARY 3
KEY INSIGHTS 4
THE TEXTILE AND GARMENT MARKET IS NOT LOCAL ANYMORE 6
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.
EXECUTIVE SUMMARY
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.
3

ANZ OPPORTUNITY CHINA
KEY INSIGHTS
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 China’s
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.
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 HM, 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. Manufacturers 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.
ANZ ASIA RETAIL
FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 YTD
Retailers WholesalersAUD/USD (Avg)
47.5%
38.4%
39.8%
37.1%
39.7% 39.2% 39.4% 39.9% 37.3%
48.1% 48.3%
49.3% 50.5% 52.1% 50.5% 49.2%
0.896
0.747
0.882
0.990
1.033 1.027
0.918
0.870
FY09
Limited retailers direct sourcing
Average exchange rates drop significantly
Wholesaler gross profit margins more affected
FY14
65% - 70% retailers direct sourcing
Average exchange rates drop by 10%
Both retailer and wholesaler gross profit margins affected
FIGURE 1. THE CHANGING IMPACT ON GROSS MARGINS
FROM DIRECT SOURCING
Source: CIQ, ANZ
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.
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 Australia’s largest source for textiles and garments.
RISK MANAGEMENT IS NOW A SOURCE OF COMPETITIVE ADVANTAGE
5

ANZ ASIA RETAIL
THE TEXTILE AND GARMENT MARKET
IS NOT LOCAL ANYMORE
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 ANZ’s 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,
it’s highly correlated to economic growth and per capita
disposable income.
FIGURE 2. GLOBAL GARMENT MANUFACTURING
Source: Global Apparel Manufacturing, IBISWorld, December 2014
Oceania 0.5%
Africa Middle East 1.9%
South America 5.0%
North America 5.0%
India Central Asia 7.1%
South East Asia 15.1%
Europe 29.6%
North Asia 35.8%
USD
604 bn
FIGURE 3. PER CAPITA SPEND ON GARMENTS
Source: India International Textile Machinery Exhibitions Society
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.
High disposable incomes and increasing wealth are
two key reasons why the Australian retail industry will
outperform other geographies in demand terms. It’s also
one of the primary reasons why many foreign retailers
have been entering Australia, as the demand fundamentals
compare favourably against their home markets.
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.
THE GLOBAL GARMENT MANUFACTURING INDUSTRY
IS WORTH IN EXCESS OF USD $600 BN
In USD
0
500
1,000
1,500
2,000
2013 2025F
USA China JapanEurope Brazil
India Canada AustraliaRussia
FIGURE 4. GARMENT CONSUMPTION BY COUNTRY
Source: India International Textile Machinery Exhibitions Society
0
150
300
450
600
2013 2025F
USA China Japan BrazilEurope
USD m
India Canada AustraliaRussia RoW
7

ANZ ASIA RETAIL
FIGURE 5. GLOBAL GARMENT TRADE (2013)
Source: WTO
Further examination between Australian retailers and
Chinese manufacturers highlights a material difference
in size from a sales perspective. Based on ANZ’s 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.
This difference in experience and relative size has two key
financial impacts:
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.
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.
(50)
0
50
100
150
200
250
300
0 50 100 150 200
Exports (USD bn)
Imports (USD bn)
Europe, 21.36%
Asia (Ex China), 14.48%
North America, 2.53%
South America, 2.84%
Africa, 1.82%
Australia, 0.05%
China, 43.3%
Represents percentage of total global exports
9
AUSTRALIAN RETAILERS MAY NOT HAVE THE POWER IN THEIR SUPPLY CHAIN
THE TEXTILE AND GARMENT MARKET IS NOT LOCAL ANYMORE
FIGURE 6: AUSTRALIAN VS CHINESE TEXTILE GARMENT COMPANIES
Source: CIQ, ANZ
Revenue Growth (Latest FY)
%
%
Size of the bubble represents the median AUD revenue
of companies within our sample universe
EBIT Margin (Latest FY)
18
16
14
12
10
8
6
4
2
0
(2)
(4)
0 2 4 6 8 10 12 14 16
AUS - Footwear Wholesaling, 42CHI - Footwear Manufacturing, 280
CHI - Apparel Manufacturing, 225 AUS - Clothing Wholesaling, 48
AUS - Footwear Retailing, 51
AUS - Clothing Retailing, 157

ANZ ASIA RETAIL
FIGURE 7: GARMENT EXPORT INDEX: 2007 = 100
Source: WTO
2008 2009 2010 2011 2012 2013
50
75
100
125
150
175
200
225
250
275
Bangladesh Cambodia China India Indonesia Sri Lanka Taiwan Vietnam
11
CHINA IS THE UNDISPUTED GARMENT
MANUFACTURING CENTRE OF THE WORLD
China remains the king, but there are challengers
China is the undisputed garment manufacturing centre
of the world. According to the China National Garment
Association, China’s garment industry employs more than
10 million people and generates annual exports of almost
USD 200bn.
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 China’s in 2013.
However the growth momentum is clearly shifting.
Despite all of China’s Asian competitors only accounting
for approximately one third of what China exports,
the growth rates of some of China’s 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
China’s 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 world’s largest
exporter of garments for a considerable period of time.
THE TEXTILE AND GARMENT MARKET IS NOT LOCAL ANYMORE

UNDERSTANDING
THE ASIAN SUPPLY CHAIN
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:
A. The sourcing of raw materials such as cotton,
wool and synthetics
B. The manufacturing of textiles fibre processing
and fabric production
C. Garment making
2. Downstream:
D. Garment wholesaling, either locally in Australia
or direct from the manufacturer or overseas agent
E. Retailing within Australia
It’s 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, ANZ’s analysis splits
these into separate business types.
ANZ ASIA RETAIL
A. Sourcing Raw Materials
Raw materials used in garment production are either natural fibres such
as cotton, wool or silk, or synthetic fibres such as nylon or polyester
Raw 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
Spinning is mostly done using machines and is capital
intensive for businesses
Before being processed into yarn, the fibres are washed
to remove impurities such as oils and wax
Fabric Production
Through processes such as weaving knitting and pressing,
individual yarns (i.e. the strands of yarn are turned into fabrics)
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%
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
Sourcing
Raw Materials
Fibre
Processing
Fabric
Production
Garment
Making
Garment
Wholesaling
Retailing
WHAT HAPPENS UPSTREAM HAS A MAJOR EFFECT
ON CONDITIONS DOWNSTREAM
Sourcing raw materials
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.
Recent changes to China’s cotton policy, and an emerging
glut in global supply, have resulted in cotton prices steadily
declining since 2011.
It is estimated that a US 30 cent decline in cotton fibre prices
is expected to save 6%-7% of total sourcing costs.
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.
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.
FIGURE 8. CHINA AND INTERNATIONAL COTTON PRICE
Source: Bloomberg
0
1000
2000
3000
4000
5000
6000
2009 2010 2011 2012 2013 2014
USD/Metric Ton
China Cotton 328 Cotlook A Index
13
Global Local (Australia)

FIGURE 9. GROWTH IN SYNTHETIC FIBRE CONSUMPTION
Source: Tecnon Orbichem
20,000
0
40,000
60,000
80,000
100,000
120,000
140,000
Wool Cotton
Cellulosic Polypropylene
Acrylic Polyamide
1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 2010 2013 2016 2019 2022 2025
Wool Cotton Cellulosic Polypropylene Acrylic PolyesterPolyamide
Metric Ton
ANZ ASIA RETAIL 15
UNDERSTANDING THE ASIAN SUPPLY CHAIN
FIGURE 11: PCI SYNTHETIC FIBRES INDEX BY REGION
Source: Bloomberg
FIGURE 10: SYNTHETIC FIBRES SOUTH EAST ASIA INDEX
Source: Bloomberg
0
400
800
1,200
1,600
Jan
10
Jan
15
May
10
Sep
10
Jan
12
May
12
Sep
12
Jan
13
May
13
Sep
13
Jan
14
May
14
Sep
14
Jan
11
May
11
Sep
11
PTA CFR South East Asia Index MEG CFR South East Asia Index
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’.
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.
LABOUR INTENSIVE GARMENT MANUFACTURERS GENERATE HIGHER
MARGINS THAN FIBRE PROCESSORS AND FABRIC PRODUCERS
Jan
10
Jan
15
May
10
Sep
10
Jan
12
May
12
Sep
12
Jan
13
May
13
Sep
13
Jan
14
May
14
Sep
14
Jan
11
May
11
Sep
11
0
World Asia USA Western Europe
100
200
300
400

FIGURE 12: REVENUE GROWTH
Source: CIQ, ANZ
ANZ ASIA RETAIL
FIGURE 13: MARGINS
Source: CIQ, ANZ
CHINESE TEXTILE MANUFACTURERS
CHINESE GARMENT MANUFACTURERS
2010
30
25
20
15
10
5
0
-5
%
2011 2012 2013 LTM
2010
25
20
15
10
5
0
%
2011 2012 2013 LTM
%
2010
18
16
14
12
10
8
6
4
2
0
2011 2012 2013 LTM
Gross Margin Net Margin
2010
40
35
30
25
20
15
10
5
0
%
2011 2012 2013 LTM
Gross Margin Net Margin
17
CHINESE MANUFACTURERS ARE NOT COVERING THEIR COST OF CAPITAL
UNDERSTANDING THE ASIAN SUPPLY CHAIN
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.
Detailed analysis of textile and garment supply chain
participants in China suggests there are three key themes
impacting profitability:
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.
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.
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.
FIGURE 14: RETURNS
Source: CIQ, ANZ
%
2010
8
7
6
5
4
3
2
1
0
2011 2012 2013 LTM
Return on Assets Return on Equity
%
18
16
14
12
10
8
6
4
2
0
2010 2011 2012 2013 LTM
Return on Assets Return on Equity
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.
LTM = Last Twelve Months
LTM = Last Twelve Months

WHAT HAVE CHINESE COMPANIES
BEEN DOING TO COMPETE?
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.
ANZ ASIA RETAIL
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, HM 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.
★ ★ ★ ★ ★ ‘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.
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.
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.
★ Vertical integration of manufacturing may lead to
cost savings being passed through but this is unlikely.
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
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.
It’s 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.
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.
WAGE DIFFERENTIALS BETWEEN PROVINCES ARE AN IMPORTANT
CONSIDERATION WHEN DECIDING WHERE TO LOCATE A FACTORY
FIGURE 15: MANUFACTURING WAGES IN CHINA (RMB)
Source: National Bureau of Statistics of China
0
2006 2007 2008 2009 2010 2011 2012 2013 2014
5
10
15
20
25
30
35
40
45
50
RMB 000's
19

1,000 - 1,150 yuan
1,151 - 1,300 yuan
1,301 - 1,450 yuan
1,451 - 1,600 yuan
1,601 - 1,750 yuan
1,750 - 1,900 yuan
Chongqing
Tianjin
Beijing
FIGURE 16: MINIMUM WAGES IN CHINA BY PROVINCE
Source: China Labour Bulletin – Article “Wages in China” dated 10 June 2013
ANZ ASIA RETAIL 21
THE WAGE DIFFERENTIAL BETWEEN CHINA AND GREATER
ASIA CAN MAKE RELOCATION EXTREMELY ATTRACTIVE
WHAT HAVE CHINESE COMPANIES BEEN DOING TO COMPETE?
The lure of South East Asia
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 China’s traditional industrial
areas have found themselves to be increasingly less
competitive compared to their regional peers.
As of 2013, China’s 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.
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.
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
China
0
100
200
300
400
500
Thailand Philippines* Indonesia Vietnam**
489
322
216
113
208

FIGURE 18: MAJOR CHINESE TEXTILE GARMENT MANUFACTURERS
Financials are the 12 months to June 2014. Data sourced from CIQ
● Indicates the Company operates in this part of the value chain
ANZ ASIA RETAIL
Company Revenue EBIT Margin 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% ● ● ●
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.
23
FIGURE 19: CHANGE IN GEOGRAPHICAL LOCATION OF ASSETS
Source: CIQ, ANZ
0
10
20
30
40
50
60
70
80
90
100
2007 2015 2008 2013 2009 2014 2008 2013 2009 2013 2008 2014
Shenzhou
%
Win Hanverky Eagle Nice Yue Yuen Fountain Set Pacific Textiles
China Vietnam Cambodia Indonesia Other Sri Lanka
Shenzhou has been a relatively
late mover, having only off-shored
~8% of its production base up until 2013
In 2011, Eagle Nice embarked
upon aggressive relocation into Indonesia,
and into the lower-cost Jiangxi in China
Recent industrial action in Yue Yuen’s China factories has
meant that the Company is now more focussed on relocating
(rather than just expanding) its capacity into SE Asia
MANY CHINESE MANUFACTURERS HAVE ADOPTED A“CHINA +1”STRATEGY

ANZ ASIA RETAIL
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 world’s largest original
equipment manufacturer of athletic shoes. The Company’s
gross margins typically experience short-term fluctuations
based on changes in labour costs, but then revert back
to medium-term averages.
FIGURE 20: YUE YUEN’S GROSS MARGINS
Source: CIQ
20
21
22
23
24
25
FY10 FY11 FY12 FY13 FY14
%
Margin dropped then
recovered, in part, due to
higher raw material and
China labour costs
Margin dropped then
recovered on the back
of Indonesia labour
cost advantages
1. Source: Leonie Barrie, Aroq Ltd, “Sharp fall in Cambodia garment strikes in 2014,
January 2015
2. Source: ACCC
3. Source: Cleanclothes.org
25
RELOCATION CAN LEAD TO COST REDUCTIONS FOR
AUSTRALIAN RETAILERS, BUT IT CAN ALSO LEAD TO INCREASED RISK
Impact 2 – Lengthened sourcing times
due to employee unrest (negative)
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 country’s GDP and employs ~600,000 people,
who are mostly women.
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 HM, 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, HM,
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 HM, 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.

FIGURE 21: REVENUE MIX FOR SELECTED CHINESE MANUFACTURERS
Source: CIQ
ANZ ASIA RETAIL
Eagle Nice manufactures sportswear for companies such as Nike, the North Face and Puma.
The Company’s two largest customers account for ~70% of total revenue. Mainland China’s
share of revenue has declined by 31% as sales to Europe and North America have increased
North American
Europe
Mainland China
Japan
Other
-31%
21%
14% 9%
10%
15%
31%
23%
54%
13%
10%
Eagle Nice
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
Europe
Hong Kong
North America
Mainland China
Rest of Asia
Other
-17%
11%
4%
5%
38%
43%
10% 7%
10%
26%
13%
30%
13%
Win Hanverky
As one of the largest casual headwear makers in the world, Mainland Headwear’s
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
US
Europe
-18%
66%
49%
35%
17%17%
16%
Mainland Headwear
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
China
Non-China
65%35%
100%
-35%
Shanghai Dragon
FY08
FY13
5 year change in home country
(Mainland China or Taiwan) %
27
Upstream trend #2
Large brands and the impact of fast fashion –
Impact for Australian retailers
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.
2. Cost structure advantage
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, HM, 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.
LARGE GLOBAL RETAILERS ARE NOT ONLY COMPETING AT THE RETAIL LEVEL.
THEY’RE ALSO COMPETING AT THE SUPPLIER LEVEL

ANZ ASIA RETAIL
Case Study: Crystal Group (private company)
Revenue: USD $1.6 bn
Market Cap: Private
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 Levi’s, Uniqlo, Victoria’s Secret,
HM, The Gap, JC Penney and Marks Spencer.
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 can’t afford to have ever-changing customers.”
The Company has taken on the expanding role
of manufacturers in the value chain:
I. Crystal Group has set up a quality assurance
team which work on behalf of the customer
to monitor production.
II. Increased focus on product design and development
as customers are demanding value added activities.
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.
Source: “Asian firms and the restructuring of global value chains”
by International Business Review 23 (2014) and Crystal Group
sustainability report 2014
Case Study: TAL Group (private company)
Revenue: AUD $1 bn
Market Cap: Private
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.
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 Penney’s 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 Penney’s 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)
Case Study: Abercrombie Fitch
Revenue: USD $3.7 bn
Market Cap: USD $1.4 bn
Attracted by high margins, well known US apparel
retailer Abercrombie Fitch (“AF”) announced in
2012 that they were to enter in the Australian market.
This came at an interesting time in Australia garment
retailing as AF decided to enter when David Jones,
Myer and Billabong were experiencing sharply
declining profitability.
Abercrombie’s strategy was to open two Hollister stores:
Doncaster (Melbourne) and Bondi (Sydney). Hollister
is a lower price point than the traditional AF 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, AF 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.
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.
29
0
4
8
12
16
20
24
%
H M Inditex The Gap Uniqlo Australian Median
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
ROE
NET MARGINS
0
10
20
30
40
50
60
70
%
0
5
10
15
20
25
30
35
40
45
50
%
GLOBAL RETAILERS GENERATE LOWER
GROSS MARGINS, BUT FAR HIGHER NET MARGINS

ANZ ASIA RETAIL
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 that’s 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.
MANY TEXTILE AND GARMENTS PLAYERS
ARE SEARCHING FOR HIGHER MARGIN 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%.
Production facilities in Mainland China are increasingly focusing on differentiated and higher value-add products.
0
25
50
75
100
FY08 FY09 FY10 FY11 FY12 FY13
%
Yarn Grey Fabrics Garment Fabrics
%
FY12 FY13
0
6
12
18
24
Core-Spun Yarn Other Yarns Fabrics
REVENUE BY SEGMENT FOR TEXHONG
GROSS PROFIT MARGIN FOR TEXHONG BY PRODUCT
31

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 higher-
margin 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, HM now sources 45% of their“basic”clothes
from Bangladesh where labour costs for basic garments are
~10% of China (source: SCMP). HM 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 HM’s strategy in sourcing
from countries outside China, as garment makers relocate
or pricing differentials become attractive.
ANZ ASIA RETAIL
AUSTRALIAN RETAILERS MAY FIND THAT THEY NEED TO LOOK
TOWARDS MANUFACTURERS IN LOWER-COST COUNTRIES
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 Lululemon’s signature“Luon”
fabric, which represents ~30% of the fabric used
in the Lululemon’s products, is manufactured solely
by a single Taiwanese supplier.
Notwithstanding this, improvements in Asia’s 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 Lululemon’s
situation will eventually be able to dilute the
percentage sourced from their top suppliers.
Source: CIQ and Company Annual Reports
LULULEMON’S SUPPLIER BASE
0
10
20
30
40
0
20
40
60
80
FY10 FY11 FY12 FY13
% No. of Suppliers
% supplied by top supplierNo. of Suppliers
33

Upstream trend #4
Increased vertical integration
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.
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.
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.
FIGURE 23: VERTICALLY INTEGRATED EBIT MARGINS
VS PURE-PLAY MARGINS
Source: CIQ, ANZ analysis
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
ANZ ASIA RETAIL
Vertically Integrated Garment + Yarn/Fabric Producers
Yam+FabricProducers
GarmentPrducers
BlackPeony(Group)
NingxiaZhongyinCashmere
PacificTextiles
EclatTextiles
BestPacific
ShenzhouInternational
YoungorGroup
FY13 EBIT Margin
%
4.2%
9.2%
13.5%
14.1%
17.1% 18.1%
18.8% 19.7% 20.5%
5
10
15
20
25
0
Case Study: Eclat
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 Eclat’s integrated supply chain.
Through Eclat’s 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, Macy’s, Fila, Calvin Klein,
JC Penney and The Gap
Garment Customers:
Adidas, Nike, Fila, Lululemon, Athletica, Reebok, Chico’s and The Gap
Case Study: Shenzhou International
Market Cap: AUD $7.1 bn
Shenzhou is the world’s largest vertically integrated
knitwear manufacturer which accounted for 13% of
China’s knitwear exports in 2012. The company is also the
largest apparel supplier of Nike, Puma, Adidas and Uniqlo.
Weaving knitting Dyeing finishing Cutting Sewing Packaging
Knitting
Dyeing
Finishing
Garment making
Vertical Integration
Shenzhou’s 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.
Source: Shenzhou broker reports by Bank of America Merrill Lynch (Feb 2013) and Kim Eng (Jan 2013)
Source: Company website and CIQ
35
VERTICALLY INTEGRATED MANUFACTURERS
GENERATE HIGHER MARGINS THAN PURE-PLAY FIRMS

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:
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
A NUMBER OF CHINESE MANUFACTURERS
HAVE SOUGHT TO VERTICALLY INTEGRATE
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 company’s 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.
37

DIRECT SOURCING IN A LOWER
AUD ENVIRONMENT
In ANZ’s 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.
ANZ ASIA RETAIL
FIGURE 24: AUSTRALIAN RETAILER WHOLESALER
GROSS MARGINS
Source: CIQ, ANZ
FIGURE 25: AUSTRALIAN RETAILER WHOLESALER
EBITDA MARGINS
Source: CIQ, ANZ
0.786
47.5%
38.4% 39.8%
37.1%
39.7% 39.2% 39.4% 39.9% 37.3%
48.1% 48.3% 49.3% 50.5% 52.1% 50.5% 49.2%
0.896
0.747
0.882
0.990
1.033 1.027
0.918
0.870
Retailers WholesalersAUD/USD (avg)
0.786
0.896
0.747
0.882
0.990
1.033 1.027
0.918
0.870
8.1%
6.6%
7.1%
6.5%
7.8%
6.5%
5.7%
5.2%
4.2%
7.5%
7.7% 7.2%
7.3% 7.2%
6.3%
7.2%
Retailers WholesalersAUD/USD (avg)
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
couldn’t for a variety of reasons. Despite AUD depreciation,
there is no indication that this is starting to unwind.
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%.
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.
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.
THE FALL IN THE AUD/USD IS STARTING TO HAVE A MORE NOTICEABLE
EFFECT ON PROFITS AND PRICES
39

FIGURE 26: AUD/USD EXCHANGE RATE
Source: CIQ, ANZ
As at 18 March 2015
FIGURE 27: PERCENTAGE OF COMPANIES MAKING AN EBIT LOSS UNDER EACH SCENARIO (NOV 2013 PREDICTION)
ANZ ASIA RETAIL
100
90
80
70
60
50
40
30
20
10
0
Direct Sourcing Retailers Local Sourcing Retailers Wholesalers
@0.950 @0.900 @0.850Current @0.750@0.800
%
0.75
0.80
0.85
0.90
0.95
1.00
1.05
1.10
1.15
AUD/USD Model Forecast FY15 YTD
Mar-10 Aug-10 Jan-11 Jun-11 Nov-11 Apr-12 Sep-12 Feb-13 Jul-13 Dec-13 May-14 Oct-14 Mar-15
A NUMBER OF PUBLICLY LISTED RETAILERS HAVE HAD TO INCREASE PRICES
DIRECT SOURCING IN A LOWER AUD ENVIRONMENT
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.
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 won’t 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.
41

FIGURE 28: FX FORECAST SCENARIOS
FIGURE 29: PERCENTAGE OF COMPANIES MAKING AN EBIT LOSS UNDER EACH SCENARIO (APRIL 2015 PREDICTION)
Source: ANZ
Group - Negative EBIT Margin
ANZ ASIA RETAIL
FY 2015 FY 2016
Decline from FY2014
avg. (0.918)
Forecast FX rate Scenario 1 0.884 0.850 7%
100
90
80
70
60
50
40
30
20
10
0
Retailers Direct Sourcing Local Sourcing Wholesalers
Scenario 1 Scenario 2 Scenario 3Current Scenario 5Scenario 4
%
MORE BUSINESSES WILL BE EXPOSED TO AUD VOLATILITY
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, there’s 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
FIGURE 31: WHOLESALER BALANCE SHEET LEVERAGE
Source: ANZ
Total financial indebtedness / Capital + operating leases
17%
33%34%
35%
37%
40%
43%42%
55%
68%
71% 71% 70% 71%
69%
62%
53%
55% 54% 54%
51%
49%
45%
37%
Top Quartile Median Bottom Quartile
FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14
0.6x
1.9x
1.2x
2.1x
1.3x
1.9x
1.1x
1.9x
1.2x
1.9x
1.3x
2.2x
1.1x
2.3x
1.4x
3.3x
3.1x
2.9x
2.8x
3.0x
3.1x
3.4x
3.0x
1.5x
Top Quartile Median Bottom Quartile
FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14
43
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.

ANZ ASIA RETAIL
Case Study: Supply Chain (ABC Retail)
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.
Solution:
ABC Retail implemented a Payables Finance solution.
This solution enables ABC’s suppliers to not only request
early payment for invoices, which enhances liquidity and
improves working capital, but also to finance this at ABC’s
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.
Anchor/Buyer Supplier
Supply Chain Finance
Provider/Financial
Institution
1. Purchase order
5. Request for early payment
2. Deliver goods/services and invoice
3. Send approved invoices
7. Pay invoice amount
on invoice due date
4. Option for early
payment of invoice
6. Send early payment
at discounted value
THE AVERAGE HEDGING TENOR HAS DECLINED SINCE JANUARY 2013
The changing dynamic of risk management
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.
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.
FIGURE 32: ANZ RETAIL SECTOR HEDGING TRENDS
Source: ANZ
0
Jan-13 Dec-13 Mar-14 Sep-14 Dec-14
1
2
3
4
5
6
7
8
0.860
0.870
0.880
0.890
0.900
0.910
0.920
0.930
0.940
Tenor (Months) AUD/USD
45

ANZ ASIA RETAIL
Case Study: Risk Management
Risk Management Considerations:
Before entering into a currency hedge, it is important
to identify the key risks and opportunities.
How much risk can the business tolerate?
How important is certainty of cash flows?
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.
For the Retail Sector:
• 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.
• 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.
The future path of exchange rates is uncertain.
You can’t control what exchange rates do, you can’t
control what your competitors do, but you can control
your own risk management.
AUSTRALIAN RETAILERS HAVE TWO MAJOR FACTORS IN THEIR FAVOUR
Two tailwinds
It’s 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.
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.
FIGURE 33: AUD/USD – WHERE TO FROM HERE?
Source: ANZ
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 Australia’s largest source for all textiles.
Both these factors will provide a much needed cost shield
against a falling currency.
0.70
Jan-14 Apr-14 Jul-14 Oct-14 Jan-15 Apr-15
today
Jul-15 Oct-15 Jan-16
0.75
0.80
AUD/USD Exchange Rate
0.85
0.90
0.95
AUD/USD has exhibited both
stability and volatility over the past 12 months
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
If AUD/USD trends lower
- you want protection
47
MARCH 2015
THE CHAFTA AND IMPLICATIONS FOR AUSTRALIAN BUSINESSES
K15179_ANZ_Business in Asia_Brochure_CCB_v2.indd 1 6/03/2015 10:02 am
ANZ Opportunity China
The ChAFTA and implications for Australian businesses
http://insites.anz.com/chinagateway

ANZ ASIA RETAIL 49
Key Contributors
Mark Ganz
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
About Client Insights Solutions
Client Insights and Solutions (CIS) is at the forefront of
developing and disseminating intellectual capital for the
benefit of ANZ’s Institutional and Corporate Banking clients.
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 client’s needs.

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