There are hardly any warm and fuzzy pre-holiday feelings in the corporate HQ confines of major retailers thanks mostly to President Donald Trump’s protracted trade war with China.
Think more along the lines of chaos and fear among the executives in charge of pulling the execution strings ahead of a three-month period that could either financially make or break a retailer’s year (and the year after).
“Most apparel retailers will avoid U.S. price increases, in our view, but if the tariff rate ticks higher, price increases are unavoidable. Mitigating strategies can only go so far because factory capacity outside China is getting increasingly constrained and concessions are not an optimal long-term solution,” says long-time Bank of America Merrill Lynch retail analyst Lorraine Hutchinson.
In short, retailers are caught between a rock and hard place right now.
The chaos ensues
The Trump administration slapped China with fresh 15% tariffs on some $125 billion of largely consumer products on September 1. Whereas products such as smart speakers, T-shirts and footwear side-stepped the first round of tariffs, they weren’t so lucky to get a reprieve this go around.
Roughly 77% of all shoes, clothes and home textile imports to the U.S. from China now has a tariff attached to it, according to research by the American Apparel and Footwear Association. More tariffs on apparel and footwear lurk on December 15.
To their credit, retailers both big and small have seen the writing on the wall all year long. They have used most of the year to reconfigure their supply chains, moving as much production as possible out of China to other regions such as India and Vietnam. Back-to-school merchandise and some holiday assortments were also brought in early to warehouses this summer so as to avoid the tariff increases.
Due to these Herculean efforts, the effects of the trade war did not materially hurt the earnings of major retailers in the first half of the year. Hat tip to the executives just making it happen.
Even still, Hutchinson points to two harsh realities despite the efforts of retailers to protect their profits.
For one, apparel and footwear sourcing costs are now starting to rise following a six-year stretch of flat to lower costs. Thank you, Trump trade war, which is causing supply chain disruption across many industries that have relied on China for decades.
It’s inefficiency in its finest form for an industry that could least afford it.
Says Hutchinson, “We expect costs to rise over the next several years because Trade War has accelerated the supply chain shift across multiple industries, creating tight capacity and an inflationary environment around key manufacturing hubs in Southeast Asia. We see risk that even a modest annual increase in sourcing costs could pressure margins for many brands given apparel pricing remains deflationary.”
No relief even in Vietnam
Next, one of the primary beneficiaries of apparel retailers shifting their production has been Vietnam. Unfortunately, other industries (see tech hardware and semiconductors) have also descended onto the emerging market to source products. That is beginning to significantly drive up costs in Vietnam, says Hutchinson, surprising many in the retail industry who thought the country would give it some cost relief.
“While minimum wages are only rising 5% year-over-year in Vietnam in 2019, our checks indicate wages for factory employees around the key cities (Hanoi and Ho Chi Minh City) are now rising at a low-double digit rate. Suppliers are struggling to recruit and train new employees fast enough to keep up with orders and vendor corporate social responsibility (CSR) initiatives limit weekly and annual overtime for existing employees,” Hutchinson warns.
With China continuing to represent about 33% of U.S. apparel imports, Hutchinson believes there will be a “learning curve” to operating in the new reality of Vietnam. Significant investments will also be required in Cambodia, Indonesia and Bangladesh, Hutchinson thinks, to handle orders Vietnam simply can’t at this stage.
Sounds like massive profit margin risk this holiday season and well into 2020 for retailers.
Consumers are the biggest loser
Investors in the retail space have already begun to voice their concerns on the earnings power of many of its constituents.
The Consumer Discretionary Select Sector SPDR Fund ETF has lagged the S&P 500 and Dow Jones Industrial Average for the better part of September. Department store stocks Macy’s (M) and J.C. Penney (JCP) have been shredded since August.
Off-price retailers such as Ross Stores (ROST), Burlington Stories (BURL) and TJX Companies (TJX) and athletic brands Nike (NKE), Under Armour (UA), VF Corp. (VFC), Lululemon (LULU) and Columbia Sportswear (COLM) are seen as relative winners, according to Hutchinson.
The ultimate loser here? The U.S. consumer hoping to score a good deal on a sweater this holiday season. Start saving your pennies today folks.