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How a ‘$30 Billion Tariff Tax’ on Consumers Will Impact Retail Margins

As retail and apparel firms think about earnings guidance for 2019, given the backdrop of a planned $30 billion tariff tax on consumers, they’ll have to take into account margin compression and the feasibility of vendor negotiations to cut some production costs.

Currently, the plan is a 10 percent hike on $300 billion in Tranche 4 imports from China on Sept. 1, and there’s the very real possibility of that levy eventually rising even higher to 25 percent.

Kimberly Greenberger, equity analyst at Morgan Stanley, said Wednesday that “gross margin compression could be the real headline” in connection to the upcoming second quarter reporting period that begins next week, particularly at the department store sector. That’s because traffic was down an estimated 5.3 percent as a cooler May and a wetter June likely hurt seasonal apparel sales, the analyst noted. The weather forecast–a cooler August and September, but then a hotter October than usual–will continue to impact the third  quarter.

And if a weak first quarter, traffic-wise, is followed by an equally soft second quarter, the upcoming planned tariffs will likely keep the pressure on for the department store sector in the third quarter, too.

“This incremental tariff represents a $30 billion tax on consumers ($300 billion x 10 percent tariff). What is not clear is how this implicit tax will impact demand and the economy beyond the discrete exposure of rising product costs to retailers,” Greenberger said.

She expects retailers in the department store sector to lower fiscal 2019 guidance, although many may also decide to wait until the third quarter to do so. That’s a period that could provide better clarity to the fourth quarter and outlook further down the road.

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Jay Sole, UBS equity analyst for softlines, said Wednesday he expects downward earnings revisions could continue into April 2020. One reason is due to his conclusion that the “probability of the tariff rate rising to 25 percent has increased significantly.”

While he expects a 10 percent hike is “actually relatively manageable” for most softlines firms within his coverage group, an increase in the tariff rate would be “much more difficult for the industry to handle,” Sole said. Because of the wide range of possible outcomes, he thinks it could take about five to six months before anyone will know which scenario will play out. Moreover, he noted that incoming tariffed merchandise won’t hit the sales floor until the middle of the fourth quarter. That means publicly-listed retail and apparel firms probably won’t discuss what the impact will be on their bottom lines until they provide updates to the holiday selling season, which usually begins in January.

Sole has already lowered his earnings estimates–9 percent below Wall Street’s consensus, on average–for the softlines companies he covers. There was evidence of weak sales growth through the third quarter even before tariff hike was announced, according to Sole, who added that “tariffs likely turn softlines into a no-growth industry over the next year.”

Dana Telsey at Telsey Advisory Group expects apparel and footwear firms to feel the biggest negative impact since they have not been impacted as much by the tariffs connected to Tranche 1, 2 and 3 merchandise. “It would not surprise us to see earnings estimates come down as companies start to discuss the potential impact” on upcoming second quarter earnings conference calls, she said.

Some firms felt the Tranche 3 impact when tariffs on that list were hiked to 25 percent. Telsey pointed to G-III Apparel Group, which said an incremental 15 percent tariff on its handbag and leather outwear businesses, representing 7 percent of fiscal 2019 sales, would increase costs by $6 million for the remainder of fiscal 2020. As of Jan. 31, 2019, roughly 61 percent of the goods G-III sells are made in China. According to Telsey, “Tariffs on apparel would likely result in price increases to customers and vendor negotiations for price concessions.”

Other companies, like VF Corp., see limited impact because of a wider sourcing base, according to Telsey. But some apparel firms, like Oxford Industries, are working to reduce exposure to China as they look to share the increase from tariffs with manufacturers. Roughly 54 percent of Oxford Industries’ product base is apparel related. For Vince Holdings, although it works with more than 40 manufacturers across nine countries, 88 percent of its goods are still produced in China, according to 2018 data. So far, tariffs have had minimal impact since its handbag business is small, but the “imposition of List 4 tariffs could have a pronounced impact when throwing apparel into the mix,” Telsey said.