MARC has assigned respective short- and long- term ratings of MARC-2 and A with a developing outlook to Axis Incorporation Berhad’s (“Axis”) proposed RM100.0 million Commercial Papers/Medium Term Notes (“CP/MTN”) Programme. The ratings reflect the group’s competitive position as an international OEM (“original equipment manufacturing”) player in the knitted fabrics industry; contract manufacturing partnerships with manufacturers in Vietnam and Cambodia; capacity expansions undertaken to increase economies of scale; increasing clientele base; long term relationships with notable clients and the group’s financially stable operating subsidiaries which form the group’s integrated operations. Moderating the ratings, however, are risks inherent in the textile industry which are characterised by intense competition; the unstable operating environment of the group’s contract manufacturers; thin profit margins; and the group’s exposure to fluctuations in prices of raw materials especially cotton yarn. The developing outlook is premised on the ongoing developments at Gap Inc. (“Gap”), a major customer of the group. Gap is in the midst of revising its brand and merchandising strategies, after registering deterioration in its financial profile and erosion in market share arising from declining sales in recent years. The upside to the ratings is constrained by the higher gearing upon eventual drawdown, high exposure to the cyclical industry and potential erosion of competitive position upon China’s accession into the World Trade Organization (WTO).

Axis was formed on 29 July 2002 as a private limited company and subsequently assumed the listing status of Ganad Corporation Berhad on 19 April 2004 through a backdoor listing exercise. It acquired three independent operating companies namely, Asiapin Sdn Bhd (“Asiapin”) (knitting and dyeing of textile); Chongee Enterprise Sdn Bhd (“Chongee”) (OEM garment contract manufacturing); and GBC Marketing Pte Ltd (“GBC”) (trading of yarn, textiles, and OEM garment contract manufacturing) which are involved in different segments of the garment and textile industry.

All of Asiapin and Chongee’s products are catered for the export markets, mainly to clients in the US and Europe. Although the demand for the group’s products is subject to a change in fashion trends and consumer preferences in the international market, MARC believes that this is mitigated by Axis’ flexible manufacturing capabilities and short production cycle. Technology and scale are particularly important in knitting and dyeing to the extent that they enable costs to be kept under control and tight delivery schedules to be met. Axis’ status as a nominated long standing supplier to a large reputed US brand, Gap Inc (“Gap”) and since then, other renowned retailers such as Target, Kmart and Wal-Mart, reflects well on the group’s ability to meet quality and timely delivery and cost parameters of customers, all of which are crucial in a free trade regime. The group has thus far, been able to sustain its profit margins by moving up the value chain through the outsource of labour intensive sewing operations to strategic partners in Vietnam and Cambodia.

In FY2006, the manufacturing arms (Asiapin and Chongee) collectively contributed approximately 64% to the group’s total revenue of RM350.2 million. Nevertheless, Asiapin tops with 44% contribution in terms of profitability given its highly automated and minimal labour operations hence lower production costs. Due to a differentiation in operational strategies adopted, the group’s operating profit margin of 6.8% for FY2006 appears better than some of its peers. The group also plans to focus in obtaining higher value added orders such as sportswear in order to contribute to better bottom line margins. Moving forward, through the expansion of its manufacturing facilities and clientele base, the group expects double digit revenue growth from FY2007-FY2009. Beyond that, as the individual subsidiaries reach optimal capacity, growth is expected to remain in the 4.0% range. Operating profit margins are projected to average at about 10.0%, which appear to be fairly robust despite the competitive environment of the garment industry.

The proposed RM100 million is expected to be drawndown over three annual tranches. Its pro-forma debt leverage is expected to reach 1.06 times upon the first drawdown. The group’s pro-forma Debt-Equity (D/E) ratio is expected to reach 1.52 times should the CP/MTN Programme be fully drawdown at once, hence breaching the covenant of not more than 1.50 times as stipulated under the issue structure.

MARC’s sensitivity analyses revealed that Axis is more vulnerable to a reduction in sales receipts as compared to an increase in cost of sales. The projected cash flow is able to withstand up to a 6.0% increase in cost of sales (assuming no cost pass-through) or up to a 5.0% decline in sales before the DSCR breaches the covenanted level of 1.25 times.