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Moody’s Cuts Apparel Industry Outlook as Strong Dollar Weighs on Earnings

When the U.S. dollar strengthens against global currencies, it can weigh on stateside sales—especially in the apparel and footwear sectors, as foreign tourists are less loose with their spending.

In its recent Outlook Update, Moody’s Investor Service lowered the 2016 growth forecast for the apparel and footwear industry to the 3-5 percent range from 5-7 percent in 2015, moving from a positive outlook to a stable one. Analysts also lowered their 2015 constant-currency growth forecast from 7-9 percent.

“While the hedges taken this year will partially protect margins, the strong U.S. dollar will continue to have negative foreign currency translation effects on the industry’s gross profits for the rest of this year,” said Scott Tuhy, a Moody’s vice president, senior credit officer.

Once 2015’s hedges have rolled off next year, provided foreign exchange rates stay the same, Moody’s said companies will experience a roughly 40 basis point drop in operating margins because of higher sourcing costs at current exchange rates.

Revenue growth for the sector, however, will remain a moderate 4-6 percent through next year.

“Apparel companies will also continue to benefit from low cotton and oil prices this year, which could help the industry’s operating margins,” Tuhy added, though negative currency effects have offset most of those benefits.

When it comes to retail, Tuhy said, “The strong dollar has discouraged spending by tourists to the United States, impacting sales at brands such as Ralph Lauren and Calvin Klein, dragging on apparel sales.” And those brands are blaming part of their lackluster performance on reduced department store spend.

Sales for department stores have fallen 24 percent since 2002 and more and more apparel companies are realigning their focus and growing their online and direct-to-consumer offerings.

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Nike has benefitted from a shift away from department stores—the retailer has opened more of its own branded stores, and according to Moody’s, grew direct-to-consumer sales by 25 percent in fiscal 2015 to more than $6.6 billion, or close to 22 percent of total sales.

VF Corp also grew its direct-to-consumer sales by 11 percent in the first half of fiscal 2015 to 25 percent of its total revenue.

“We anticipate apparel companies, particularly big names like Nike, Ralph Lauren, VF Corp and PVH, to grow sales and expand operating margins through their organic growth initiatives, which will be more recognizable in the long run without FX noise,” Moody’s said.

Nike, VF Corp and Hanesbrands have been the primary revenue and income growth drivers for the apparel sector this year, and they all sell athletic apparel, which points to the continued trend toward athleisure-focused sales. The demand for athletic wear has weighed a bit on denim, but Moody’s said denim sales from companies like PVH and Levi’s will recover.

E-commerce sales in the apparel sector should grow 15.3% this year, 14.2% next, and online penetration will reach 16 percent of total sales by next year.

Despite China’s currency fluctuations and its economic slowdown, Moody’s said the country will still be a big growth opportunity.

“While Chinese macroeconomic conditions have been very volatile recently, the Chinese consumer is showing a continued propensity to spend,” the report noted. Nike, for example, recently reported future orders growth of 22 percent in China, which is considerably higher than the 9 percent future orders growth for the entire Nike brand.

So what could change the apparel industry’s outlook back to positive?

Signs of stabilizing foreign exchange rates and companies showing that pricing will ease exchange rate risk so that operating income growth might exceed 6 percent could do the trick.

If, however, Moody’s expects operating income growth to dip below 2 percent, it could lower the outlook to negative.

“This would most likely require recessionary conditions in key developed markets that would result in negative sales trends or if the US dollar showed sustained and meaningful strengthening beyond current levels, which could lead to greater than expected pressure on operating margins from transactional FX impacts,” analysts noted.