Archroma’s eroding margins

Sometimes top-line growth doesn’t lead to higher profitability, as in the case of Archroma Pakistan. In the first quarter of the financial year (the company’s financial year ends in September), the company predicted a lower gross profit because of rupee devaluation and imposition of regulatory duty, both of which have driven up raw material prices.

Its concerns appear justified as gross profit has declined year-on-year for every quarter this year. Unstable global prices for its imported raw materials further eroded its gross profit margin. While the dip in gross profit is insignificant, its impact was exacerbated by an increase in finance cost due to higher interest rates. Since Archroma’s total liabilities increased by about Rs1.8 billion, i.e. 40 percent, in part due to a jump in short term borrowings, the higher interest rates had a deep impact.

As a result, its net profit has decreased significantly on a yearly basis. Exchange losses of Rs216 million and increase in royalty that Archroma has to pay by Rs306 million has also dragged down net profit.

Archroma tried to stem the tide through lower distribution and marketing expenses as a percentage of sales and by decreasing ‘other expenses’. Other than optimizing operations to curtail costs, the company also has been slowly but steadily increasing prices to assuage the impact of currency devaluation.

Higher prices while demand was steady increased the top-line. Sales growth was led by paper and packaging segment that accounted for 43 percent of the increase in sales, followed by textile chemicals that made up nearly 16 percent of the higher revenue. At 3 percent, coating adhesives and sealants were the smallest contributors of the increase in top-line. Exports increased across most categories, rising by nearly 50 percent year-on-year.

Packaging sector in Pakistan has been flourishing lately, especially since the Punjab Food Authority imposed an embargo on the sale of open food products through its Authority Food Regulations, 2017. The FMCG sector, a major driver of packaging demand, has also been witnessing double-digit growth which has given packaging companies a boost.

So it comes as no surprise that Archroma’s increase in sales were driven by its packaging segment. However, its textile segment comprises of the biggest chunk of its portfolio. While textile exports in FY18 have witnessed a modest increase of 9 percent as compared to the previous year, higher hopes were pinned to the myriad of incentives provided under the PM’s Textile Incentive Package. Shabby implementation has limited growth of the textile sector and constrained increase in sales by Archroma’s textiles segment.

The textile sector faces a host of challenges as cotton cultivation area has decreased and electricity and gas tariffs may go up in the near future. Archroma’s profitability is linked in part to favourable climate for textile sector and in part to rupee volatility. Given these circumstances, it is possible that Archroma’s margins will continue to remain under pressure.