Economic Woes—Pain Means Gain for Some Apparel Retailers

The economy is slowing and the daily news has been generally grim. Skyrocketing oil prices, a chaotic mortgage/real estate market, and a weakening dollar are playing havoc with consumers’ pocketbooks, and perhaps more important, undermining their sense of trust in the economic health of the nation and a better future for their families. There’s the tax refunds coming up in late spring to early summer, but some surveys are indicating that many people plan on paying off debt or adding to savings, hardly the “let’s go shopping” reaction that the government wants. Adding to the confusion—we’re in the middle (or is it “muddle”) of election year mania, which always creates a crooked trail of bread crumbs that Wall Street has trouble following.
To talk about a struggling economy, however, is like talking about a forest as if it consists of one species of tree. Our economy is supported by many markets and submarkets, some of which are doing better than others. In fact, the pain of one market may mean gain for another. For example, when retail, in general, is struggling, off price and discount retailers may appear quite enticing to consumers, as was evident during the past holiday season when Wal-Mart and various off-price retailers outperformed their full-price competitors.
In a recent USAToday.com article, Jayne O’Donnell quotes retail analyst Jeff Stein as saying that off price retailers are in a “customer-gathering mode,” and according to experts, these retailers are likely to outperform their higher-priced competitors next year as well. O’Donnell goes on to say that “the weaker the economy gets, it seems, the more some discounters benefit and the bleaker the outlook for their higher-priced competitors.”
Of course, price isn’t the only variable controlling consumers’ shopping patterns. Value, as determined by perceived quality in relation to price, is always an important factor in the equation.
Many off-price stores today sell the same brand name merchandise consumers find at full-price department stores—and consumers know this. When the economy gets tough, consumers who ordinarily frequent department stores are more willing to forego fancy merchandising displays for low prices on quality goods.
Economic downturns often present opportunities for discount and off-price retailers. They attract new customers, many of whom will remain customers when the economy turns around. For retailers, particularly smaller specialty store retailers, while the times may be precarious, downturns can push them into new and more efficient ways to source goods and manage their stores. For example, the Off-Price Specialist Show, the premiere tradeshow for off-price apparel, accessories, and footwear, has seen a noticeable increase in new buyers at its past two shows.
According to Don Browne, marketing director of the Off-Price Specialist Center, “At our February 2008 Show, we saw an influx of international buyers looking to take advantage of great values on branded items, especially with the dollar getting weaker. We also saw first time buyers from the biggest names in retail, who finally ‘get’ what off-price merchandise can do for their margins. A thousand buyers came in the first hour of the show alone, which is unprecedented. This figure by itself represents how critical off-price is to the industry during economic downturns.”
Opportunities and perils aside, economic downturns are nevertheless troubling for everyone. We asked a few experts in the financial field to gives us their view of the current economic environment in general and its effects on apparel retail in particular. Here are their responses.

Richard D. Hastings, CCE
Economic Advisor
Federation of Credit and Financial Professionals
Senior Retail Analyst
Bernard Sands LLC

Retailers today are suffering from changing consumer behaviors, including a significant increase in spending on technology concurrent to much greater participation rates in online browsing and spending. These phenomena are changing everything merchants knew traditionally about consumers. The pressure is on to increase spending on technology in order to analyze these new behaviors. In addition, many retailers will have to deal with the resurgence of Wal-Mart in 2008—a force that could potentially throw another monkey wrench into retailers best laid plans.
For apparel manufacturers, importers and jobbers, the international market is generally healthy. Apparel is shelf-durable so costs are manageable. Global trade patterns appear stable with no existing threats from pandemics or trade sanctions at this time. However, cotton prices are increasing dramatically, which poses a threat that could slow demand in the U.S. where prices are trending up. The outlook for Europe and Canada is generally more stable, except for Europe-based exporters.
The credit crisis has sent shock waves throughout the financial services industry. Generally speaking, deals are getting done, but at a bit slower pace than before. Deals that are highly speculative and that require too much debt are more difficult to close. Prices for insurance and credit default swaps are anywhere from higher to downright unaffordable, making some deals impossible to close. There are rising concerns with regard to credit risk in the retail industry supply chain as consumers slow their spending and home refinancing deals become more difficult or slower to get done. The overall mood in the financial community is cautious—certainly as cautious as it has been since the early 1990s.
What does the future hold? The economy is moving into its first inflationary outbreak since the 1980s, and policymakers will have a difficult time fixing the problems that are driving inflation. We are expecting continued difficulty from housing-related wealth effects, with as much as $200 billion less in personal spending by 2010. This would put tremendous pressure on public policy and fiscal policy. Unemployment is beginning to rise after a period of extended job gains. The healthiest sectors are tech and software, mining and minerals, and alternative energy. The lengthy post-war period characterized by U.S. consumer-centricity is over and we are now entering a new global economic phase.

Lucy Orozco
Vice President, Business Development
Capstone Business Credit, LLC

Today, we are faced with a very challenging economic environment: retail sales for ’07 declined and we are experiencing stock market volatility resulting in an eroding market. Many retail stock prices fell sharply as oil prices continue to climb. The real estate slowdown and high fuel prices will continue to affect the apparel and related businesses as well as the American consumer. A weak dollar is the number one problem and concern for importers. As a result, prices are rising sharply in foreign markets, primarily in China, causing a negative effect on FOB. Consumers are finally realizing that they need to be more frugal, cost conscious and save for anticipated turbulent times. As discretionary and disposable income declines for American consumers, the retail industry will shift downward, that is, consumers will be forced to look for good value and will increase their spending at mass market retailers and off-price retailers.
Many merchants are looking to keep low inventories and those faced with the impact of the overall slowdown have instituted drastic markdowns, coupon incentives and promotional sales to move ageing inventories. While the Fed has taken aggressive measures by lowering interest rates, investor confidence has been shaken and uncertainty created.
I believe all these events will have a profound effect on the apparel industry and the availability of funds. Banks are tightening-up on credit, and jobbers, wholesalers, manufacturers and importers will see a lagging payment stream on accounts receivables. Many traditional lenders and factors focused on balance sheet lending or formula-based accounts receivable financing, coupled with slow collections, will not be able to provide enough liquidity for these consumer and commercial product sales companies. As a result, these companies will need to turn to alternative financing options provided through merchant banks, which rely on the ability of these companies to produce goods against pre-sold purchase orders.
There are a select number of merchant banks financing rapid growing companies that may lack historical performance or assets required by typical banks, asset based lenders and factors. In addition to pre-sold purchase orders for credit worthy debtors who will pay timely on orders shipped according to specs, these potential borrowers need to have acceptable gross margins. A vertically integrated system of Purchase Order and Accounts Receivable funding within the merchant bank company allows the principals of apparel and related businesses to do what they do best – market and sell their product without the worry of finding the next dollar. Though merchant banking models can be an excellent financial solution during a credit crunch, this model works in all economic cycles. They key is a solid growing company that has pre-sold purchase orders, credit worthy customers and margins.

Bret Schuch
Partner
Goodman Factors

Those looking for signs that this recession will be short lived may need to look harder, as all indications are that this one will last deep into 2008. The drop in spending on housing projects was at a 26-year low in the fourth quarter, and with rising unemployment rates and fuel prices and with credit markets experiencing a degree of turmoil, unfortunately there is little the Fed can do to reverse this misfortune.
This is to say, discretionary spending will be negatively impacted, a reality that will loom very large when it comes to sale of apparel and accessory items. Discounters will continue to fare better than most, and some retailers within this group (Wal-Mart, Costco, TJX, for example) will likely see increases in same store sales as a result of consumer caution. The luxury brands and markets will not be impacted as much, but all signs thus far point to the department stores and apparel chains having a rough ride in 2008, with more than a few not being able to make it through the year without some form of reorganization or recapitalization.
Last year on the whole was a good year for our clients operating within the apparel industry, but regrettably we are not looking for this overall trend to continue. There will, however, be exceptions to the rule: Vendors who are able to differentiate themselves in terms of product identity and perhaps price will gain an advantage. Expect retailers, on the other hand, to be more proactive in enforcing vendor charges, which will put even more pressure on what are already thin gross margins, particularly among those that serve the discount sector.
Despite the expected downturn in apparel sales, we at Goodman remain committed to the industry and in fact expect to see new opportunities for expansion within this niche as other larger and bank-owned factoring companies begin to weed out those vendors who are underperforming and begin to focus more on non-traditional industries for their own expansion.

Barry J. Essig
Executive Vice President
Crestmark Bank

It’s easy to express concern about the present economic environment and how it relates to the apparel and retail industries. With energy, food and the jobless rate rising, and housing prices, the stock market, fixed rate investments down; consumer spending, which represents two- thirds of GDP, will certainly be negatively affected.
Logic dictates that consumer spending this year will be geared toward “value,” and those retailers, both large and small, who can deliver will benefit. It’s difficult to predict how luxury products will fare this year. While luxury sales have held up during prior slowdowns, the current economic dynamics mentioned previously will likely have an impact.
Some economists are concerned that the economy will enter a period of stagflation (stagnant growth coupled with inflation). Hopefully, with sound monetary and fiscal policy this will be avoided. The effect of lower interest rates and the economic stimulus package is yet to be seen.
Traditional factoring companies have had the apparel industry as the single largest percentage of their portfolios for 25 years or longer. The experience gained in working with countless apparel companies over a number of economic cycles has provided factors with valuable knowledge to be an important resource to their clients and their customers. With the consolidations on the retail level and the dramatic shift to off-shore manufacturing, factors have also seen some modification in the type of loan structure they provide their clients. With longer lead times in manufacturing, factors work more closely with their varied clientele as their businesses evolve.
What generally goes unpublicized is the service aspect of non-recourse factoring. Many companies outsource their credit and receivables management function and do not engage in taking advances against factored accounts receivable. Instead they continue borrowing from their bank under a tri-party agreement known as “Assignment of Factoring Proceeds.”
Crestmark’s factoring portfolio experienced considerable growth in 2007. With the current liquidity problems and tight credit markets, coupled with a more conservative lending posture by traditional banks, we are forecasting strong new business activity this year. In prior economic downturns, factoring companies showed significant new business growth, while existing client volume was either flat or down.
With difficulties come opportunities. Those organizations that can react in timely and in a variety of ways will usually benefit. Depending upon the product line and price points, some companies may take an aggressive approach this year while for others a more conservative strategy may be warranted. It’s worth emphasizing, however, that success can be measured in different ways, that is, growth and profitability, as well as, laying a foundation for a stable structure in order to be poised for an uptick in the economy.
One last thought: Stay focused and stick to the fundamentals—not only in sourcing, manufacturing and distribution, but with disciplined financial and risk management controls.
As Will Rogers said, “Even if you’re on the right track, you’ll get run over if you just sit there.”

By Robert Nordstrom