Hytex Integrated Bhd - 2008 / 2009

MARC has affirmed the ratings of apparel manufacturer Hytex Integrated Berhad’s (Hytex) RM100.0 million Murabahah Underwritten Notes Issuance Facility/ Islamic Medium Term Notes (MUNIF/ IMTN) at MARC-2ID /A-ID. Concurrently, MARC has revised the rating outlook to negative from developing.

Hytex’s revised rating outlook reflects MARC’s view that while contract manufacturing orders for delivery until December 2009 provide a measure of near-term earnings visibility, the weak retail environment as implied by the decline in orders of global sportswear brands poses significant concern. As contract manufacturer for global sportswear makers such as Nike, and previously Puma, Hytex will likely be affected by the declining apparel order backlogs of its key customers, in particular its earnings and cashflow remain weak relative to outstanding levels of debt which has remained elevated following an earlier move to expand its production capacity in expectation of robust demand. However, since the fourth quarter of 2008, orders have slowed down significantly for sportswear brands in part due to the completion of major sports events.

Furthermore, MARC remains concerned over Hytex’s high gearing ratio which stood at its covenant threshold of 1.50 times as at December 31, 2008. Hytex is seeking to amend its gearing covenant threshold to 1.75 times which will provide much needed headroom to the company. MARC is also concerned that Hytex’s financial performance will continue to be pressured by challenging business conditions in the near to intermediate term in addition to the poor retail sales performance of its own apparel brands and high level of finished retail goods inventory. Accordingly, the negative outlook principally reflects the uncertainty of Hytex’s cashflow generating ability beyond 2009 under the prevailing challenging business conditions.

In FY2008, Hytex achieved sales of RM152.6 million (FY2007:RM153.7 million) and operating profits of RM11.4 million, translating into a largely unchanged OPBIT margin of 7.46% (FY2007:7.51%). Despite its relatively stable operating profits, the group’s financing costs of more than RM6.9 million, arising mainly from its MUNIF/ IMTN borrowings, eroded pre-tax profits and cash flow  from operations to a net amount of RM11.2 million, resulting in free cashflows of  negative RM3.0 million. In light of this and Hytex’s modest cash balances, MARC views its overall liquidity to be tight and financial flexibility, limited. For the first 9 months of FY2009 (3QFY2009), Hytex registered lower sales of RM112.31 million (3QFY2008: RM115.29 million) and a profit before tax of RM4.64 million (3QFY2008:RM6.84 million) despite maiden contributions from its first batch of completed contract manufacturing orders in China.

Hytex’s near-term earnings visibility benefits from a sizeable amount of contract manufacturing orders made by Nike for delivery until end-2009. However, as a major portion of the company’s revenue is derived from its short-term sales orders from a few OEM clients, it is exposed to significant customer concentration risk. These arrangements also put the company at risk of lower capacity utilisation in the face of reduced demand in the end-user market. Mitigating these risks somewhat are Hytex’s robust relationship with its OEM customers, its established track record in order fulfilment and adherence to stringent quality standards which continue to be important underpinnings of the affirmed rating.

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