Finding Fashion in Asian Small Caps

September 16, 2014

Investors looking for the kind of growth that up-and-coming smaller companies can deliver can’t afford to ignore Asia. We see exciting niche opportunities there—but finding them requires patience and on-the-ground expertise.

This summer we visited with more than 70 senior executives at small- and mid-cap companies in seven Asian countries, including developed economies such as Japan and Singapore and emerging markets like the Philippines and Vietnam. There are opportunities in all of these countries.

But we’re not talking about household names.

Fewer than half of the firms we visited have much brand recognition outside the region—only 40% conduct “road shows” abroad to publicize security offerings to potential foreign investors. So, it’s easy for investors who don’t dig deeply into the Asian SMID-cap landscape to miss opportunities.

Taiwan’s Rising Textile Stars
Among the potential hidden gems, in our view, are some of Taiwan’s textile makers. Many of these firms have made significant investments in functional fabrics—materials ideal for athletic apparel that’s useful and fashionable. These investments are starting to pay off, thanks to a surge in global demand for fashion-forward sportswear.

The demand comes primarily from members of the fitness-conscious millennial generation, defined as people born between 1980 and 2000. Millennials put a premium on healthy living and the latest styles—they eat well, exercise often and want to look good doing it.

In a recent report, Goldman Sachs estimated that health-conscious and hyperactive millennials will, over the next five years, go from being the smallest spenders on consumer staples and discretionary items to the biggest spenders, with average annual growth of 3%–4%. Baby boomers’ spending on these items, by contrast, will decline by about 2% a year over the same stretch.

What’s more, Euromonitor International estimates that global sales of sports apparel, which have been rising steadily since 2007, will total $219 billion in 2018, compared with $162 billion last year (Display).

We think all of this adds up to healthy growth potential for textile firms with the ability to supply Nike, Under Amour and other athletic apparel and footwear makers with clothing that’s both functional and fashionable.

Catering to the Wellness Generation
During our travels, we found that the brightest stars in Taiwan’s textile universe are working closely with their clients to roll out fashion-forward athletic gear that can also be worn in casual, everyday settings.

For many, that effort has involved working with designers such as Stella McCarthy and Jason Wu—one of Michelle Obama’s favorite designers—to produce appealing garments with bright colors and stylish digital prints; threads that look as good as they feel.

The savviest companies are also innovating and filing for patents. Among the focus areas are polyester blends that pull moisture away from the body instead of retaining it, and fabrics that protect against sun, water and cold weather. As functional fabric orders from top global retailers pile up, astute firms are investing in production capacity to accommodate the thinner, stronger fabrics consumers want—capacity that’s still lacking in the region.

Production: Getting Cheaper and Greener
Many firms are also putting their money to work by investing in new factories in Southeast Asia. Labor costs there are lower than in China, home to most current production. Cambodia and Vietnam are attracting significant investment, as tariff-free export arrangements with Europe, Japan and the United States have the potential to increase profit margins. We noticed that firms are also devoting more investment to automated equipment that will speed up production and cut costs.

Savings on the labor front will be critical for the textile winners: Stricter wastewater treatment standards in China, Vietnam and elsewhere will require investment in green technologies. Among these is water-free dyeing, a process that eliminates wastewater altogether. In our view, firms that have the technical and financial know how to address these issues are most likely to pull away from the pack.

We think investors may be able to earn a similar sort of competitive advantage by looking closely at Taiwan’s textile sector and its most promising up-and-coming firms. SMID-cap stocks around the world tend to get less research coverage than large-caps. As we’ve noted, that’s especially true of many Asian firms with limited global name recognition.

While flying below the radar can make these stocks more volatile, it also creates more chances to capitalize on growth potential that the broader market hasn’t discovered yet. In investing, as in fashion, it pays to be ahead of the trend.

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AllianceBernstein portfolio-management teams.

Finding Fashion in Asian Small Caps
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