• It's Here!

    Etf Pro

    Get the big financial market moves right, bullish or bearish with Hedgeye’s ETF Pro.

  • It's Here

    MARKET EDGES

    Identify global risks and opportunities with essential macro intel using Hedgeye’s Market Edges.

Excess capital in the apparel supply chain freed up about 18% of the industry’s EBIT for EACH of the past 8 years. Let’s look at some unit margin math…

I think that the biggest issue facing the industry today is what I’ll call the ‘Margin Grab,’ or the sheer amount of capital that is being either consumed by, or freed up by the apparel supply chain. It sounds theoretical, but I believe that it is absolutely quantifiable.

I love when I hear someone tell me something like “that analysis can’t be done,” or “there’s no way to arrive at that number.” To no surprise, this usually refers to something where a management team, third part data firm or lobbying organization has not done the work and made it available to the free world. I’ve had several people argue that the apparel retail industry’s margin structure cannot be quantified. It might not be ‘easy’ to get, but the answer exists.

Let’s pull out our calculators for a minute and do some good ‘ol fashioned math. We know the following. a) apparel CPI, b) the change in import prices and raw material costs, c) import ratio, d) US manufacturing cost premium, and e) the delta in units sold by month. We also know the pricing algorithm for a garment – i.e. the percent of each dollar that goes towards factors such as raw materials, shipping, factory costs, selling, obsolescence, mark-up, shrink and promotions.

When I net it all out, I get the net consumer price change per garment, and then the cost input change per garment. Net those two against one another, and viola! That’s the margin. A mere $0.14 in added net margin per garment might not sound like a lot. But multiply that by 19 billion units per year and it’s a different story. In fact, the average trailing 12 month net change in capital freed up by the supply chain over the past 8 years in this industry was $2.8 billion (see chart below). For a $200bn industry with 8% margins, this equates to about 18% of annual operating profit. Yeah… Not good.

Here goes McGough the broken record again…but even if macro factors improve, there are still big issues here. Over this time period the industry went from a 72% offshore model to 99% (which it hit last year). At a 5 to 1 cost differential that will not recur, this is a massive consideration. Also, it is before the added raw material costs we’ll see next year, and the lack of any benefit from a weak dollar (and potentially FX going the other way).

Be careful what you buy here… Numbers are still largely too high.

With that, have a great weekend…

Brian
An average of $2.8bn annually over 8 years was pumped into the industry's supply chain. There's structurally no more ammo left in the tank.