Category Archives: Retail

pricing out a low-end shirt: investment implications

May 21, 2013 By in Asian economic development, comparative advantage, Current Market Thoughts, economics, emerging markets, Industry Analysis, Retail Tags: , , , , , , Leave a comment

A while ago, I wrote about pricing out a polo shirt that retailed for $150 then ($175 now).

Today’s post goes to the other end of the fashion spectrum:  pricing out a “fast fashion” shirt that might sell at H&M or Zara for, say, $15.  The source of my information about Bangladesh is an op ed column, “The Economics of a $6.75 Shirt,” by Rubana Huq, who owns a garment business there.

Just for reference, the factory gate cost of the KP MacLane  luxury polo is:

–materials           $10.35

–manufacturing          $11.05

= $21.40.

These figures are unusually high for a shirt, mostly because of the small initial lots involved.  The unit price could easily be below $15 now, depending on how successful KP MacLane has been in its sales efforts.

in comparison, costs in Bangladesh…

…for an order of 400,000 fast fashion shirts:

materials      $5.75

–cotton cloth           $4.75

–labels, other          $1.00

manufacturing     $.875

–wages          $.38

–finishing          $.15

–utilities, factory rent          $.11

–overhead          $.11

–debt service (for manufacturing equipment)          $.125

= $6.625

The selling price at the factory door is $6.75.  Therefore, the per garment profit is $.125.  The total order earns the manufacturer, before paying himself (or, in this case, herself), $50,000.  In the example Ms. Huq gives in her op ed column, this order represents about five months business for the factory.

what I find interesting

Although the KP MacLane polo and the fast fashion t-shirt sell for wildly different prices at retail, the material costs aren’t that different.

The markup over production cost is 718% for KPM, 140% for the tee.  As I mentioned in my earlier post, a Hermès polo sells for $455, or about 2.6x the price of the KPM one.  Hermès’ production costs are probably lower than KPM’s, so the markup is likely higher than 1800%.   In both cases the buyer is clearly paying primarily for the branding, not the garment.

The operating model for classic luxury goods is far different from that of fast fashion.  The former sells far fewer items-most of which have very long shelf lives–at huge markups.  The latter sells huge numbers of items with short shelf lives at low markups.

The two styles demand different skills.  Fast fashion, in particular, has little room for error in design or sourcing/pricing from manufacturers.

the Bangladesh situation

First of all, we have to remember that the data Ms. Huq present come from a manufacturer in Bangladesh, hardly a disinterested party.  Certainly she will want to put her best foot forward.  Still, I’ve found the situation she describes to be typical of the garment industry over the decades, whether located in New York City, Japan, Thailand, China or Bangladesh.

Bangladesh employs 4 million garment workers, the vast majority of them women, who are the chief breadwinners in households totaling 20 million.  They earn US$70 – $80 a month, which is far more than an unskilled laborer could expect in any alternative employment in Bangladesh.  Although their families are barely surviving, the greatest fear of these workers is doubtless that the garment industry will shift away from Bangladesh to other low labor-cost countries, like Vietnam, leaving them unemployed.

The garment manufacturer in Bangladesh may make $100,000 a year if everything runs smoothly.  But that could be considerably less if he’s inefficient or if he encounters production delays that, say, require him to pay for shipment by air.  So one can certainly understand–not condone, just understand–the temptation an unscrupulous owner may feel to lower rent by turning a blind eye to safety violations.   It’s not clear how much leeway fast fashion has to alter its operating model by raising prices, either (look what happened to JCP).

In theory at least,  consumer pressure on international retailers for a keener eye to worker safety when sourcing garments may solve that issue–although the same problems seem to recur decade after decade and in country after country.

The more difficult issue to reconcile are the ideas that income of $70 a month is a good situation to be in, which in Bangladesh it is, and that well-intentioned efforts to improve it may make the workers’ lot considerably worse.

new financing for J C Penney (JCP)?

April 29, 2013 By in Retail, Stock ideas, Uncategorized Tags: , , , , , , 1 Comment

the news

During New York trading last Friday, CNBC reported that Goldman had lined up $1.75 billion in new debt financing for JCP.  The stock, which had already been rising strongly on news that the Soros-run Quantum Fund had acquired a 7.9% stake in the ailing retailer, jumped sharply.  JCP ended the day at $17 a share, up 11.6% on the day.

According to the Wall Street Journal, which isn’t 100% clear, the new loan to have the following characteristics:

–$1.75 billion in size

–a five-year term, after which repayment in full would be due

–a 6.5% interest rate, implying $113.75 million in annual interest expense

–secured by many/most/all the company’s assets not already acting as collateral for other loans.

Neither JCP nor Goldman have confirmed the press reports.  As of Sunday night, when I’m writing this, there’s no SEC filing about this on the Edgar site, either.

my thoughts

1.  From the WSJ account, this new financing appears to be a bond offering rather than a bank loan.   Two differences:   on the one hand, the loan must be made all at once, starting the clock on interest payments, even though the money might not be needed right away; on the other, the lender has, generally speaking, no right to ask for early repayment.

The cost of the financing–before Goldman’s fees– would be close to $570 million over the next five years.

Unlike a bank loan, which can have an indeterminate term, JCP would have to have $1.75 billion available to repay the loan five years from now.  It’s possible that JCP could negotiate an extension, or borrow from someone else to get the money.  Without one or the other, the loan would seem to put a time limit on how quickly the operational turnaround must occur.

2.  To the extent that any assets of JCP serve as collateral for the loan, they would presumably not be able to be sold without the lender’s permission.  This could prove another, possibly severe, limitation to JCP’s options.

In a related story, the WSJ cites a brokerage report by ISI.  The report, which I haven’t seen, asserts that if the top 300 of the properties JCP controls were rented to third-parties instead of being used by JCP, they would fetch yearly rental income of $1.2 billion.  That’s more money than JCP has made in any of the past five years!

I don’t know whether this figure is correct.  If it is, it suggests that even pre-Ron Johnson the value of Penney’s real estate was being frittered away supporting a retail operation that only turned a profit because of a massive rent subsidy.

I’m sure JCP situation is much more complicated than just shutting down retail and allowing the value of the company’s real estate to be recognized–especially now that JCP stores have absorbed so much damage in the recent past.  Still, the point is that accepting the new loan might close out completely the possibility of forming a separate entity with these properties and rerenting them.

It will be interesting to see what JCP chooses to do.

J C Penney (JCP) just borrowed $850 million…why?

April 16, 2013 By in Current Market Thoughts, Recent Market Action, Retail, Stock ideas, working capital Tags: , , , , , , , Leave a comment

the 8-k

Yesterday, JCP announced in an 8-K filed with the SEC that it has borrowed $850 million on its newly expanded $1.8 billion bank credit line   …even though it doesn’t really need the money right now.  It also said it’s looking for other sources of new finance, which I interpret as meaning finding someone to purchase new bonds or stock.

My guess is that as the company needs seasonal working capital finance it will borrow more on the credit line rather than deplete its cash balances, which should now amount to around $1.8 billion.  This despite the fact that paying the current 5.25% interest rate on the $850 million will cost the company $44.6 million a year.

Why do this?

We know that the Ackman/Johnson regime inflicted terrible damage on JCP.  Part of this is actual–the stuff about lost sales and profits that we can read in the company’s financial statements.  Part of it is psychological–we don’t know how deeply JCP is wounded, how long it will take for the company to heal, nor even how much healing is possible.

a psychological plus

By borrowing the money now, JCP is in a sense buying itself an insurance policy on the psychological/confidence front by establishing several things:

– it now has enough cash to be able to weather two more ugly years like 2012, rather than one.  This gives it much more breathing room to negotiate any asset disposals, to say nothing of getting customers back into the stores.

–it has lessened the possibility that its banks will withdraw or reduce the credit line if sales continue to deteriorate.  After all, they now have their $850 million that’s in JCP’s hands to protect.

–it demonstrates to suppliers that the company has ample cash to pay for merchandise.  JCP will likely get better payment terms with the money on the balance sheet than without it, although it’s not clear to me that payables still won’t shrink this year.   More important, in my view, is that suppliers won’t restrict either the quantity or selection of merchandise they deliver to JCP for fear they won’t be paid.

–it avoids the negative publicity (see my 2011 post on Eastman Kodak) that would likely have been generated were JCP to wait until it genuinely needed the funds, or until its banks might be getting cold feet.

so far, so good

So far, Wall Street is taking the move in stride.  The stock showed no adverse effect from the announcement.  And in pre-market trading today, it’s up.

Ron Johnson out at J. C. Penney (JCP): implications

April 10, 2013 By in cash flow, earnings conference calls, Industry Analysis, Recent Market Action, Retail, Stock ideas Tags: , , , , , , Leave a comment

Yesterday, only a few weeks after major shareholder Bill Ackman gave Ron Johnson a ringing endorsement as CEO of JCP, Mr. Johnson is out.

Former CEO, Mike Ullman, who was unceremoniously dumped not that long ago to make room for Johnson, is back in.

Wow!

What can we make of this?     …quite a lot, I think.

1.  The change comes right after monthly sales results for JCP in March, the second month of the company’s fiscal year, would have been available.  Presumably they’re really bad (the Wall Street Journal is reporting that quarter-to-date sales are down at least 10% year on year).

This is a big problem.  JCP marks up merchandise by about 50% over what it pays.  It uses the gains from sales, called gross income, to cover the costs of running the store network (like advertising, rent, utilities, salaries…).  What’s left over is profit.

JCP’s sales in fiscal 2010 were $17.6 billion;  its pre-tax profit was $581 million.

In fiscal 2012, sales were $13.0 billion, or 26% lower than in fiscal 2010.  My back of the envelope calculation is that JCP lost just under $800 million from retailing last year–offset by a number of non-recurring gains (see my post).

To my mind, the largest factor in the profit decline is the loss of sales.  The March figures suggests sales may not have bottomed out yet.

2.  Since the company was quick to boot Mr. Ullman not so long ago, he’s probably not the company’s first choice as the new CEO.

I can see two possibilities:

–he may be the only experienced executive willing to take the job, or

–JCP may have been pressured into making the change quickly and Mr. Ullman was available on short notice (I’ve heard he was first contacted last weekend).

Neither possibility is encouraging.

3.  Where would outside pressure come from? The two main sources, as I see it, would be:

–suppliers.  Last year JCP generated $140 million in cash by getting suppliers to agree to wait longer to be paid. As the perceived riskiness of dealing with JCP rises, the standard response by suppliers would be to rethink a decision like this.  In a more extreme situation, suppliers would start to reconsider the amounts and types of merchandise they send to a customer.

–banks.  In its 4Q12 earnings conference call, JCP highlighted the fact that it had negotiated a $500 million increase in its bank credit lines, to just over $2 billion.  The message from this seemed to me to be that JCP had ample funds to weather any problems it might encounter in 2013.  Again, the standard response to continuing deterioration in sales would be for banks to reassess their exposure.  All it would likely take to reduce a credit line–something that would doubtless have adverse effects for JCP–would be one credit committee meeting.

There’s no direct evidence that either suppliers or banks have started down this road.  It’s conceivable, though, that one or both told JCP they’ll have to change their thinking if sales don’t perk up soon.  That might have been the final straw for Mr. Johnson.

Tiffany (TIF) reports so-so 4Q12 earnings

March 22, 2013 By in earnings conference calls, Industry Analysis, Luxury goods, Retail, Stock ideas Tags: , , , , , , , , , , Leave a comment

the results

Before the opening bell this morning on Wall Street, TIF reported 4Q12 (the company’s fiscal year ends in January) results.  Sales were up 4% year on year during the quarter, at $1.2 billion.  Net earnings were up 1% yoy, at $180 million.  That works out to eps of $1.40, vs. the $1.39 reported for 4Q11.  But it was $.04 above the brokerage house consensus of $1.36.

For the full year, sales were up 4% at $3.8 billion.  Net income was $416 million, down from $465 million in fiscal 2011.

In its earnings release, TIF also gave its first guidance for fiscal 2013.  It expects sales to be up by 6%-8% and eps to move roughly in line–but possibly with a touch of positive operating leverage evident later in the year.  1Q13 will be relatively weak (TIF fingers marketing costs and high raw material prices as the culprits), but earnings comparisons will likely improve from then on.

As I’m writing this, shortly after the open, TIF shares are up almost 3% in a market that’s up by about half a percent.

I don’t see why.

my take

TIF is an exceptionally well-managed company with a powerful brand name in the Americas and the Pacific, and in a business, luxury goods, that has strong long-term growth prospects.

This is the first time in five quarters that TIF results have exceeded the Wall Street consensus.  That’s a plus, although the “beat” is at least partly due to analysts’ low-balling their estimates after having whiffed four quarters in a row.

Management guidance of 6%-9% eps growth for fiscal 2013 is also a low-ball number, in my view.  I think +10% is easily attainable but believing in +15% would be a stretch.

my issue is valuation

I’ve owned the stock in the past but don’t now. Based on management guidance, the stock is trading at 20x year-ahead earnings, which is about as high as the PE has gotten over the past decade.

–Yes, there have been short periods when the multiple has spiked higher, but who wants to count on this happening again.

–Yes, there may be another, say, 5% to count on in the stock as earnings come in better than guidance.  But a professional investor should be looking for the potential +30%s and the +50%.  There’s just not enough upside here.

–Yes, there’s recurring speculation that some EU luxury conglomerate may buy TIF.  But, again, is this enough of an investment thesis?  In my view, no.  If the stock were trading at 15x earnings, however, it would be a different story.

what catches my eye in the release

TIF still doesn’t have its balance sheet completely back under control.  A while ago, when world economic prospects looked brighter, TIF decided to boost its inventories significantly.  That was so as not to lose sales for lack of stuff to sell, as well as to support a quickened store expansion plan.    …an aggressive, but very sensible strategy.

As global growth started to fade, TIF put on the manufacturing brakes.  But at 1/31/13, inventories were still $161 million higher than a year earlier.  And debt, net of cash, was up by $176 million.  That’s the reason, I think, why TIF bought back no stock during 4Q12, despite the fact the shares spent much of December in the mid-high $50s–vs. TIF’s full-year average buyback price of $66.54.

Comparable store sales in the Pacific, ex Japan and ex currency effects, were +6% for 4Q12.  I interpret this figure as saying sales there, which I view as the key factor that could make fiscal 2013 surprisingly good for TIF, have passed their low point.  TIF is penciling in a “mid-teens” total sales increase for the region–implying, I think, +10% for comparable store sales.  In a better Chinese economy and with clarification of the new government’s view on luxury goods consumption, that figure may be way too low.   If there’s one thing TIF bulls should monitor, this is it.  If there’s one thing that could change my mind about the stock, this is it.

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