The Chinese government's growing battle against pollution in the manufacturing sector has the textile industry simultaneously facing operational challenges and strategic opportunities.
While the green push will likely result in increased costs for textile producers in China, those that can afford factory upgrades will be in a position to raise product quality and gain a competitive advantage in attracting sustainability-minded brands and investors.
Inspection officials from China's Ministry of Ecology and Environment have been shutting down factories that fail to meet regulations. Textile producers, especially smaller ones, are feeling the squeeze on profitability as they must hike capital expenditures to revamp their facilities and avoid closure, according to Jiang Feng, co-owner of Shaoxing Hourun Textile Co. Ltd. in Zhejiang province.
A worker operates machinery at a textile production plant in Yiwu, China. Factories across the country are being inspected for compliance with environmental regulations.
"Processing costs have surged since we have to increase investment into equipment and personnel training, but the product selling price hasn't grown much," Jiang said in an interview with S&P Global Market Intelligence. "Our profit margin is getting thinner and thinner."
As part of a wider effort to reduce pollutant discharges, the southern Chinese city of Shantou issued a notice in July that it will shut down all printing and dyeing mills in its textile manufacturing district by 2019, China Textile reported. That adds to a list of factory closures in recent years as the country aims to build a green economy and fight pollution in older, resource-intensive industries such as textiles, paper production, mining and heavy metals.
For the textile industry, the Chinese government in 2016 set a target for water use per unit of GDP to decrease 23% by 2020, while also aiming for key pollutant discharges to be down 10% by that year, according to the National Development and Reform Commission.
Small and medium-sized textile mills like Shaoxing Hourun typically need to invest between 3 million and 4 million Chinese yuan upfront for a sewage treatment plant, which then calls for at least another 2 million yuan per year for operation and maintenance, according to Jiang.
"If a factory fails to meet environmental regulation requirements, it's not just about a shutdown — the owner could go to jail too," Jiang added.
The business challenges have partially contributed to a decline in production capacity, said Ma Li, a textile and apparel analyst at Soochow Securities. Fabric printing and dyeing mills, the most polluting segment of the textile industry, are declining in numbers, according to Ma.
"The total output volume of dyed and printed cloth has continued to drop, while their costs increase," the analyst said in an interview. "The reduction in production capacity has already affected delivery of orders for garment makers."
But as the pollution crackdown forces transformation throughout the textile industry, leading players with the financial resources to comply with regulations stand a chance to become more competitive and gain market share, according to Ma.
"In order to ensure stable and timely delivery of orders, buyers prefer to source from bigger and cleaner suppliers, which run less risk of closure or production suspension," the analyst said.
Multinational brands, consumers and investors are also placing greater emphasis on sustainability, according to Harvest Global Investments. The Hong Kong-based asset manager invests in industry giant Lu Thai Textile Co. Ltd., which supplies international brands such as Giorgio Armani SpA, Burberry Group PLC and Fast Retailing Co. Ltd.'s Uniqlo.
"[Clients are] demanding proper chemical management to ensure product quality, particularly for those that need to meet EU and U.S. chemical safety rules," Harvest Global told S&P Global Market Intelligence in an email. "Domestically, we also see consumers are [increasingly] aware of chemical safety and product quality during the wave of China's consumption upgrade."
Institutional investors are looking at how a company's green efforts affect its short- and long-term profitability and growth, according to the asset manager. "We need to see if the management have a clear vision on how to cope with these changing regulations ... and whether they have put proper governance structure and accountability on the table to stay on top of these challenges and opportunities."
Environmental management has become a major factor when brands evaluate suppliers. German sportswear giant Adidas AG, for example, rates its suppliers using an Environmental Key Performance Indicator offering transparency into consumption of energy, water and waste.
"We work closely with our suppliers to help them improve their performance," an Adidas spokesperson told S&P Global Market Intelligence. "However, where we face situations of severe or repeated noncompliance, we can and do terminate business relationships with suppliers."
To keep up with buyers as well as Chinese government demands, some of the country's largest textile producers are making sizeable investments into pollutant treatment facilities and greener technologies.
Shandong-based Lu Thai Textile has so far invested about 200 million yuan into building sewage treatment plants for its Chinese factories and also runs a water purification company for the local community. In addition, the company developed a "half-immersion" fabric-dyeing technique that saves more than 36% of water, 15% of electricity and 26% of gas compared with the traditional method of fully immersing fabrics in dye chemicals.
Knitwear producer Shenzhou International Group Holdings Ltd., which counts Nike Inc. and Uniqlo among its clients, set up a boiler heat recovery system that produces steam energy. During the production process, the Ningbo-based manufacturer applies ozone, a strong natural oxidant, instead of chemicals to discolor clothes for a washed look. It also uses digital printing that cuts consumption of film and water required by standard printing.
Hong Kong-headquartered Pacific Textiles Holdings Ltd., which mainly operates in mainland China and supplies brands such as Adidas and PVH Corp.'s Calvin Klein, has invested nearly 300 million yuan into energy conservation initiatives such as switching to LED lamps for lighting. It also installed waterless dyeing machines that use air to disperse colors into fibers.
Beyond compliance purposes, the new focus on environmental initiatives can help improve the reputation of China's textile industry, according to Soochow Securities' Ma.
"For a very long time, the industry has been criticized for polluting the environment and abusing cheap labor," the analyst said. "Green and smart manufacturing will help change the situation and push the industry toward the higher end of the value chain."