• It's Coming...

    MARKET EDGES

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My Research Edge colleague on the ground in China just fed me an interesting tid-bit regarding the lingering impact of the quake on Chinese footwear production. Recall that the initial read from our sources in China was that production was not directly impacted, but that raw material delivery flow was in jeopardy.

A new challenge is brewing, however, with more far-reaching implications. Consider the following.

1) Most factories have a static number of workers in any given month to fill roughly 50-60% of maximum capacity. Then they fill the remainder with migrant workers when seasonal demand kicks in.

2) Peak production takes place in the summer in order to ship in July/August and sell at retail in August/September. That means that we're just hitting the most important part of the demand cycle for such labor. (You probably see where this is going...).

3) Due to the quake, many migrant workers are not reporting to factory-duty as employers expected (a recent comment by a factory owner employing 40,000 people confirmed this). Pouring salt in the wound, such workers already on the job are walking away in order to care of family members who are homeless. As a frame of reference, the latest figures for homeless in China are hovering around 12 million -- that's the equivalent of nearly half of Canada.

4) Yes, everyone talks about the 'China cost pressures' theme. But I'm willing to bet that 2H COGS pressures for the footwear space spike up again. Someone is going to have to fund this. It's probably not you and me. And it's probably not the big brands (though they'll feel some pain). My sense is that retail margins take it on the chin. Check out my 'Supply Chain Math Does Not Lie' post from last week to see why I think that the margin squeeze will hit retail.

5) Lastly, the migrant worker shortage just months after the biggest blizzard in Chinese history is serving as something of a one-two punch. The industry trend had been to push production into the central part of the country to side-step cost inflation. But the blizzard exposed a weak transportation infrastructure, and the migrant worker challenge is likely to be an issue for all of 2008.

I've used this statistic a dozen times, but it's an important one. 85% of our footwear consumption comes from China. By my math, a $60 shoe at retail will see between $2-3 per pair of higher costs. That translates to 3-5% price increase at retail just to cover the higher costs. Don't hold your breath there. It hasn't happened in well over a decade.

Keep an "Eye" on this one folks...