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Off-Price Could Gain from Fashion’s Glut of Garments–But Sector’s Success Won’t Be Smooth Sailing

Conventional wisdom might dictate that off-price giants will be the biggest beneficiaries of fashion’s current inventory crisis, but the sector is facing risks and pitfalls of its own.

There’s scant evidence to indicate a pent-up demand to shop for clothing even when loosening lockdowns lift nationwide. The coronavirus pandemic’s impact just might chill consumer sentiment longer than initially expected.

A UBS report examining consumer spending intentions in the U.S. indicates a “dramatic drop,” with industry sales growth rates falling into the low-to-mid 40 percent range through July.

Though “the market is wondering if stimulus checks can provide a meaningful apparel sales lift,” said UBS retail softlines analyst Jay Sole, “We think it’s unlikely.”

Research shows just 4 percent of Americans plan to put their federal windfall toward a “‘splurge’ purchase,” Sole added, while 80 percent of Americans say their stimulus check will augment savings, pay down debt or cover everyday expenses.

The analyst believes consumer confidence, and not store reopenings, will be the best indicator of what retailers can expect to happen with apparel sales. And consumers currently seem to be “preparing for a long economic slowdown” that coincides with a more cautious apparel spending attitude, Sole said.

The UBS report shows 46 percent of consumers believe it will take at least one year for the economy to recover. Furthermore, just 8 percent disagreed with the statement, “Buying items like clothing and electronics are not as important to me at this time.”

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But there are glimmers of hope on consumer sentiment. Despite The Conference Board’s Consumer Confidence Index tumbling to 86.9 in April from 118.8 in March, the outlook, or the expectations, component that considers consumer sentiment six months out, rose seven points to 93.8 last month. While the short-term expectations uptick was “likely prompted by the possibility that stay-at-home restrictions will loosen soon,” consumers were also less optimistic about their own financial prospects and “this could have repercussions for spending as the recovery takes hold,” said Lynn Franco, the group’s senior director of economic indicators.

The prospect of freedom from stay-at-home orders presents just as many problems as possibilities for store operators. Many investors believe department store chains and specialty retailers will find few viable options beyond dumping their glut of garments onto willing off-price players, giving the likes of Burlington, Ross, TJX, Century 21 and Stage the chance for “opportunistic buys.”

In theory, off-price retailers are the most obvious choice because they only buy when there’s a certain volume in order to spread out the merchandise across their big-box doors. Even if they buy and don’t sell this year, they can easily pack up those goodies and store in their warehouses for next year as off-price shoppers tend to be less seasonally focused than main-line consumers.

Despite the off-price sector’s enduring strength, this segment of retail, largely devoid of an e-commerce business to compensate for closed stores, is initially expected to bear the brunt of the coronavirus crisis. By the time the back-to-school season rolls around, Bank of Americas Securities expects “inventory positioning to be clean, allowing off price to choose from the significant volumes of branded product available due to other retailers’ store closure,” said retail analyst Lorraine Hutchinson. “We think this present an unprecedented level and quality of product and will allow for a faster sales and margin recovery.”

Dana Telsey of Telsey Advisory Group believes off-price retailers are well suited to endure the crisis and ride out a “lost year.” With high levels of unemployment shrinking household incomes, Telsey believes consumers will increasingly look to stretch their tight budgets. Burlington, TJX and Ross could emerge as the maelstrom’s biggest winners.

The off-price channel just might continue to gain market share from department stores, according to Cowen & Co. analyst John Kernan , noting too that the buying environment “will be incredible in coming months, [while] off-price anchors a critical role in clearance.”

Sole, however, says that’s just one probable scenario. His research, including a discussion with a former off-price planning executive, suggests the retail channel has its share of unique risks ahead.

“Off-price retailers likely have two or three months of spring inventory trapped in stores and warehouses. Once stores reopen, many of these goods may be out-of-season and require discounts to entice consumers to buy them,” Sole said, noting that discounts could cost off-pricers 800 basis points or more of second-quarter gross margin pressure.

As for the third quarter, the time when many investors believe stores reopen and life returns to normal, there are other risks that could cause problems for the off-price channel. The coronavirus might accelerate the shift to online as consumers continue with social distancing, or off-price retailers could find themselves ending up with lower margins as they compete with their department store counterparts who are also doing their own promoting to aggressively clear out their own inventory levels.

On a more macro level, the recession could be deeper than expected, translating into sales ramping up at a slower rate than anticipated, Sole noted. There’s one other risk factor from the supply chain side. “Many of off-price’s vendors could go out of business, giving a bit more negotiating leverage to the surviving brands,” a point raised by the former off-price planning executive, Sole said.

While merchandising and inventory levels present one set of problems, store locations raise other concerns.

Just exactly which states can begin reopening plans and when–while still keeping social distancing in place–is currently the subject of much debate. Population density, rate of infections and ongoing testing and containment strategies are just some of the considerations. The Wells Fargo biotechnology team believes that some states are better positioned to attempt a full recovery in the third quarter, while others might not be in position until the first half of next year.

Among the off-pricers, Ross Stores look best positioned geographically, while TJX has the least favorable geographic position related to a re-start, according to Wells Fargo senior analyst Edward J. Kelly.

The Wells Fargo biotech team divided the states into four quartiles, with the first and second—about 26 states representing one-third of U.S. gross domestic product—likely in a position to fully re-start between now and summer, or third quarter of 2020. Quartile one states include South Dakota, Texas, Tennessee, West Virginia, Idaho and North Dakota, to name a few. The quartile two group includes Oklahoma, Nevada, Washington, Kentucky, New Hampshire, Virginia and Minnesota.

The third quartile of 12 states, about another one-third of GDP, could attempt a full re-start over the fall, or start of the fourth quarter, and include Pennsylvania, Georgia, Colorado, Florida, Ohio and California. The balance of 12 states represent quartile four and 24 percent of GDP, aren’t expected to fully re-start until sometime in the first half of 2021. The states in this last group include New Jersey, New York, Connecticut, Massachusetts, Michigan, Illinois and Maryland.

Kelly notes that re-start dates don’t equate to a full economic recovery.

Based on geographic location, most retailers under Wells’ coverage universe fall into the re-start quartiles, with Ross one exception in the off-price world. The off-pricer has over 40 percent of its stores in quartiles one and two, which sets up Ross more favorably when compared with its two primary competitors. Burlington has 33 percent in the first two quartiles, and 67 percent of its doors located in three and four, meaning its store re-openings are skewed toward the second half.

And TJX has 29 percent of its stores geographically located in the first two quartiles, with 71 percent located in the states in quartiles three and four. While TJX is least favorably positioned by geographic locations, there’s potential for the off-pricer to cushion the headwind as 30 percent of its stores are outside the U.S., in Canada, Europe and Australia, Kelly noted.