This article first appeared in The Edge Malaysia Weekly on December 4, 2017 - December 10, 2017

THE financial year 2019 could see a “turning point” in Prolexus Bhd’s growth as its first fabric mill comes on stream in the first half of next year, says executive chairman Ahmad Mustapha Ghazali.

According to him, the mill is part of the group’s strategy to expand into upstream fabric production and become an integrated apparel manufacturer.

“Fabric manufacturing will complement our core business of apparel manufacturing by internal procurement of knitted fabrics instead of purchasing from external suppliers. It will also lead to better control of the supply chain while further improving our profit margins in the long run,” he tells The Edge in an interview.

The mill, which has a built-up of 111,590 sq m, is located in Kluang, Johor, and will add to the group’s three garment factories in Batu Pahat, Penang and China. The project will be undertaken in phases.

In June last year, the group raised RM56.8 million via a rights issue. Initially, the proceeds were earmarked for the setting up of an apparel factory in Vietnam and the fabric mill.

However, says Mustapha, the group is putting its Vietnam factory plan on the back burner for now to focus on the fabric mill.

The Vietnam project is a casualty of US President Donald Trump’s decision to withdraw from the controversial Trans-Pacific Partnership agreement. The trade deal would have brought benefits to textile and apparel industry players like Prolexus, mainly in the form of an elimination of tariffs and duties among the TPP countries.

Mustapha says the group has hardly started on the project except to secure the lease for two parcels of industrial land measuring 61,950 sq m in Long Jiang Industrial Park in Tien Giang Province.

“We will now reallocate the funds set aside for the apparel factory in Vietnam to the fabric mill to accelerate its commissioning. This will also save us the cost of borrowing. We will look at the Vietnam project again when the time is right. There’s still a lot of uncertainty about what it will mean for businesses there,” he adds.

Meanwhile, there has been a delay in the completion of the mill that was slated for the second half of 2017 because of the time taken to obtain the authorities’ approval. “What’s left to be done now is bringing in the machines, and the fabric mill will be up and running,” says Mustapha.

Prolexus saw its net profit fall 19.6% to RM22.78 million in its financial year ended July 31, 2017 (FY2017) — for the first time since the premium sports apparel maker returned to the black in FY2009. Revenue in FY2017 also fell, to RM348.51 million from RM402.74 million in the previous year. Mustapha sees more of the same in FY2018 and FY2019, mainly due to the start-up cost of the fabric mill.

The group will have to bite the bullet for long-term gain, he says. “This is an investment we have to make to go upstream. This is a long-term strategic project. We should see the benefits after two years.”

Mustapha expects earnings growth again in FY2020.

He believes the group’s current challenges are temporary as the demand for sportswear remains strong. Today, Nike Inc and Under Armour each contribute 30% to Prolexus’ total sales while ASICS accounts for 10% to 15%.

“Nike’s contribution to our sales has fallen to 30% from 60% previously due to a reduction in its orders as well as an increase in sales from other and new customers. This, in a way, is good in terms of risk management as we are not too reliant on a single customer.

“The global athletic wear industry remains robust, driven by an increased emphasis on healthy living and the trend to wear activewear in everyday life,” Mustapha says, adding that the group expects upcoming events like the 2018 FIFA World Cup and the 2020 Summer Olympics in Tokyo to boost sportswear sales.

Prolexus is also forging ahead with a plan to grow its overall customer portfolio in strategic locations, providing it with more geographic diversification.

Mustapha says the group’ performance is tied to how its customers perform globally as it currently exports predominantly to the US. “There is a lot of anxiety in the global market, like the UK political uncertainty, particularly about Brexit. And what happens in the US and Europe will affect us. China is now the engine of growth in this region. You can’t ignore it. That’s why we don’t want to be heavily reliant on the US market. For example, the recent industry downward trend actually comes from North America.”

He adds that the group is close to securing a new customer that will help improve its top line but declines to elaborate.

For starters, the fabric mill will cater for Prolexus’ own consumption. Last year, the group procured 15 million metres of fabric.

“Upon the full commissioning of Phase 1, the mill will have an annual production capacity of 30 million metres of fabric. Thus, it is also our intention to sell the knitted fabrics,” Mustapha says. “Ultimately, our goal is to have equal contribution from internal procurement and external sales of knitted fabrics.”

The group is expecting the mill to produce a 5% improvement in its profit margin by reducing the amount of polyester fabric imported from countries such as Taiwan, Thailand and China. Currently, Prolexus realises an average gross profit margin of 20% and a net profit margin of 7% from its garment production.

To further boost its earnings, Prolexus plans to sell its own branded sportswear in China next year via Taobao, the country’s biggest e-commerce platform. “We are in the midst of shortlisting the names of our products. This could potentially open up an additional revenue stream for us. Why China? It is a market nobody should ignore because the local demand there is very big. If we could capture even a fraction of overall demand there, it would help us grow,” says Mustapha.

The company is confident of making its own branded sportswear, having met world standards by manufacturing for global brands like Nike and Under Armour. “If we get the right brand and do our marketing well, it could be quite a significant revenue stream for us.”

In the garment business, Prolexus’ closest local peers are Magni-Tech Industries Bhd and MWE Holdings Bhd. In an Oct 6 report, Public Investment Bank Bhd said Prolexus was trading at 8.9 times CY2017 price-earnings ratio — at a discount to Magni-Tech’s 10.8 times and MWE’s 10.2 times.

“We are not happy with the PER (accorded by analysts) or our market valuation. But these things are beyond our control. We will try our best to perform well. Hopefully, our numbers will produce the right PER and share price,” says Mustapha.

“I think the fabric mill will be a game changer for us in the long term so that we are not totally dependent on garment manufacturing. We will consume whatever we produce and sell the excess to the market. Still, the group’s major revenue contributor will be garment manufacturing.”

As at Oct 31, 2016, Mustapha was a substantial shareholder of the group with a 12.35% stake while Prolexus managing director Lau Mong Ying and his brother and company director Lau Mong Fah hold 18.29%.

“We have no plan to sell any of our shares,” says Mustapha.

Prolexus closed unchanged at RM1.01 last Friday, giving it a market capitalisation of RM178.87 million. The stock has fallen 30% from RM1.45 on Jan 5.

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