Kitex Garments Limited

We met up with someone who has looked at several textile/infantwear/innerwear companies especially in the southern belt - both listed and unlisted entities.

Following are some of the key takeaways, which we will try to dig into more:

1). Stringent customer process for supplier selection - usually takes 6-9 months the first time. There is also lot of scrutiny on labour processes and compliance norms - especially Effluent/Discharge treatment plant.

2). Post that the accent is on Quality at the right cost and on-time delivery

3). Many customers want to operate on near-zero inventory and require suppliers to supply direct to the Showrooms - in show-room ready condition - with branding and bar-coding tags, etc.

4). While there is negotiations on margin front it is unlike the Auto OEM situation- where perforce every year there is a squeeze. Infact most have contracts that allow room for increase in RM, Cotton and even Power to be passed on with a lag.

5). Labour/ Scaling up is the main issue given the current rural wages/MNREGA situation

6). 10% EBITDA levels is the norm. He was of the opinion 20% plus EBITDA levels are not sustainable (price points are mostly same, people supply to similar customers)

7). Main Process Components

Spinning/Yarn making >>>Dyeing/Bleaching>>>KnittingWeaving>>>Fabric>>>Cutting m/c>>>Sewing m/c. Dyeing/Bleaching requires alongside the effluent treatment plants

8). Knitting : Inner wear and Infant wear ( products have elasticity properties); Weaving: Shirting/Suiting etc

9). Yarn making is complex Capital Intensive. Knitting/Weaving is capital Intensive. Most capital intensive is Dyeing/Bleaching/Effluent treatment plants - easily 120-150 Cr investment according to him. Norms are very strict today. There are many plants in Erode area which had to close down because they couldn’t meet the effluent treatment norms. Cutting & Sewing machines are easier to set up.

10). There are some companies like BEST Corp - which is a completely integrated operations - no process is outsourced. 1000 Cr plus turnover; supplier for Hanes and other innerwear companies

11). Role of Automation/can come in where the process is Labour Intensive. Yarn making is labour intensive. Dyeing/Bleaching there is limited labour so role of automation is limited. Garmenting is labour Intensive. Cutting machines can be completely automated - where part-wise specs can be fed and the machine optimises the cutting completely, there is very little wastage. Stitching also there are advanced machinery.

12). Technology upgrades are necessary usually in 8-10 years. There are people who continue to use for 20 years

13). Utilisation levels are very high in spinning. Also high in Weaving machines. But utilisation levels are usually low in Knitting machinery - couldn’t explain why - maybe due to changeover processes, etc. He has seen utilisation levels being as low as 30-40%. In that way utilisation levels of Kitex being 60% seems good. Management had mentioned they can take utilisation levels to max 70% - cant be more.

14). He was of the opinion while there is room for process optimisation and assembly-line efficiency improvements, this isn’t rocket science. You are not like re-inventing the wheel here. There cannot be very drastic efficiencies over the next guy

15). Processes are not very complex. Anyone with the resources can set things up. Scaling up will be an issue - but not something that is not being managed. Why an Arvind doesn’t enter the field could be to do with the size of the infantwear niche. He doesn’t buy that Arvind wanted to but failed while trying to enter this segment because of some technical complexity!

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What remains in the puzzle is how come Kitex is doing 20% EBITDA margins when the norm is 10%? is this sustainable? why?

This is somewhat like the Mayur story - where the norm is somewhere but the shining knight in the industry was operating at some other level. There its was because of continuous process improvements and de-bottlenecking exercises. Mayur used to hire consultants to come down every month from Delhi at RS 2 lakhs/visit. I remember with the help of the consultant Fabric roll changeover - that used to take 45 minutes was brought down to as low as 5 minutes in a years time. That led to a major boost to utilisation levels and small small stuff like that made the difference. However Kitex’s is a much more labour intensive process.

So understanding the sources/key factors behind the high EBITDA and the role/scope of automation in future-scale up are the two key areas to solve the Kitex puzzle, for me.

Balkrishna - and others friends from Textile Industry - please get to work and help us connect with the right folks so we can dig into this better.

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I think 20% EBITDA margins is sustainable in niche textile segment like Kitex.

One of my contact in Surat runs Infantwear retail stores (J&K Fashions). He has recently launched 2nd bigger store after huge success in past. According to him Margins are one of the highest in kidswear industry. Also if business is for pure exports then one can expect better margin.

**Some of the textile group having higher margins are
**Vardhman Textiles, Alok Industries, Trident etc

Going forward I think, EBITDA margin along with top line numbers will be important figures to watchout for Kitex. It is challenging to sustain such high margins but not impossible as we can see from some the proven companies.

Kunal

Nicely summarized Donald.The key take away is to

  • Establish the source of high margin.
  • Establish the technology related superiority including automation possibilities in garmenting. This could be a game-changer as labor risks will reduce/can be controlled.
  • Difficulty in procurement of Okeo Tex Class-1 raw materials including yarn, chemicals, accessories etc
  • Demand-Supply situation. Why is it a seller’s market? How long will this last?

The other important fact which came across during the discussion was the number of pieces/day metric for capacity and the rate/piece metric for realisation. The number of pieces/day can be 5 million or 7 million depending on who the customer is and what is the type of garment he has asked to manufacture. If Jockey’s contribution increases how will this look as undergarment making could be different from making a dress. Same with realisation per peice… it could be misleading.

Cheers

Vinod

Western Buyers are looking to diversify their sourcing after fires in Bangladesh factories and the general sweat shop reputation of most garment factories. Ethical and socially responsible sourcing is becoming the new trend.

Kitex could thus be in a sweet spot with its clean air conditioned factories and good dormitories for workers. If one combines this with good quality and a track record of on time deliveries then it is quite conceivable that western buyers would be willing to pay a premium.

Bobby

Jay Jay MIlls CARE Ratings Report

The key to proper in-depth research is not to take anything for granted. And to question anything that prima facie does not add up.

Jay Jay Mills as you may be aware is at half the capacity of Kitex and supplies to some of the same large Customers. It manufacturers infantwear and also sells fabric - the same as Kitex does. It operates at 10-11% EBITDA margins

It’s not good enough to dismiss/opine western buyers will pay a premium or Infantwear is a niche with very high margins. We all need to become better at collecting facts and question hard - based on the facts.

And then establish whether or not superior EBITDA performance is sustainable. Just as whether the company can continue scaling up at 25-30% for next 5-10 years despite the labour issues. Find the answers as to why this is possible to sustain, or why it won’t.

[

JJ mills fabric sales as % of reported sales is around 40%. Entire fabric is being exported to its subsidiary in Sri Lanka. If like Kitex one assumes that its at nominal or breakeven level, adjusted EBITDA margins will be much higher. Infact 2009-12 will be much closer to Kitex margins…

Jay Report Link: http://www.careratings.com/upload/CompanyFiles/RR/Jay%20Jay%20Mills%20_India_%20Private%20Limited-02-10-2014.pdf ](http://www.careratings.com/upload/CompanyFiles/RR/Jay%20Jay%20Mills%20_India_%20Private%20Limited-02-10-2014.pdf)

Some observations…

As an IT Infrastructure support company I came in close contact with quite a few large garment houses in Bangladesh, Thailand and Vietnam and visited many garment / sweater / knitting shop floors.

From the two Videos of Kitex (links enclosed below) it seems to be one among the finest set up I have seen.

About margin etc., I know for sure most Owners / Promoters keep a large portion of the money outside their home country. There are many mechanisms they deploy in collaboration / collusion / understanding with the long chain of intermediaries and merchandisers in the trade to keep lower profit in the main books. They make comprehensive trade off calculations on exchange rates, export value addition benefits, hedging costs (and off course their personal interest) in mind before arriving at the % of money they want to take directly into company.

If Kitex management is honest, transparent and a real visionary then their may be a possibility that their margin on the books are higher than many.

It is just a possibility.

Secondly, since the factories need only young woman (well 99%), I think scaling up may be easier over time as word of mouth would spread through the existing large pool of rural woman folks would help in spreading the good word of mouth in their neighborhood, villages, relatives about the safety, security and overall environment of Kitex factories. Over time, it self will become a formidable entry barrier for others to penetrate.

If the corporate videos are even 50% true, I guess Kitex is doing a great job in woman empowerment.

I personally don’t think MNREGA etc. are major hurdle in labour market… Employability, skill development, targeting right areas are the issues.

Videos below:

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@ T Anil Kumar

If Kitex sold 350 Cr Garments, it also sold 218 Cr Fabric (126 Cr adjusted for inter-segment) or ~90-100 Cr Fabric Sales. Fabrics segment is currently negative ~10 Cr at EBIT level. What would the calculations show once these are taken into account?

@Aveek

By all accounts the Management is visionary. Anyone who has seen the factory does mention it is a world-class set up.

Scaling up to 8000-10000 labour is one thing. Going to 20000-25000 is quite another. Local labour ceased to suffice long back. Most of the labour force now comes from the Bimaru states and there is very very high attrition despite some superb facilities. This is a very big challenge before Management…they are aware of it, and hence the efforts at Automation ongoing.

Collecting more data points will help - not generalisations.

Aveek- good point on actual margins versus reported margins. 20% EBITDA ( all inclusive) actually does not sound that high for a niche exporting business.

Donald- fair point, one should not confuse hypothesis for facts. However in a dynamic game like investing the “facts” themselves keep changing. To avoid boiling the ocean I would set up this problem as follows with specific hypotheses that can be tested for validity where facts are available.

Issue- Why do Kitex’ EBITDA margins appear to be higher than industry peers? Are they sustainable long term?

Following are some of the hypotheses which come to my mind:

1). Cost superiority- Kitex has lower costs than others in the business owing to scale, efficiency in its manufacturing process and/or lower labor costs which gives it a cost advantage over peers leading to higher operating margins at similar realizations.

2). Dominant market position)- There is a paucity of large scale credible suppliers in infant clothing thus suppliers such as Kitex enjoy more bargaining power with buyers at least till the time new credible supply emerges.

3). Higher realizations)- Kitex commands better prices than peers owing to deep customer relationships, high quality products, high service standards, socially responsible image etc. This is sustainable as long as Kitex maintains its quality and service standards and the industry characteristics don’t change fundamentally.

4). Niche segment)- Kitex’ relatively high margins are due to the specific characteristics of infant wear segment where many players enjoy such margins, it has nothing specifically to do with Kitex’ operational or quality superiority. Question then becomes how much this specific niche can be scaled up before others jump in?

Important to remember that operating margins are not the be all and and all. What ultimately matters is growth in absolute profits so if Kitex does lose a few points on margin but scales up sufficiently in volumes profits will still increase.

Disclosure: invested at lower levels

Bobby

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@Donald… Presently Kitex have 3700 employees and they have taken 7% increase in current employee cost. None of this are high and doesn’t show they have problem on scaling due to labor. There AR 14 nowhere mentioned Labor Scaling as major threat. They mentioned that Transit Time delay and Forex Rate are two major threat items. Also, cost per employee is roughly Rs. 7.5K - 8K as per my estimate (all inclusive).

I know that they are sourcing labor from other states (it is there in one of the Videos I enclosed). I have seen shop floors with more than 10 K people for Youngone, Mustgarment. Dragon Sweater etc. situated in smaller geographies. But for improving productivity automation at specific areas are better and can improve margins.

Challenges for keeping people may not be related to availability but may possibly be cultural or food related or isolation or anything like that. MNREGA etc. which you mentioned earlier for labor unavailability is not relevant here.You can get good idea about problems of Indian labor market if you happen to read some reports published by Teamlease (Bangalore). GER of 12%, brutalexploitativenature of manycompanies, monocultural bias in many geographies are India’s problem in availability and mobility not MNREGA.

I do feel, scale created by people taken from different states itself may give them a huge competitive advantage as discussed earlier.

@Ricky76 … I think your points are valid. I have no better understanding than this. large players attract each other and customer stickiness is very high in this industry… Comfort level across entire value chain built over decades of work can be penetrated only with substantial cost advantage or technology advancement which I don’t think can happen very soon.

Disc. : Not invested and no immediate plan for it unless price corrects substantially (below 175/).

@Donald,

While I agree with your view to avoid generalization and to do objective assessment of the scaling issue, Do we have any specific data to think that labour requirements will be in the scale of 20K-25K when the current is 3.7K? I also agree that increasing focus of management for automation might be an indication of labour scaling issues, but as Aveek rightly pointed out, it might be because of some major process improvement as well, where Automation may be making more sense, otherwise, I don’t really think automation really makes sense as a total replacement of manual labour. What’s the advantage of low cost labour then?

Notwithstanding any of the arguments above, I concur with you that scaling up will remain a major challenge for the management.

We should compare Apples to Apples. Compare Jay Jay Mills Margins with Kitex. Then we will refrain from making excuses about niche and premium pricing and things like that - and attack the problem on the exact specifics.

a) As Anil Kumar has suggested - taking into account the difference in Fabric Sales being 40% in case of Jay Jay to 25% in case of Kitex

b) We should take into account - try to get a break up of Government subsidies, Export Incentives and the Dollar appreciation effect (there are other Textile companies which are approaching 20% + margins) - but then why is Jay Jay at half Kitex margins again.

c) Cost structures - Yes Bobby, this may indeed be the important differentiator - but is difficult to get a handle on Jay Jay cost structures - let me try to collect that as possible.

Sure Kitex has other levers for growth in high Asset Turns and Capital Turns as compared to other Textile companies. That is a good thing to have - no dissecting needed there. What we are trying to dissect is the sustainability of Margins - why or why not? In order to be able to quiz the Management properly.

What will help us do the job better - is to focus on key specifics and equipping us with underlying data. Re-iterating all the good things about the Kitex story isn’t helping much. Please take my comments in that perspective.

@ Aksh

No specific data point on the labour requirement right now. Except that Kitex has ambitions of growing very fast - At 11 L/day by FY16 they aim to be near double the capacity of the next competitor (KCL+KGL). Even growing at 25%-30% CAGR implies doubling between every 2-3 years.

So if you stretch out the horizon to 8-10 years - and call it a really sustainable growth story - what is the main challenge in execution - scaling labourforce to 8k, 16k and 32 K in 3, 6 and 9 years. That is certainly a line to probe with Management, isn’t it?

Rather than dismissing labour scale up as not a problem, we like to throw these questions at Management and see what their current thinking is and what their plans are. Instead of taking a high-level automation/robotics spend as the answer to above, we like to probe deeper, where will automation have the biggest impact - in Dyeing (unlikely), in Knitting Or in Garmenting (high labour engagement) - and then put a dimension to each - to arrive at likely estimates/contours of the puzzle.

Urge everyone to think more on specifics like these on the Kitex puzzle.

@ricky76

Your hypotheses make sense. I should agree with you that only OPM is not important. Higher growth in top line and bottom line is key.

OPM for Page industries is stable since 2007(between 20 to 21) but in that last 5yr 35% CAGR growth in sales, profit is ultimately value creator for Page investors. Sowe shall better look at sales, profit growth more than OPM. It is equally important that OPM must not swing heavily.

@Aveek Mitra

Labor issues can be sorted out with right mix technology and operational excellency by management. Kitex is doing right here. Mayur Uni is a great case study for alltextile manufacturing cos for “how to achieve highest level of operational excellency”. Mayur hired best consultants to improve cycles, turn over ratios. Constantimprovement in manufacturing process and smart backend integration are key take away.

Your wish of dream entry level at 175 demands 35% correction at CMP! I checked Point & Figure charting. It suggests extremely strong support at 215 to 230 level.Rather than getting truck load of Kitex at 215 or 175, why not think to add Kitex at various milestone levels. This way we can improve our convictions and betterallocation decision is made. So invest as story unfolds

@Donald

We have valid questions for management regarding labor, automations scaleup to understand their strategies. We can ask some specific questions like plan for creatingown brand and its marketing strategies, how will it impact OPM, potential growth in own brand, competitor threat, customer bargain power, etc

Disc : Still not invested : (

Trying to solve few puzzles…

10% EBITDA levels is the norm. â Even Jay Jay mills reported average EBITDA margins for 2009-12 were around 15% [without any adjustments, taking reported nos by Care, one can download care reports from care websites]. Kitex reported margins were much higher than this. Yes 2013 margins fallen steeply, reported margins at 11%, but this could be due to increase in overheads or some company specific issue. So 10% EBITDA margins WERE NORM BEFORE 2008, if at all, when both JJ and Kitex were purchasing majority of processed RM from outside

EBITDA margins improved due to INR depreciation: This is little tricky. Kitex processing plant begin functioning to full capacity from FY2008 end and in 2010 new capacity garment capacity and processing plant became functional. Company had been repeating from 2007-08 that once processing plant becomes functional, their margins will improve drastically. Processing charges which were above 15% for FY08 & 09 declined drastically to low single digit by FY12 & 13.

Further note that during FY05-08/09, emp cost increase by 3x, but during FY09-14 emp cost increased only at a CAGR of 7%, during same time garment sales increased at 11% CAGR. Emp cost as a % of sales declined by 200 to 300 basis point during FY11-14 compared to FY05-10.

INR depreciation/ Appreciation: From above, aleast we can say that entire increase in EBITDA margin post 2009 is NOT DUE TO INR DEPRECIATION. There must be some benefit without doubt, but not entirely. Letâs see what happened when INR appreciated to INR 41-42 during FY07-09. EBITA margin remained flat and there was NO decline in gross margins.

Steep increase in cotton prices in FY 11 lead to 31% decline in garment sales [i.e excluding fabric sales]. Despite such a massive decline in garment sales, there was no pressure on Gross & EBITA margins. Ofcourse, FY11 was period in which company was getting advantage of its additional processing plant and reduction in processing charges, but it does indicate company has weathered turbulence in its operations well.

EBITDA margins sustainability Vs JJ mills: For the time being letâs not get stuck with comparison with Jay Jay mills. As highlighted earlier they have 40% fabric sales as exports, we do not know whether these sales are at breakeven levels, loss or at premium. My GUESS is IT COULD BE AT LOSS, as in India there are no tax benefits to textile companies. [ JJ mills standalone profits is merely 6 crs but consolidated profits are 29crs for FY13, which indicates much higher profits at subsidiary levels. Thanks to Vinod, for highlighting higher subsidiary profits]

Better way to think about sustainability could be to think what could put pressure on margins. Two things 1) First pressure on ASP 2) company not able to pass on the RM price hike. I highlighted earlier that despite, massive increase in cotton prices during 2011, there was no pressure on margins. Company, probably took decision to take hit on sales rather than cutting margins. Secondly regarding pressure on ASP, we should note that company is running on full capacity for most of the time in last 5-7 yrs, except for may be in 2011.

In my view most imp. variable to track and understand is the China capacity and ability of other Indian/Asian countries to quickly add capacity. Even if some one start from today, it will take atleast 3-4 years to match Kitex capacity [Kitex took 20 yrs to come to this level]… and Yes we need to understand about labour, because if something could break this story, it WILL BE LABOUR.

Automation: Donald as already talked in detail about this and I broadly agree with him. Mgt is saying no labour, but even if we assume 100% labour there wonât be any impact on margins, but YES the issue remains on AVAILABLITY OF LABOUR and if FULL AUTOMATION IS REALLY POSSIBLE, then why western countries need to depend on Asian countries, or is it a Mix OF AUTOMATION AND LABOUR.

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See below article from the Wall Street Journal. Lower cotton prices (Check out the cotton price 10 year chart from Bloomberg to get a sense of where we are in the cycle)in the foreseeable future are likely to provide a strong tailwind for garment players provided they are NOT locked into long term contracts with the mills.

Does anyone know how Kitex procures cotton? is it through long term supplies or short term contracts? Does it hedge through the futures market?

Bobby

Cotton Price Unravels as Supplies Rise

By

ALEXANDRA WEXLER

July 27, 2014 2:07 p.m. ET

Cotton prices have retreated to the lowest level in nearly five years as investors worry that global production could overwhelm demand for the fiber.

The U.S., the world’s biggest cotton exporter, is expected to produce a large crop in the season that begins Aug. 1. But global demand is likely to fall short, especially with top importer and consumer China wrapping up a 2-year stockpiling program. U.S. government forecasters predict the amount of cotton left over in warehouses world-wide when the next season ends will reach an all-time high of 105.7 million bales.

“That’s going to weigh heavily on world supplies,” said John Flanagan,presidentof brokerage Flanagan Trading Corp. in Fuquay Varina, N.C. “Prices are on their way down to the 50-cent level.”

Cotton prices last traded around 50 cents a pound in April 2009. On Friday, cotton for delivery in December, the most actively traded contract on the ICE Futures U.S. exchange, fell 1.1%, to 65.35 cents a pound. It was the lowest closing price since Oct. 12, 2009, and down 3.5% for the week. The front-month contract, for October delivery, ended down 1.9%, at 65.16 cents a pound.

“We’ve had great weather and that’s got everyone on the run,” said John Payne, market strategist at Daniels Trading in Chicago, referring to growing conditions in Texas, the top U.S. cotton-producing state.

After years of drought, Texas has begun to see rain in cotton-growing areas. Government forecasters, citing the rainfall, recently increased their estimate for U.S. cotton output during the 2014-15 season by 10% to 16.5 million 480-pound bales, exceeding market expectations for a 4.7% upward revision to June’s estimate.

There are also concerns about weakening demand. The International Monetary Fund recently cut its global economic-growth forecast for this year to 3.4% from an April estimate of 3.7%, damping sentiment in the cotton market. Cotton prices are particularly sensitive to economic data, because demand for the fiber is tied to consumer spending on items such as apparel, bed sheets and towels.

China had been a major support for the market, quadrupling its stocks since it began a strategic purchasing program in late 2011. But that program is wrapping up, as China has had trouble unloading its massive stores of the fiber on the domestic market.

The recent drop in cotton prices could spark defaults from mills that contracted cotton at higher prices, said Jordan Lea, co-owner of Greenville, S.C., cotton merchant Eastern Trading Co.

After prices plunged from a post-Civil War high three years ago, a wave of defaults by mills hit balance sheets at some of the largest cotton traders, setting off a surge of legal battles, some of which are still unresolved. “It’s always the elephant in the room,” Mr. Lea said. “Anytime you get a move down like this, the risk exists.”

Fain Shaffer,presidentat Infinity Trading Corp., a brokerage in Indianapolis, expects prices to slide to 60 cents a pound in the near term. “We’ve got large production and questionable demand,” he said.

Below is an approx cost structure ( does not include retailer/wholesaler markup) for a garment manufacturer. Key takeaway for me is that the really labor intensive part or what is called CMT ( cut, make, trim) in the industry makes up the bulk of costs and does not look like it can be automated much to save costs- need to probe management on this.

COGS SPLIT, %
Cut, Make, Trim (labor) 31
Yarn, textile manuf ( labor , energy) 23
Raw Materials 11
Supply chain overheads 8
Duty 8
Textile manuf profit 7
Other mfg costs 8
Freight 5
Source: Deutsche Bank estimates as reported in the Financial Times- May 2013


KITEX’ US EXPORT MARKET SHARE

Some calculations based on Nikhil’s US imports data and Kitex numbers

1). As per US import data India exported 125m USD worth of babies garments in 2013

2). Kitex had a total garments revenue of Rs 350cr for FY 2014 ( pg 53 AR 2013-14) out of which 80% was to US ( as per this thread) so its exports to US in FY 2014 = ~USD 50m

3). 50m/125m= 40% market share. Does this sound right?

Other point to note is the rather slow organic US import growth of ~4-5% based on growth rate from 2012 to 2013 and ytd 2014 and 2013.

This would imply that for Kitex to majorly scale up it would need to take share from other players rather than depending on the sector itself growing fast.

Had an excellent first discussion with someone from the Infantwear Industry in India.

These kind of discussions with industry insiders/experts are invaluable. We must get our focus right on prioritising the digging and focus all energies first on getting to industry folks:)

There is more to the story than is being put out!

1). There are lots of players who are scaling up in India. There is no big differentiator or technical superiority. Every knitting player in India can potentially match up to the technical or quality demands of any global brand. Everyone is looking to scale up vertically

You can get more on players from Apparel Export Promotion Council.

Task of the day : get insidehttp://aepcindia.com/and get us the key players scaling up in infantwear or get us a key knowledgable person contact in AEPC

Shirtings/Suitings woven players are a different kettle of fish - saying Arvind can’t or won’t to infantwear is like asking a cotton products manufacturer to start making silk products

2). On-time delivery, price competitiveness, Collections (design inputs) are the main things a global brand looks for while deciding

3). It’s a very very competitive world - Brands will move to where price is competitive

4). Huge difference between the way American Brands and European Brands operate. Americans its a volume game. European brands are much nimbler and under big profitability pressures/targets and work with much smaller volumes

These are the main new insights into the business/industry. Will try to summarise over next week as we look to identify and speak to more people and more players in this very industry.

Cheers

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