Muhammad Ali Chaudhry is serving as a director of Resham Textile Industries Limited, a leading yarn manufacturing company. After completing a Bachelor’s degree in Economics from the University of Toronto in 2007, he started his career in corporate banking, managing a portfolio of top-tiered corporates engaged in the textile, sugar, and power sector. He joined Resham Textile in 2011, and after serving as chief financial officer for five years, he moved to Canada in 2016, where he worked for RBC Capital Markets, the investment banking wing at the Royal Bank of Canada. He came back to Pakistan in 2021 and rejoined Resham Textile. Currently, Muhammad Ali is also a member of the Punjab Zonal Committee at the All Pakistan Textile Mills Association (APTMA).

Below are selected excerpts from BR Research’s recent interview with Muhammad Ali, focusing on bothsector-level and firm-level competitiveness in the current macroeconomic climate:

BR Research: Resham Textile is primarily engaged in the manufacturing and sale of cotton yarn. First off, how is the current macroeconomic situation—which is marked by rising cost of inputs, demand slowdown, and exchange-rate volatility—affecting businesses similar to yours?

Muhammad Ali Chaudhry: A very senior corporate banking head, who happens to be my former boss and continues to be my mentor, recently recounted: “Going forward, textile entrepreneurs are questioning whether viability still exists in this business.” He was alluding to sponsors in the industry weighing up the decision on whether to continue to operate and risk loss in reserves, or shut down completely. According to the veteran banker, those who remain on the pitch are banking on a future supply shortage in textile products, and the opportunity it would present to release overloaded inventories at favourable prices. Interestingly, these apprehensions come right after unimaginable profits reported by textile businesses, breaking all previous records.

Indeed, it is a challenging environment. Input costs are on the rise; as a result, regional competitiveness of Pakistani textile products in the international market is at stake. The Generalized System of Preferences (GSP+) status, whereby exports from Pakistan are able to compete across European markets, is expiring next year. This is in addition to a global demand reset, showing lackluster uptake of cotton-based textile products from Pakistan despite an annual growth rate of 8.8 percent witnessed by the global textile market in 2022. Moreover, there are costly delays within the supply-chain related to raw material and heavy machinery import. The rise in US dollar is severely impacting prices of international cotton contracts as we recently witnessed a major correction in cotton futures.

International lenders have targeted subsidies affecting energy prices. Favorable credit schemes such as Temporary Economics Refinance Facility (TERF) have already been exhausted. The State Bank’s Long-term Finance Facility (LTFF) and regular borrowing rates have become increasingly expensive. Eco-friendly investment opportunities such as solar-energy generation have shown diminished advantages, as a result of rising import cost and the changes to net-metering rates. Sales tax zero-rating for export-oriented industries has been withdrawn, and a super-tax of 10 percent on profit-after-tax above a certain threshold has recently been imposed.

With respect to local cotton production and uptake, it is reported that 30 percent of this season’s cotton crop has been washed away as we speak, whereas a large number of spinning units have dampened or stopped production due to a lack of direct and indirect export orders, despite a declining Pak rupee. Companies that procured cotton in September are seeing up to 30 percent inventory loss as cotton prices fell sharply at the start of November.

The sector requires certainty in terms of input cost, stable cotton production, and consistent demand for textile products. All three factors are showing uncertainty at the moment. It is generally believed that there will be greater clarity at the end of March next year.

BRR: To what extent is Resham Textile topline linked to Pakistan’s textile exports?

MAC: Our core client base consists of major exporters within the organized air-jet sector from Karachi, Multan, Faisalabad, and Lahore. These exporters use our yarns to produce home textile products such as bed-sheets, pillowcases, curtain inlays, towels, and tablecloths. Our lower count yarns are used extensively in production of export quality terry, denim, and other similar fabric constructions. Resham Textile’s manufacturing units were designed to manufacture export quality, using a mixture of German, Swiss, Italian, and Japanese machinery.

Out of the top 50 textile exporters in Pakistan during FY21–22, our yarn was used by 16 companies that collectively generated revenues of USD 2.93 billion. We are gradually growing our share of sales to these companies, and also working on sampling approvals with new exporters. The company is compliant with various international certifications such as OEKO-TEX® Standard 100 and BCI (Better Cotton Initiative).

BRR: What is the annual capacity of yarn currently being spun at your factory? Are there any plans to enhance this capacity in the near future?

MAC: Resham Textile can produce equivalent to 14 million kilograms of yarn annually, although this can vary depending on the spin plan. Production is split between two spinning units, and includes compact carded, combed, and slub yarns. Output is easily reconfigured to meet the types of yarns demanded by the air-jet weaving market that serves the European and US home and related textile markets.

Although yarn manufacturing is a familiar business to the sponsors, and high-efficiency vortex and similar technologies are being installed in this sector, the company is best suited to vertical integration. There are plans to use its reserves to set up a greater value-added project with the help of its existing banking partners and industry consultants, who have shown interest in this vision. The benefits of being closer to the end-user across the supply-chain offers multiple advantages, including faster recalibration of production, reduced financial risk, and access to more diversified markets.

However, with the present external and internal environment, the focus has been to preserve its retained earnings. Many businesses that took advantage of TERF are retiring letters of credit at exorbitant forex rates, and there is a perception that there may not be enough foreign reserves for remaining retirements. Based on the previous year’s consumption figures, nearly 50 percent of raw cotton import is also benchmarked, adding additional pressure on our dollar reserves. This is not the right environment for any capacity expansion or new project investment, in my humble opinion. However, according to various sources, there is significant acquisition activity. There is a perception that production houses in India, Pakistan, Vietnam, and Bangladesh will benefit from European and US textile imports as a result of the US ban on cotton and cotton products originating from the Xinjiang region of China. However, this massive reconfiguration may take a while.

BRR: What is the market share of Resham Textile in its main product market (yarn)? What is the nature of competition in this market?

MAC: According to various sources, including the Board of Investment and credit rating agencies, Pakistan is globally ranked No. 3 in terms of yarn production. China (6.4 million MT), India (5.3 million MT), and Pakistan (3.4 million MT) together account for 72 percent of global yarn production. Out of a total production of 3.4 million MT of yarn production in Pakistan, Resham Textile has maintained a share of 0.5 percent over the past several years.

Yarn spinning is a highly competitive business. Margins are normally small, and heavy emphasis is placed on volume. One spinning unit at the company is configured to produce finer counts, while the other serves the courser yarn markets. The weaving segment that buys our yarns has access to more than 400 yarn manufacturers, including varieties from neighboring countries which are favorably priced due to lower energy and interest cost. There are issues with the implementation of weighted average cost of gas, and a disconnect in pricing between provinces. For example, Punjab-based industries like Resham Textile are buying gas at $9 per MMBTU and electricity at Rs20 per unit; this is approximately two-fold higher than textile manufacturers based in Sindh. However, there are genuine reasons for these disparities, and the way forward is to work collectively through consensus.

BRR: Back in 2016/17, Resham Textile decided to de-list from the Pakistan Stock Exchange. What was the reason for going private at that time? And in retrospect, how has that decision panned out thus far?

MAC: Resham Textile share ownership by main sponsors and larger family was 99.74 percent prior to voluntary de-listing. With the non-existence of any long-term liabilities and enough cash reserves to finance another project through a mix of own and other sources, it was decided that the main sponsors would buy back shares and voluntarily delist.

Should the company choose to expand operations further, it stands on a strong unleveraged balance sheet. The company enjoys confidence in the market it serves, and is also successfully growing its working capital base through the addition of large financial institutions within its banking panel, and reliance on its existing banking partnerships, which are enhancing exposure based on company performance and goodwill.

BRR: Speaking of balance sheet performance since de-listing, between FY17 and FY22, the asset base of Resham Textile more than doubled to Rs3.53 billion. The topline also more than doubled to Rs7.37 billion in the same period; whereas profit-after-tax saw over six-fold growth to Rs0.61 billion. What are the main reasons behind this growth over the past five years?

MAC: The company sponsors have had a strong focus on reinvesting earnings into the business. This has been successful in reducing working capital costs in addition to allowing other intrinsic benefits of high free cash flow. Since the company is largely owned by one family, the decision against excessively-large dividend outlays was easily coordinated. Furthermore, dividends paid out to main sponsors are normally re-loaned to the company, and are interest-free. This policy has allowed steady growth in balance sheet size.

Gross margins have averaged nearly 10 percent during this period, with nearly 17 percent over the past two commodity-boom years. Yarn-spinning performance is largely driven by the commodity business. If raw material is procured in a timely manner and at a reasonable average cost, unless there are issues with production quality or financial constraints, spinning companies generally make reasonable returns. Resham Textile’s latest annual financial results demonstrate return on equity of 25.47 percent and earnings per share of Rs17.05. The company has maintained a current ratio and asset turnover above 2.0. Operating expenses margin does not exceed 3 percent, and its interest coverage ratio is above 10.

BRR: What about the role of any external factors during this period, such as the pandemic?

MAC: Record sales growth and high margins over the past few years are attributed to two reasons: Firstly, nearly all spinning companies in this industry, both directly and indirectly, benefited from international export contracts that diverted to Pakistan from existing international suppliers who suffered production closures during the COVID-19 pandemic. The sudden shortage of production skyrocketed cotton prices. For example, from March 2020 to April 2022, cotton future contracts on the New York Mercantile Exchange and Chicago Mercantile Exchange rose from 46 cents to 152 cents in just two years. Many companies were successful in paying off their entire long-term liabilities during this period. Some written-off units came back into business, and many multiplied. In the year 2020, SBP announced the Rs100 billion TERF scheme, allowing for capacity expansion, and Pakistani textile exports grew from approximately USD 12 billion to USD 19 billion by June 2022. Resham Textile’s sales of Rs7.37 billion, and profit-before-tax of approximately Rs1 billion were mainly a result of the above.

On the other hand, the company had been consistently expanding its client-base while keeping quality consistent and products diversified. Having paid off all loans against its second spinning unit, the company benefited from negligible finance cost, and remained a reliable and valuable partner to its customers. This allowed the company to be in the right place at the right time, so to speak. Additionally, the company has focused on retaining most of its earnings throughout the past five years, further explaining growth in equity.

BRR: How confident are you to sustain the growth trend in FY23, considering the macroeconomic headwinds?

MAC: Gross margins in the spinning industry over the last two years have been phenomenal, as already discussed. We just witnessed a 10-year high as cotton prices crossed 152 cents per pound, and so the entire textile chain from raw cotton to finished textiles experienced massive gains.

At the moment, however, we are in November. Cotton prices recently saw a 22-month low in cotton futures. Local cotton prices have fallen sharply. There is downward pressure due to a stronger US dollar, and lingering demand concerns due to uncertain economic conditions. Global cotton production is on the higher side, despite lower production in the US and Pakistan, with greater area and yields from India, Bangladesh, and China. Until global demand rises, and there is greater clarity with respect to the Ukraine-Russian conflict, and stability within the local environment, I am bearish at best.

However, I have mentioned some significant opportunities with respect to the new US-China trade relationship. With a small share of 2 percent in the global textile exports market, Pakistan has huge potential for growth. Pakistan is the fifth-largest producer of cotton, the third-largest yarn manufacturer, and it is equipped with a relatively complete industrial chain. Much can change over the next six months.

BRR: Let’s talk a bit in the end about costs. The ‘cost of sales’ accounts for about 83 percent of Resham Textile revenues. What measures are you taking to bring about efficiencies in these core costs and improve profit margins down the line? Additionally, how difficult will it be in the current inflationary environment to optimize costs?

MAC: Generally speaking, costs as a percentage of sales, range between 80- 90 percent in the spinning industry. This range is slightly less for composite units, where spinning, weaving, processing, and finishing are under one roof. However, regardless of how efficiently energy cost and labor expenses are controlled (roughly 10% and 5% of cost of production, respectively), margins rely mainly on raw material procurement decisions. Spinning units like Resham Textile that make 100 percent cotton yarns cover sales bookings for two months, whereas raw material is procured for at least six. Local cotton with strong qualitative parameters is only available for a few months during the months beginning August, necessitating bulk purchase of raw material. The company also imports cotton from the US, which increases yields, and lowers average procurement cost. In summary, there are many assumptions which play into cotton buying decisions that are heavily reliant on agricultural output and quality. Whereas prices fluctuate plenty, emphasis is always to produce high quality yarn, using superior raw material. This can increase core costs immensely.

With respect to energy cost, Resham Textile is equipped with gas-powered generators which cover the entire load requirement, in addition to Wapda supply, which is primarily used as a backup. At present, the per unit cost of both sources is very close for Punjab-based industries. The company is able to quickly switch from one source to the other as per latest government price fixation. There is strong focus on the company to optimize the combination, and this helps reduce production costs significantly.

BRR: Lastly, what kind of specific policy and/or regulatory challenges are being faced by Resham Textile and similar-sized firms? What can the government do to alleviate some of those issues?

MAC: One could argue that policies such as fixation of support price of cotton could alleviate the large variation in supply. This would be beneficial to the farmer who would know how much to sow, and also provide the value-added exporter an estimate for cotton import. Essentially, it would provide clarity on production volumes and pricing. The US has largely grown its agriculture on the back of similar farmer-focused policies. In Pakistan there is scattered information on cotton production, lack of inventory tracking and, unfortunately, the farmer often reaps the lowest share in margins.

Energy has been a major issue for similar-sized units. When Resham Textile was incorporated in 1990, the nation consumed 305tWH. This consumption has expanded to 1,070tWH in 2021. Manufacturing companies have not been able to rely on Wapda, so they invested heavily in generating their own power. There has been heavy investment in private power generation – funds that could have been used for capacity enhancement or value addition. Resham set up its gas generation plant to ensure maximum output as Wapda faced shortages. Largely speaking, companies invest in coal-based, furnace oil, gas, and diesel generators as there are no guarantees of a year-round supply of energy.

Fortunately, the textile industry is represented by a strong manufacturing association. This is largely because textile export earnings account for more than half of total exports, and the industry employs more than 38 percent of the entire workforce. However, significant effort is made to convince policymakers and regulators to safeguard the interest of the industry. Policymakers change frequently, as do their policies. Whether it’s energy supply and pricing, input tax refunds, or release of foreign exchange to retire letters of credit, the effort is coordinated privately. Back-dated changes in policies such as recall of interim reliefs, retrospective imposition of super-tax, deviation from promised energy rates,restrictions on imports and barring of exchange hedging hurts business confidence. There is a dire need for policy continuity, and medium-to-long-term plans need to outlive the official tenor of the policymakers who devise them.