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These Factors Could Impact Retail, Apparel Credit Risks in 2020

Global trade tensions and continued protectionist posturing continue to pose a risk for credit conditions in 2020, testing consumer confidence and potentially affecting the U.S. retail and apparel sectors.

While credit analysts from Moody’s Investors Service don’t expect a recession in 2020, they note in a new report that recession risks run high, given the uncertain backdrop connected to trade policy, and the unpredictable political and geopolitical environment.

For now, the outlook is stable for both the retail and apparel sectors, despite plenty of risks like high leverage, numerous debt issuers with weak credit quality and possible consumer pullback. The supply chain will continue to be a big focus for retailers, while the apparel sector will find the North American market to remain a challenge due to bankruptcies and store closures.

On the environment, social and governance front, companies will need to continuously work toward “sourcing transparency while making investments in sustainable supply chains,” the analysts wrote, noting that responsible product sourcing can affect an apparel company’s brand image over time.

Terms of the phase one trade agreement between the U.S. and China have not been revealed, providing little clarity on what could be an enforcement trigger that would allow U.S. President Trump to reinstate certain tariffs. The agreement calls for a hold on the 15 percent tariffs that was to go into effect on Dec. 15 on certain Chinese imports, and it lowers the tariffs that went into effect on Sept. 1 to 7.5 percent from 15 percent. Tariffs that were in place earlier this year remain in place. There’s also the possibility of retaliatory tariffs against France, following French lawmakers’ decision to institute a digital tax on foreign firms.

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“Increased trade friction could trigger spikes of volatility in financial markets and further disrupt trade flows,” the report said, noting that the offsets to price increases within the industrial supply chain now available to companies may not last if tensions persist. That, in turn, could result in higher prices and constrain consumers’ willingness to buy, at least for those accustomed to steady price reductions, the Moody’s credit team said. An “enduring U.S.-China trade deal will remain elusive and trade disputes will weigh on credit conditions,” the analysts said of what could remain an important theme for the year ahead.

Barring material, industry-wide supply chain disruption, the credit analysts expect the U.S. retail sector to remain “stable” in 2020, although the department stores and drug segments will remain a drag for the group as a whole. Department store operating income is expected to decrease by 1 percent, following a major contraction in 2019. The sector still hasn’t transformed enough to meet changing consumer needs, and debt reduction remains critical due to the challenges to stabilizing earnings growth, the analysts concluded.

Companies that have made strategic investments in e-commerce will continue to see gains from improved operating efficiencies. Discounters, such as Walmart and Target, and warehouse clubs are expected to see operating income gains in 2020: Walmart for its ability to extract share in its grocery business, and Target primarily for its investments in exclusive and private-label merchandise. Also expected to see operating income gains next year is the off-price sector, both for its value proposition and ability to drive traffic through its treasure-hunt format.

As expected, e-commerce sales are projected to grow at a rate of 14 percent to 15 percent annually through 2022, although growth could decelerate by 1 percent starting in 2023, the report said without elaborating.

For the apparel sector, international markets and the direct-to-consumer channels are expected to remain the key growth drivers for 2020. One negative will be the continued challenges in the North American market, including wholesale customer bankruptcies, store closures and ongoing inventory management issues.

On the other hand, innovation and new product introductions, along with improved marketing efforts, are expected to help drive sales. However, while a decline in tariffs or other input costs would be a positive for the companies, a weakening in global economic conditions or continued tariff increases could cause a decline in sales.

Another risk for the apparel sector could be input costs, currently mixed. While cotton prices have declined as demand has slowed and supply has increased, synthetic and polyester fibers remain elevated. And a strong dollar–the typical currency used to determine costs for sourced goods–will likely lead to higher costs in 2020, but it won’t get any offset as the goods in overseas markets are sold in local currencies.