As domestic and global factors weigh on company performance, Moody’s Investor Services has lowered its outlook for the U.S. apparel and footwear sector to stable from moderate.
A slowdown in global economic growth, ongoing trade conflicts, currency woes and sourcing shifts are some of the developments impacting the outlook.
“After two strong years, industry operating profit growth will moderate from 2019 levels, but remain solid,” Moody’s said in its “Outlook Update” for top public companies in the field.
Operating income growth is expected to ease in 2020 to around 4 percent to 5 percent, with sales in the same range. According to forecasts, Moody’s said 2019 operating income growth in the 6 percent to 7 percent, and revenue growth in the 4 percent to 5 percent range.
“While challenges are increasing, growth will remain widespread as companies continue to benefit from new product introductions and innovation, [and] continued direct to consumer (DTC) and international growth,” Moody’s said. “They will also benefit from improved marketing efforts and previous cost savings steps, restructuring initiatives and synergies.”
Moody’s projects global growth to slow to 2.7 percent in 2019 and 2020, about half a percentage point below the level in 2017-18. Risks like trade frictions and Brexit will weigh on business and consumer sentiment, which will increase promotional pressure within the sector. China, a key player in the supply chain and consumer market expansion for many large apparel companies, will see growth slow to 6.2 percent in 2019 and 5.8 percent in 2020 from 6.6 percent in 2018.
The strong dollar is another “looming risk in 2020,” according to Moody’s, and “will likely lead to higher costs in 2020.” Since apparel companies normally source products from foreign manufacturers in dollars and sell goods in foreign markets in local currencies, a stronger dollar will increase the foreign entity’s costs of goods sold.
“From a consumer perspective, we are also seeing signs that the strong dollar is driving a decline in tourist spending in gateway U.S. cities, leading to increased promotional activity,” Moody’s said.
As for the effect of tariffs on Chinese imports, Moody’s expects them to pressure earnings. Analysts estimated that 52 percent of combined sales for rated U.S. apparel companies are generated in the U.S. and are at risk of increased tariffs on Chinese imports. Companies like G-III Apparel Group that sell a greater percentage of imported Chinese goods in the U.S. would take the biggest profit hit, while Levi Strauss & Co. and Hanesbrands are well diversified or not significantly exposed to Chinese imports into the U.S., the report said.
“We estimate annual cost increases would have a 30 to 50 basis point hit on the combined operating profit of our rated entities, not including ongoing efforts to mitigate the cost increases through moving more production away from China, obtaining supplier support or increasing prices on selected product,” the report said, noting that companies have been making progress in these areas.
In its most recent fiscal year ended Jan. 31, G-III generated around 86 percent of its revenue in the U.S. and sourced around 61.5 percent of its inventory purchases from China, according to Moody’s. Now, the company recently said it has had conversations with its vendors and retailers and that all parties are willing to share in the increased costs. G-III has also implemented select price increases and said its production in China will be down to less than 50 percent this year.
DTC channels and international markets will continue to drive growth in the sector, Moody’s said.
“While there are still pockets of growth, the North American apparel retail market remains challenged, with an increasingly promotional environment, which will pressure margins,” the report noted. “Retailers also continue to manage to lower inventory levels and delay product orders until later in the season.”
Moody’s said it could lower its outlook for the apparel and footwear sector to negative if its sees operating income growth falling below 2 percent. This would most likely be driven by further weakening in global economic conditions in key markets that would result in negative sales trends, continued strengthening of the dollar or continued tariff increases.
On the other hand, it could change the outlook to positive if it sees signs that constant currency operating income growth will grow 6 percent or more over the following 12- to 18-month period. This could occur if the dollar materially weakens, if tariff or other input costs decline or consumer spending strengthens.