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July 6, 2010

Is anyone paying attention to cost/price spreads in the apparel supply chain? With such a tight historical relationship with margins and the consensus banking on peak margins next year, the ‘proactive vs. reactive’ management style will be front and center in 2H.


Welcome back from the holiday everybody. Unfortunately, if you’re a bull I’m not going to give you much to support any view that lends itself to increasing exposure to US retail. That’s not to say we can’t still make money on the best ideas, but the supply chain headwinds start to kick in  -- well…about now.   Look at the charts below….

1)      Chart 1: This is what we call ‘Apparel Margin Kitty.’ In effect, it takes the change in the Apparel CPI and backs out the change in the import cost for apparel (a better proxy than PPI for the real cost of goods). It’s kinda simple. If the spread goes positive, it means that there is excess margin to be spread between suppliers, brands, retailers, and consumers.  If the spread goes negative, then the rate at which pieces of the supply chain start to beat each other up for margin dollars starts to go up. Anyone notice that we just had an event where the spread was 3-Standard Deviations above the mean (and had 8 quarters where it was 2SDs or better)? Do you also notice the latest point, and how dramatic the change has been as the ratio returns to Earth?

2)      Ok McGough, thanks for the academic exercise. I know that company-specific stories can still work in such an environment (in fact, that’s kind of my point). But check out chart #2. It shows the apparel/footwear supply chain’s margins over time vs. changes in the Price/Cost spread.  That’s pretty tough to argue with.

3)      Lastly, it exhibit 3 we outline correlations during different periods for different retailers. Statistically, there’s a ton of ways we can look at this. You can argue whether or not looking at the positive margin performers in a positive industry environment and neg. vs neg. is the way to go. Either way, it should give a little something to chew on to see how each company performed during different cycles over the past 13 years.

The punchline is that the industry is coming off a 2-year time period where sales have been down 5%, SG&A has been off 8-10%, working capital -20%, and capital spending down -30%.Margins remain near peak (esp in consensus estimates). Now we’ve got extremely tough cost/price spreads coming down the pike in 2H. We like names that have been proactively investing in their growth over the past 2 years (UA, NKE, RL). We’re downright frightened of those that are the inverse (JCP, JNY, DG, ROST).

Hedgeye Retail: Mind This Freight Train - Apparel Margin Kitty


Hedgeye Retail: Mind This Freight Train - Apparel CPI les Import Price and Industry Margins


Hedgeye Retail: Mind This Freight Train - Apparel CPI Less Import Price Industry Cycles 


- While this may not be the first time such a bill has been proposed, keep an eye on efforts to end tax-free internet shopping from those sites with no physical outlets. The bill’s author, Democrat Bill Delahunt suggests that such a measure to level the playing field between on and offline purchases could generate as much as $23 billion in incremental state taxes. Not surprisingly, Amazon and Ebay are against these efforts, while more traditional retailers are in favor.


- A study by Unity Marketing discovered that luxury shopping by “affluents” was down in 2009 from peak levels in 2006 (no surprise there). Approximately 44% of affluents purchased personal luxury items in 2009, down a full 10% from 2006 levels. Interestingly, those who did spend, spent on average 50% more than they did in 2008.


- According to the 2010 Digital Influence Index, 76% of consumers are less inclined to trust content written by a blogger who received a free sample in exchange for a review. Additionally, less than 20% of consumers trust blogs or posts written by writers being paid for their work. Despite this growing distrust, blogging and paid blogging remains one of the fastest growing PR mediums.


New York Suspends Sales Tax Exemption on Footwear and Apparel Under $110 Until Q2 2011 - The New York Assembly passed legislation last week to include the sales tax on clothing and footwear under $110. The sales tax exemption on clothing and footwear under $110 would be temporarily suspended from October 1 2010 through March 31 2011. Beginning April 1, 2011, the exemption would be reinstated at $55 until March 31 2012. The exemption would revert back to $110 on April 1, 2012. Local governments would be given the option to maintian their current exemptions, or opt into the exemption schedule spelled out in this section of the law.  <wwd.com/business-news>

Hedgeye Retail’s Take:   While this is a blow to those  New York residents, this is hardly a one state trend.  We expect to see and hear about more tax benefits being taken away as local governments look to bridge budget gaps.  As it stands, it looks like back to school will be the last hurrah for New Yorker’s to fill their closets without paying a tax ranging from 4%-8.875%.

WMT's Chief Merchant Stepping Down, Opening Up a Chance to Remake Apparel Division - The impending departure of Wal-Mart U.S. chief merchant John Fleming gives Wal-Mart Stores Inc. a chance to remake the country’s largest apparel business — and Wall Street hopes the world’s largest retailer takes advantage of it. Fleming, a former Target Corp. department store executive who has spent the last decade at Wal-Mart, will step down as executive vice president and chief merchandising officer of the retail giant’s namesake division on Aug. 1. <wwd.com/business-news>

Hedgeye Retail’s Take:  Though somewhat surprising given Fleming’s rise through the ranks, the role of Chief Merchant has never been a glorious one at the world’s largest retailer. In this case, any change should be viewed positively as the status quo was not driving non-food sales.  Given the company’s size it’s likely that the apparel program remains in limbo until a new leader emerges.

My-Wardrobe.com Gets Investment from Venture Capital Firm Balderton Capital -  Balderton Capital, the London-based venture capital firm, is the latest investor to throw its weight behind online fashion retailing. The firm has taken a $9 mm stake in my-wardrobe.com, a London-based men’s and women’s online fashion retailer that sees its niche as “accessible luxury.” The site specializes in designer labels and diffusion lines such as Alice by Temperley, D&G, McQ, and Vivienne Westwood Anglomania. Balderton joins existing private investors, including the retailer’s founder and chief executive officer Sarah Curran. <wwd.com/business-news>

Hedgeye Retail’s Take:  If there’s one area that remains hot in  the world of retail investments, it’s private equity’s focus on e-commerce.  In this case, it looks like growth-starved “accessible luxury” brands are more than comfortable selling online vs. the old model which limited distribution to boutiques and high-end department stores.

Cutters Gloves Acquires Nokona - Cutters Gloves has acquired majority ownership of Nokona, the original American-made ball glove company. Rob Storey, who grew up in the business and has been the President of Nokona for the past 18 years, will remain as VP Operations and will continue to oversee all glove production.  sportsonesource.com>

Hedgeye Retail’s Take: The marriage of innovative technology (Cutters – most commonly used football) with the legacy brnad of Nokona is a natural fit as the company looks to gain share of athlete’s bag. Still a minority player in the baseball glove market after 85-years, the youth of Cutter’s team should help breathe some life into Nokona’s brands.

Gulf Coast Oil Spill Threatens Retailers - As oil continues to flow into the Gulf of Mexico, retailers along the coast are facing a grim summer and an uncertain future. More than 10 weeks after BP’s Deepwater Horizon rig exploded offshore, storeowners throughout the region told Footwear News that their sales are down between 20% and 35%, due, in part, to the shutdown of the oil and fishing industries and the sharp drop in tourist traffic. <wwd.com/footwear-news>

Hedgeye Retail’s Take: Among the most heavily exposed footwear related retailers to Gulf states (TX, LA, MS, AL, FL) include HIBB at ~31% and SCVL at ~26% of total stores. Interestingly, while SCVL (-23%) has underperformed the S&P (-15%) since the April 20 Deepwater Horizon oil spill occurred, HIBB has solidly outperformed (-11%). Yes, HIBB has less footwear exposure relative to SCVL, but this calls into question the sustainability of demand for $200 The North Face jackets that has driven sales of late at the sporting goods retailer.

Japan Luxury Market Improving According to McKinsey - McKinsey & Company, which surveyed both shoppers and executives, said the Japanese consumer appears to be emerging from her deep slumber although she’s more discriminating and price-sensitive than ever, seeking out deals at outlet malls or online. McKinsey said it doesn’t expect the Japanese luxury market to experience ”significant growth” anytime soon but it emphasized that the mood of both executives and consumers has improved substantially since last year.  <wwd.com/business-news>

Hedgeye Retail’s Take: With the suggestion of “significant growth” aside, which we can’t say is expected by any in retail, improvement on the margin in Japan is an obvious notable for local retailers and those over-indexed to the market (e.g. TIF & COH) – the launch of RL’s ecommerce sites beyond its domestic portal couldn’t come soon enough.

PVH's Tommy Hilfiger To Open Paris Flagship - Tommy Hilfiger confirmed Monday it will open a 9,000-square-foot flagship at 65 Avenue des Champs-Elysées here this fall, solidifying the firm’s presence in one of its fastest-growing markets in Europe and on one of the city’s busiest and most famous boulevards. Daniel Grieder, chief executive officer of Tommy Hilfiger Europe, characterized the flagship as a dream come true for the American brand.  <wwd.com/retail-news>

Hedgeye Retail’s Take:  Following in Ralph Lauren’s footsteps, yet another Americana brand planting an expensive stake in the Paris market.  We wonder how Tommy will one-up Ralph and his restaurant which serves beef raised on his Colorado ranch.

Overstock.com Steps Up Its Loyalty Program - Overstock.com Inc. announced it has added new benefits, such as a cash back incentive and promotions, to its Club O loyalty program. The program offers 5% in reward dollars for each purchase. Customers can redeem those dollars on future Overstock.com purchases, including gift cards. They can also combine those reward dollars with other Overstock.com coupon offers. Previously Club O offered members a 5% discount that excluded certain categories, such as books and media, and members couldn’t combine the discount with an additional promotion. <internetretailer.com>

Hedgeye Retail’s Take:  Subtle but notable convergence towards a more traditional promotional tactic.  Loyalty programs have long been a part of retail, but less so in the e-commerce only world.  

E-retail in UK to Grow Big, To Become 50% of Total Sales by 2020 - E-retail sales in the U.K. will grow by 110% in the next 10 years, reaching 123 billion pounds ($186.7 billion) in 2020, predicts trade association the Interactive Media in Retail Group and technology and consulting company Capgemini in its 10th annual report on online sales. Moreover, the report suggests that online retail will account for half of all retail purchases by 2020 and retailers’ online presences will influence most other retail sales.  <internetretailer.com>

Hedgeye Retail’s Take:  This has got to be one of the more bullish studies on e-commerce we’ve seen.  Historically, the a direct business has tapped out at around 13% of total retail sales, but this suggests otherwise.  If this holds true, we’re likely to see retail real estate enter a slump while margins (in theory) should rise.

Mango Ramps Store Growth - Spanish fast fashion retailer Mango plans to open about 60 new stores in China this year and double the number of stores around the world in five years from 1,400 stores that they currently hold to almost 3,000. CEO of Mango, Enric Casi, stressed that the company’s long-term goal is "to be present in all cities of the world, exceeding its average of three openings a week, approximately 150 new stores a year”. <fashionnetasia.com>

Hedgeye Retail’s Take:  Without getting into the nuances of Mango’s business, any retailer looking to double its store base over a 5 year period, globally, is likely to hit some speed bumps along the way.  Growth for the sake of growth does not appear to be a concern for the Spanish retailer at the moment.  Clearly the family ownership structure keeps Mango less worried about outside concerns.

More Taiwanese Shoemakers Moving to the Mainland - In view of ever-increasing wages and currency fluctuation, Taiwanese shoe manufacturers have been relocating their business focus to the mainland in order to meet the growing domestic demand, according to the China Leather Industry Association.  <fashionnetasia.com>

Hedgeye Retail’s Take:  More inflation drivers.