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Hong Kong activist investor David Webb just bought a 5.0% position in Hong Kong-listed Pacific Textiles (1382 HK － US$299 million).
Pacific Textiles is the preferred supplier of knitted fabrics for Japanese fast-fashion brand Uniqlo. It also sells knitted fabrics to lingerie companies like Victoria’s Secret, Calvin Klein, Triumph, and Maidenform.
When most people think of textile businesses, they picture factory floors full of young people cutting and sewing fabrics. But that’s only the downstream part of the industry, and it tends to be labor-intensive and commoditized.
What Pacific Textiles does is to run relatively automated factories producing fabrics from yarns. It’s a capital-intensive business that relies on machinery to run 24/7. But it also tends to be highly profitable, with Pacific Textiles earning 20-30% returns on equity for most of its history.
The only problem with fabric manufacturing is that it requires high utilization rates. Pacific Textiles was founded in 1997 and did well until 2015. But then, several issues emerged:
Vietnam joined the Trans-Pacific Partnership, enabling it to import cotton from the United States and elsewhere at zero duties. That cotton continues to be roughly 30% cheaper than in China’s regulated markets.
Reports of forced labor in China’s Xinjiang province and a US ban in 2022 caused several Western brands to switch away from Xinjiang cotton.
China's costs have increased significantly due to the government pushing for higher minimum wages and stricter environmental standards. That’s been especially problematic for Pacific Textiles, which sells to Japan with its depreciating currency.
Since 2015, Pacific Textile’s share price has dropped over 80% despite having no debt during most of that period.
So why has David Webb taken a 5.0% position in the company? Analysts at Smartkarma have tried to untangle the story, and I think they’re spot on.
There are two parts to the earnings recovery story:
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