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Specialty Retail Faces Several ‘Grim’ Months of Moving Stale Merch, Fighting for Margins

Specialty retailers saddled with mountains of inventory could need as much as six months to clear through this stale merchandise—and competitive dynamics are likely to dictate just how deep product-moving promotions will go when retail reopens.

And that’s not all, according to UBS U.S. softlines analyst Jay Sole, who expects retailers will match their peers rock-bottom offers in a bid not to be undercut. “These types of incremental, unplanned discounts very often have a direct negative impact on gross margin,” he said.

Specialty soft-goods sellers could find themselves in a race to the bottom on the pricing front, raising troubling questions about their prospects of full-price selling once desirable new merchandise hit their shelves and sites. And many will seek to bolster sagging margins, whether by assorting trend-light basic goods or squeezing supply chains for favorable terms and pricing.

How COVID-19 will impact gross margins

Based on conversations with two former senior leaders from large apparel firms, Sole said these executives believe fiscal 2020 will see sales declines in the negative 25 percent to 30 percent range, even if stores reopen as anticipated during the second quarter. But the two also expect specialty retailers will see fiscal 2020 gross margins fall up to 500 basis points, with as much as a 1000-basis-point drop in the most impacted quarters, likely the second quarter, presuming retail can slowly begin to reopen in parts of the country by June. It’s a scenario that prompted Sole to describe the specialty retail outlook as “grim.”

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Retail traffic will gradually build up until it returns to “flat by September,” according to Sole.

That also could translate to a slow fiscal year 2021 rebound, the two executives said, and that decline could be down 5 percent to down 20 percent from fiscal year 2019 levels. Retailers that primarily sell women’s apparel are expected to see tougher margin pressure than those selling men’s or kids’ apparel, while those skewing more towards basics are likely to be less impacted than merchants offering more risky seasonal or fashion goods.

The quandary specialty chains face

According to Sole, specialty chains will face a tough choice in fiscal year 2021. “Companies can try to recover sales or margins,” he said, “but probably can’t do both.” It’s tough to wean discount-addicted consumers off of those promotions, he added, as “they are often reluctant to resume purchasing at full-price even when a retailer’s inventory levels are ‘clean.’”

Specialty retailers can raise their prices, which will improve their margins, but that likely won’t come without a decline in unit demand, Sole said.

That leaves the chains on the hunt for how to recover lost margins. Retail business models are generally based on achieving a certain level of merchandise margin but there’s a limit to how a retailer can accomplish this. They can try to lean on supply chains for better pricing, or eschew risky merchandise that’s subject to the whims of trends and seasons.

Many fashion retailers shied away from risk-taking during the Great Recession more than a decade ago, banking on the belief that less trend-driven product offers a longer shelf life. While that’s true, it also spawned a sea of sameness across retail as buyers were unwilling to engage in any in risk-taking on the merchandise front. And it was precisely during a time when even a slight bit of risk could have presented some newness and gotten more shoppers to buy. In the end, retailers lost sales as most were selling stuff consumers already had in their closets.

Though consumers have “been getting away from shopping in stores,” says retail consultant Walter Loeb, brick and mortar is precisely where shoppers go for newness during the critical back-to-school season. This is where specialty stores can grab some advantage points over the department store channel, provided they make sure they have some new BTS merchandise coming in, he added.

Relying on data could help

Retailers are in quite a quandary if they’re planning now for what post-pandemic consumers will want to purchase in six months—a standard lead time for their global supply chains.

In an April 20 survey, The Accessories Council queried consumers about what they planned on purchasing in the next two weeks, with results indicating the top two choices as sneakers and underwear or intimate apparel. In fact, these were the only categories that skewed into the positive territory range. While some said they didn’t intend to buy anything, categories in the negative range included sweats, activewear, sandals, slippers and other apparel items. Skewing in deep negative territory were jewelry and bags, definitely not a good sign for firms such as Coach parent Tapestry and Versace owner Capri, two firms best known for their core handbag lines and footwear and accessories offerings.

Sole believes an important catalyst for the sector will be first-quarter earnings reports in May, which he expects will provide a clearer picture of the extent of gross margin pressure and year-over-year change in inventory levels. “When sales grows faster than inventory, this often leads to gross margin expansion and vice versa,” he said. Given the extent of store closures and long supply chain lead times, he expects to see a deep spread between sales and inventory growth from the first to second quarters of fiscal year 2020, and resulting in steep declines in gross margin.