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Yes, companies are starting to show their negative exposure to currency fluctuations. This was inevitable. But a theme in ’09 will be those companies that have proactively managed around this.

One theme I think is consistently misunderstood is ‘Imported Cost Inflation’ from China. Is it a big deal? You betcha. But to really understand the dynamics, we need to understand that FX changes and the shift in China from an export economy to a consumption-based economy impacts two parts of the P&L. Some companies are better positioned than others.

The ‘no brainer’ here is that as China’s currency continues to appreciate on both a cyclical and secular basis, it puts pressure on the COGS line for companies who overwhelmingly depend on Chinese labor. Unfortunately for the footwear industry, almost 88% of US footwear consumption comes from China. Yes, that’s bad.

But where’s the offset? It comes from the few that have though ahead and proactively planned for such an imbalance. No, this is not a 1-year investment. These are the companies that saw this coming 3-4 years ago (and in some instances 10+). Nike, Ralph Lauren, Adidas, and dare I say 3nd class citizens like CROX and Skechers. These are companies that have built-up sales organizations in anticipation of hitting a time when the revenue opportunity would eclipse sourcing cost challenges.

What’s the math? Let’s look at two examples…

Company A (Nike) has 32% of COGS sourced in China, or about 16% of sales (given that COGS is about half of revs for Nike). The company also has about 8-9% of revenue based in China. That’s only an 8-9% spread between the two, and given that incremental top line growth is coming from China while incremental sourcing costs are coming from elsewhere in Southeast Asia, this gap will continue to narrow.

Company B (K Swiss) has better than 90% of COGS sourced out of China, and less than 3% of revenue. I probably don’t even need to go through the math to show that the challenge here is very meaningful.

The companies that look best in this regard are Nike, Adidas, Timberland, Coach and Ralph Lauren. On the flip side, Brown Shoe, Payless, K Swiss, Foot Locker, Dick’s and many small footwear and apparel brands are at a meaningful disadvantage.

I don’t think that this analysis gives us much of a feel as to who the near-term longs and shorts might be, but for those that can invest with a duration of a year or more, this is an incredibly relevant issue to consider.
Here's a sampling of companies that disclose exposure to China (including some that do not, but should).