March 5, 2019 / 5:38 PM / 5 months ago

Retail stocks set to bypass tariff woes but face aftershock risk

NEW YORK (Reuters) - Shares of U.S. retail and consumer goods companies appear set to emerge largely unscathed from the trade dispute between the United States and China.

FILE PHOTO: Traders work on the floor of the New York Stock Exchange (NYSE) in New York, U.S., February 27, 2019. REUTERS/Brendan McDermid

But the conflict could leave behind negative effects on the supply chains of some companies in the industry, which could narrow their profit margins and eventually weigh on their stock prices.

The current U.S. tariffs on $200 billion worth of Chinese imports were scheduled to increase to 25 percent from 10 percent if a trade deal were not reached by March 1. Last week U.S. President Donald Trump announced an extension of that deadline, and the United States and China have reportedly moved close to a deal that would roll back the tariffs altogether.

Only certain categories of consumer goods, such as furniture and accessories like handbags and luggage, are subject to the 10 percent tariffs. Apparel and footwear, for now, are excluded.

So far this year, the S&P 500 consumer discretionary index, which includes shares of retail and consumer goods companies as well as restaurants and leisure companies, has reflected optimism on trade as data have pointed to the overall strength of the U.S. economy. The index has risen 11.2 percent, slightly ahead of the 10.6 percent rise for the S&P 500 as a whole.

“Companies continue to do well from a (consumer) discretionary perspective,” said Mona Mahajan, U.S. investment strategist at Allianz Global Investors in New York. “Once President Trump said he was extending the deadline for the tariff jump, the overhang over the market was lifted.”

A significant portion of U.S. consumer goods, including 72 percent of footwear and 84 percent of accessories, originate from China, according to the American Apparel and Footwear Association.

Yet companies have made preparations to blunt the effects of current and possible future tariffs. In conference calls, companies including footwear maker Steven Madden Ltd, furniture retailer RH and Rubbermaid housewares maker Newell Brands have said they have offset cost increases by moving some manufacturing to other countries or negotiating discounts for their production in China.

“Companies have been incorporating tariffs in their guidance for a year,” said Charles East, equity strategy analyst at SunTrust Private Wealth Management, who covers retailers. “It’s a known quantity.”

Yet even with a rollback of tariffs, lingering effects on the production, shipment and storage of goods could eventually weigh on consumer stocks.

Retailers have ramped up shipments of imported items in anticipation of potential increases in U.S. tariffs. According to the National Retail Federation, major U.S. ports handled 1.97 million containers in December, a 13.9 percent year-over-year increase. For the first half of 2019, U.S. ports are forecast to handle 10.7 million containers, a 4.1 percent increase from the first half of 2018.

The advance shipments could lead to an uptick in warehousing costs, cutting into companies’ profit margins, said Jonathan Gold, vice president of supply chain and customs policy at the National Retail Federation in Washington.

If retail sales were to soften, retailers could be stuck with excess inventory. Data from the U.S. Commerce Department for December showed retail sales posting their biggest drop in more than nine years and warehouse inventories increasing by the most in more than five years.

Department stores such as Macy’s Inc have already been grappling with inventory issues, said Simeon Siegel, senior equity analyst at Nomura Instinet in New York. Macy’s shares plunged 17.7 percent on Jan. 10 when the retailer cut its fiscal 2018 forecast and have not recovered those losses despite rising last week after the company announced a restructuring.

In its earnings conference call last Wednesday, TJX Companies Inc hinted at the potential for an uptick in discounted goods, saying that disruptions resulting from changes in shipments and production could lead to opportunities for the company.

The shift in production away from China could also lead to price increases as demand grows for factories in countries such as Vietnam and Bangladesh, said Rick Helfenbein, president of the American Apparel and Footwear Association in Washington. In December, Calvin Klein parent company PVH Corp warned of such an adverse impact during an earnings conference call.

“When you get that bump, factories will raise the prices,” Helfenbein said. “It’s going to happen throughout the supply chain.”

Likewise, shoe company Crocs Inc stated in a Securities and Exchange Commission filing on Thursday that “it may be time-consuming and expensive for us to alter our business operations in order to adapt to or comply with any such changes.”

Such risks could catch equity investors off guard, market watchers said, given the sanguine outlook on trade.

“They’ve priced in a trade deal,” said Alicia Levine, chief strategist at BNY Mellon Investment Management in New York. “All the risks are to the downside now.”

Reporting by April Joyner; Editing by Alden Bentley and Jonathan Oatis

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