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Touching Base: HSBC’s Eric Fisch Warns of DTC Financing Challenges as Recession Looms

Trade wars, Brexit, Fed rate cuts and inverted yield curves indicating investors’ fears of an economic downturn have all signs pointing to a recession on the horizon. And it’s more a matter of “when” it will hit than “if,” as economies that expand eventually end up contracting, only to repeat the cycle again.

Amid these market conditions apparel companies—whether they’re direct-to-consumer brands new to the boom-bust cycle or even more established retailers—must consider how to plan their businesses, and how best to position themselves should they require financing during a downturn.

In another installment of Touching Base, a financial Q&A series, Sourcing Journal spoke with Eric Fisch, head of retail and apparel, commercial banking at HSBC, for his read on the commercial lending environment, as well as some insight into how a banker evaluates a company in deciding whether or not to provide financing. The conversation has been edited lightly for clarity and length.

Sourcing Journal: What does the current lending environment look like now?

Eric Fisch: Somewhat cautious, but banks certainly are still looking for good opportunities. The banking and financial industry is looking to grow in retail. Generally, we’ve seen refinancing for retailers that don’t have any major issues.

SJ: Is there a high proportion of retailers showing growth these days?

EF: Over the broad spectrum, there are definitely retailers that are showing growth. Some plan to double their store count over the next two to three years. If they have a small base, say 12 stores, they might grow to 20….They see an opportunity to get some advantageous real estate leases done.

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There are opportunities for kick outs after one or two or even three years…. With Instagram and social media, it can be a good time to grow retail, but no one wants to lock into a long-term lease anymore.

SJ: What’s the current criteria for evaluating whether a retailer is creditworthy?

EF: The [overarching] criteria for any company, we believe, is whether the business is sustainable. Does it have a reason to exist? Is there a consumer for it? Is there a demand for that retailer or brand? Is there reason for it to exist alongside others?

SJ: Does anything change amid projections of a downturn ahead?

EF: Our approach to management and the company’s growth plan is whether we believe it is appropriate depending on a number of factors, including the economy. Our philosophy is to see if the company is able to extend beyond whatever speed bumps they might encounter. Banks all use similar credit metrics to keep a healthy portfolio. The key is to find companies with appropriate credit metrics. And you have to use a lens that is thinking about the business over the long term, or you could end up lending to a company that quickly turns into a distressed situation.

SJ: In this lending environment where there’s a touch of the unknown ahead, such as political or financial risks, how often do you see companies you think are okay turning into distressed firms?

EF: We see it because every portfolio has a spectrum of borrowers that at some stage hits a bump. We have companies that have banked with us for 40 to 50 years, and at various points over the decades have gone through different cycles.

As long as the company can take active steps to mitigate the problem, there is no reason why they can’t pivot quickly and [change] their performance.

This ties to a company’s ability to be flexible. We’ve seen companies that have been around for a long time that have been able to pivot quickly because they’re not wedded to the old way of doing things or even to old assets or old approaches. A heritage brand is important, but heritage systems and operations are not.

SJ: What’s the common theme here? Is it because they don’t know what to do or just don’t see the big picture?

EF: People aren’t adjusting appropriately, and that’s a big theme. They’re not adjusting across overhead or lack either automation or updated POS systems. Some lack [thinking on] potential investments.

In apparel, whether retail or wholesale, you live and die by your inventory. Inventory in this industry does not age like fine wine. It ages like fresh fish.

What we’ve seen are some companies that are excellent at very quickly and very efficiently seeing styles or categories that are not successful and they sell it to the off-price channel. They write it off and move on.

SJ: Many of those firms, if they’ve been clients for decades, are run by what the industry calls garmentos. Now we’re seeing more direct-to-consumer apparel start-ups that don’t have that same retail-wholesale experience. What’s their big problem?

EF: For some businesses the strategy is not to be profitable at the moment but to spend on marketing. They want to grow the topline, which they think is more valuable than generating a profit. That’s the case as long as venture capitalists and private equity investors are looking to grow in the DTC space. But in a down cycle, that potentially might no longer be the case. In turn, these companies won’t be able to get the financing they want.

If companies looked for a more moderate and more stable growth trajectory where they can both grow and show profitability, as well as better financial metrics, they would have a more stable business. I’m not saying every DTC firm is [ignoring profitability], but there are quite a few of them that are doing that.

SJ: What’s your advice on what these digitally native brands should be doing now to prepare in case they might need financing during an economic downturn?

EF: Whether they are pure players or have some component of wholesale or one or two retail stores, we generally look at revenues and profitability. Are they at break-even? Have they turned a profit, or are quickly approaching a sustainable and profitable business? While driving marketing spend could accelerate growth, and it could be a sound equity strategy for investors, that’s not a strategy that allows a bank to necessarily provide financing.

We’d also be looking to see if the company has a sound understanding of inventory requirements. DTC firms are different from wholesalers. There are no open orders and no budgets from retailers. There’s no cadence of purchases that match delivery windows for retailers. So instead you look at how quickly they discount and is there a strategy to make sure their inventory stays fresh? How are they cycling? There are very few categories that don’t have seasonality [because] consumers usually buy on some sort of seasonal basis. When you look at the cycle, like in cardiology, a flat line is not a good thing. You want to see up and down showing a healthy purchase cycle.

SJ: Anything else companies should be considering?

EF: There are two [things]. The first is don’t spend too much on social media. Still think about how to achieve exposure without the expense. What are the alternatives?…Is there a social responsibility angle for the brand? Where you can use that to reduce the marketing spend and still get exposure for the brand?

The other is something old that could be new again–the catalog. We’re seeing more DTC brands using catalogs, which is more targeted than social media. You can specify the zip codes and the consumers that resonate with the [reach-out] tend to be people with relatively high net-worth. It could be a photo flier showcasing the product, much like a magazine spread with a coupon. A website can be hard to evoke the feeling of luxury or premium apparel, but when people touch paper–think matte finish–it can evoke a conscious reaction where [the consumer] can now appreciate a brand’s positioning.