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Moody’s Sees Upside for Back-to-School

U.S.-based apparel marketers are likely to have an easier time generating strong profit increases during the back-to-school season.

In a reversal of the 2011 trend, U.S.-based apparel marketers are likely to have an easier time generating strong profit increases during the back-to-school season than they are producing robust sales growth.

According to a report by Moody’s Investors Service published Thursday, apparel brands and retailers can expect third-quarter sales increases of 2 to 3 percent while operating profits, boosted by lower cotton input costs, should grow 8 to 10 percent over levels from the comparable quarter of 2011. In last year’s period, sales were up about 10 percent while operating earnings were “essentially flat as operators were unable to pass through higher input costs, most notably cotton.”

“The benefits of lower cotton costs will be evident in the second half of 2012, and this should enable apparel companies to recapture a meaningful portion of the gross margin lost last year when input costs were higher,” said Scott Tuhy, vice president and senior credit officer of Moody’s and author of the report. “We expect to see positive operating earnings trends starting in the back-to-school season, with those companies with meaningful sales in the children and young adult categories benefiting most, along with companies that sell cotton-intensive products.”

 

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Among the principal beneficiaries would be Gap Inc., Justice parent Ascena Retail Group Inc. and two firms with financial results closely tied to cotton prices, Hanesbrands Inc. and Levi Strauss & Co. Wal-Mart Stores Inc. and Target Corp. should see benefits as “consumers remain cautious and look to save.” Moody’s anticipates that J.C. Penney Co. Inc. will experience mid- to high-single-digit sales declines for the season as it continues to engineer the transformation of its business model.

The Commerce Department pegged apparel sales growth in the first quarter at 7.9 percent, with second-quarter increases cut by more than half, to 4 percent.

Overall, Tuhy noted, relatively lower gas prices should add to consumers’ disposable income and prudent management of inventories, like lower input costs, should allow brands and stores alike to move a higher percentage of their sales to the bottom line.

“Given all the macroeconomic uncertainties,” Tuhy told WWD, “companies have been pretty conservative about their inventories. They came in a bit high for holiday last year, getting a little bit ahead of themselves, but they generally don’t make the same mistake twice. It’s not a season to be overly aggressive. Selling out a week before Christmas wouldn’t be such a bad thing.”

He expects earnings pressure from a different source this year than last. “Last year there were decent top-line numbers that didn’t flow to the bottom line because of inputs,” he said. “We haven’t seen it in the second quarter, but you’ll have a reversal of input pressure in the third quarter. Even if you remove the effect of currency shifts, we’ve seen some slowdown in Europe and Asia is beginning to show some signs of weakness. Still, American businesses with overseas operations will have the cost benefit working in their favor, and many of them, as you can see from Levi’s, as an example, will have the benefit of being more upscale in their international operations than they are outside of the U.S.”

Third-quarter revenues will be consistent with those of the second quarter, he noted, although the early advent of spring weather tended to move some apparel dollars ordinarily spent in the second quarter into the February-to-April period. “We expect sales to be consistent with the overall sluggish trend at retail,” Tuhy said.