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How the New Tariffs–Chinese and American–Could Affect Apparel

The new tariffs that President Donald Trump has proposed of up to 25 percent on $300 billion of goods that include apparel and footwear is likely to go into effect by Labor Day and is expected to impact back-to-school and holiday sales.

While the product list of targeted goods was released Monday afternoon, the imposition of the tariffs first needs to go through a public comment period. A hearing has been scheduled for June 17.

Chris Krueger, Washington strategist for Cowen & Co., noted that so far the effect of the trade war on U.S. growth appear modest, but moving to a 25 percent increase could raise the potential for GDP and inflationary effects down the road.

Matthew Shay, National Retail Federation president and chief executive officer, said in a CNBC Squawk Box interview, “Retailers have done everything they can up to now, but when we get to 25 percent on this final fourth tranche, if we go there … It’s going to be difficult for any retailer in the country to avoid passing along price increases to consumers.” Shay added that there’s “just not enough leverage and wiggle room left to make it happen.”

Krueger’s colleague covering equities, John Kernan, noted that China is the largest apparel importer at 34 percent, with footwear at 71 percent. Kernan believes that a 25 percent tariff on apparel and footwear will create major disruption.

The analyst believes companies such as Sketchers, G-III Apparel Group Ltd., PVH Corp. and Ralph Lauren Corp. will have “outsized EPS risk.”

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According to Kernan, citing company statements from conference calls and regulatory filings with the Securities and Exchange Commission: Sketchers is majority sourced in China; G-III has the majority of its goods sourced in China and PVH has $400 million of Chinese imports to the U.S.

Deckers and Ralph Lauren face the most “significant financial headwinds in our view,” Kernan said, noting that Lululemon, VF Corp., the off-price retailers, Adidas and Puma are most insulated.

Shares of G-III and Ralph Lauren were particularly hard hit on Monday, as were shares of Deckers and Sketchers, as investors reacted to China’s retaliation by imposing up to a 25 percent tariff on $60 billion of American imports into the Asian nation. Shares of most retailers also shared a similar fate in Monday’s trading session. And while most apparel and retail stocks regained some of their losses during Tuesday’s trading session, shares of G-III and Ralph Lauren lost more ground, closing down 4.2 percent and 3.8 percent, respectively.

Kernan’s equity colleague Oliver Chen noted that the factors connected with supply and demand planning would likely impact back-to-school and holiday selling seasons, key drivers of the retail calendar. “Retailers with greater vendor exposure, slower inventory turns, and greater scale may have more time to negotiate changes,” he said.

For both Cowen equity analysts, the key issues for apparel and retail firms are connected with the percentage of goods sourced in China, how much of the costs might be absorbed by Chinese manufacturing partners, consumer reaction to price increases and how quickly companies can move production outside of China. There’s also another non-tariff factor that has to do with related disruptions that could crop up, such as either through forced inspections or shipping delays.

According to Kernan, one thing is clear and that is that there is “little capacity in other regions for a mass migration out of China sourcing,” and he expects supply chain costs will continue to rise globally. What remains the biggest unknown is how the consumer will react to price inflation, likely as early as Holiday 2019.

Cowen’s Chen said that among the retailers, Walmart Inc. and Costco Wholesale Corp. face the least significant impact from the tariff hikes, mostly because they have a higher grocery component, at 56 percent and 55 percent of the merchandise mix, respectively. That puts specialty retailers and their narrow category mix, such as Gap Inc., American Eagle Outfitters Inc. and J. Jill Inc., at a higher risk.

Its the argument for favoring retailers that sell consumer staples and against those in the consumer discretionary categories. That means that retailers within consumer discretionary, such as apparel, that have a higher proportion of private-label merchandise could be impacted more by tariffs because they do more direct sourcing. Gap, for example, conducts 20 percent of its sourcing in China, according to Chen. Others in his coverage universe that face this issue include American Eagle, Limited Brands, J. Jill, on the vertical side. Broadline retailers that sell multiple apparel brands should see less of an impact, such as Macy’s Inc. and Nordstrom Inc. But the opposite would be true for J.C. Penney Co. Inc. and Kohl’s Corp., both of which have sizeable private-label brand operations at 46 percent and 39 percent, respectively.

And while there’s been a heavy emphasis on what the impact could be for U.S. companies when the new tariffs on Chinese imports occur around Labor Day, a separate but equally important issue is the impact from China’s retaliatory tariff on American exports. On Monday China said it would hike tariff rates to 25 percent on $60 billion worth of American goods, effective June 1.

Chen noted that should tensions between the U.S. and China continue to escalate, tariffs on U.S. goods imposed by the Chinese government could lead to lower sales in China for select firms, with luxury companies having the highest sales exposure in China and to Chinese nationals.

“We view that as the trade war escalates, U.S. luxury brands may also lose their relevance and desirability as the domestic sentiment changes, which will put Tiffany [& Co.], Tapestry [Inc.] and Capri [Holdings Ltd.] more at risk,” the analyst concluded.

Tapestry’s largest overseas market is China, where its Coach brand has a significant presence. The company is building out its distribution for its Kate Spade and Stuart Weitzman brands. Capri owns the Michael Kors, Jimmy Choo and Versace brands. Of the three, it’s the Michael Kors brand that has the largest presence in the Asian country.