NEW YORK — Economic and geopolitical turmoil may have achieved what prosperity could not.
With sales growth so difficult to come by in the past year, and especially since last September’s terrorist attacks, retailers and manufacturers have made discipline their mission and performance their mantra.
In adapting to this harsh and frightening environment, they’re entering the second half of 2002 closer to the ideal of the “lean, mean fighting machine” and better able to transform revenues into profits. That course should prove prudent as the prospects for an energetic turnaround before year’s end appear small.
As the economy has sputtered its way back to something approaching full speed, public companies and their auditors have also faced a serious crisis of confidence since Enron’s collapse. Harvey Robinson, analyst at The Chapman Co., said that the higher level of scrutiny being applied to financial results by the Securities and Exchange Commission should translate into improvements in both earnings and the level of independence among security analysts going forward.
“Companies have been extremely conservative with respect to their guidance. Now you see it is more of a case of, `Show me, show me, show me. Show me that you can grow your earnings and then we will attach a value to your stock,”‘ he noted.
Robinson expects the second half of the year to be “better than the first, in part because excess inventory either will be or has been reduced over the last couple of quarters. Consumption has leveled off and it could possibly pick up in the second half.”
Tim Page, chief financial officer at Perry Ellis International, disclosed that his company has attracted the interest of many buy-side analysts, such as those who make recommendations for mutual fund holdings.
“Based on their questions, they’ve been very focused on profitability. The big hype is not on growth, but whether a company can run a business properly. `Show me that you know what you’re doing, and then maybe I’ll believe your top-line story too’ has been the focus. They are asking questions about how we are managing costs and about our margins. These analysts understand the issue relating to markdowns and want to know how we are controlling those costs. While they are always interested in sales growth, what they really want to know is whether a specific company can make money in good and bad times,” Page said.
Mark Bienstock, executive vice president at DCD Capital, a factoring firm, observed, “The economy overall is still very soft, in part because the stock market has no direction. After the Internet bubble and Enron-accounting issues, people are starting to take more responsibility in analyzing the true financial picture. Financial experts are relying less on pro forma earnings. Now they want to hear about actual bottom-line results.”
Last year’s slowdown and the pullback on orders after Sept. 11’s terrorist attacks forced apparel vendors and retailers to closely watch their inventory levels. Many companies expect to maintain the same tight controls for the balance of the year, regardless of short-term sales results.
In fact, the technology-aided disciplines bolstered in the past nine months have become part of a new standard of post-boom American business.
When Kellwood on May 30 announced first-quarter results, the company attributed the 19.6 percent drop in volume and 66 percent drop in net income to the cautious buying of both retailers and consumers. Kellwood’s inventory level for the period that ended April 30 was down 40 percent from year-ago figures.
Hal J. Upbin, chairman, president and chief executive officer, said in a statement, “The retailers continue to be cautious in placing orders for the upcoming season. Orders are booked 45 to 60 days later than normal. The stores are also withholding a portion of their fall open-to-buy for at-once delivery just in case the consumer returns to a more normal level of consumption during the peak fall selling season.”
Upbin added that Kellwood would not be building inventory for fall in the hopes that retailers will need it.
Jeffrey Edelman, apparel analyst at UBS Warburg, wrote in a research note last month that management of retailers polled had “reiterated their conservative outlook and inventory planning” and that apparel manufacturers have “benefited from lower markdown allowances and are also taking a conservative approach to their planning. They are minimizing the amount of potential closeout merchandise, thereby enhancing the profitability of their business.”
One notable change, he wrote, is that “the balance of pricing power, having moved steadily in favor of the department stores in recent years, is beginning to swing the other way toward the apparel manufacturer.”
Another shift, the analyst observed, concerns how manufacturers have responded to the later placement of orders from retailers with tighter lines that are updated more frequently: “This shortens the delivery period from manufacturer to retail — perhaps from four months to three — but increases the probability that a manufacturer’s orders will more likely be definitively confirmed for shipment.”
Edelman concluded that the department stores will have to be a “little less demanding on price” if they want to be well assorted with merchandise at the beginning of the selling season.
This will put added pressure on new players. “Many of the smaller manufacturers do not have the scale and technology to meet the growing demands of the retailers,” the analyst said.
The stock market isn’t expected to provide relief in the short term. Hampered by questions ranging from domestic security to fiscal “transparency,” financial and fashion sources expect stocks to struggle through the end of year, with the impact on consumer confidence and corporate capital expenditures uncertain.
With unemployment expected to hover in the 6 to 7 percent range for the year, the 5.6 percent pickup in first-quarter gross domestic product viewed as aberrational and the stock market moving in reaction to news and not in anticipation of it, encouraging news may be a rare commodity.
Byron Wien, managing director and senior investment strategist at Morgan Stanley, who spoke last month at a Market Forecast presentation by the New York Society of Security Analysts, said, “My view at the beginning of the year was that this would be the third down year in a row. It was not a popular view inside or outside of Morgan.”
He said he expects GDP for the year to gain about 3 percent.
“The lack of pricing power is not good for corporations. The rest of the year will be a struggle. I don’t see the market going up or down much. I think next year will be a good year if we can still hold our jobs until then,” Wien said.
He also worried openly about “the possibility of another terrorist attack, which I think is very high in some form,” as well as the outlook for the U.S. dollar in world markets.
John Manley, senior U.S. equity strategist and managing director at Salomon Smith Barney, who spoke at the same presentation, observed that first-quarter results looked best when judged against lower expectations. He explained that many companies had updated earnings estimates in October for the first quarter, with a good portion providing “negative, downward revisions,” which made first-quarter results appear stronger by comparison.
Philip J. Orlando, chief investment officer at Value Line Asset Management, said at the discussion that the overhang of the Enron and Arthur Andersen scandals, the New York investigation of Merrill Lynch and the crises in the Middle East are also discouraging investors from putting their money into the stock market.
The stringent management of inventories could contribute to another economic hazard. Peter Hooper, managing director and chief U.S. economist at Deutsche Bank Securities Inc., observed: “I do see inflation coming back on the radar screen next year. We’ll be shifting down the road to a mood that will be less favorable for interest rates.”
Steven R. Ricchiuto, economist at ABN-AMRO, wrote in a report last month that the Federal Reserve’s decision to leave interest rates at the current level confirmed a “deep-seated uncertainty among the committee members over the sustainability of the current recovery. This concern is amplified by the sharp downturn recorded in the broad equity indices over the past few weeks and the associated widening in credit spread for a number of high-profile companies.”
He doesn’t expect any increase from the 1.75 percent rate until September at the earliest and maybe not until November.
What does this mean for apparel and retail firms concerned about second-half outlook?
“The U.S. economy won’t shut down,” Chapman’s Robinson stated confidently. “You’ll have both back-to-school and some business casual apparel sales. What we have is a more efficient economy, with companies reacting more quickly in terms of bringing inventory to the correct levels and reducing or increasing the workforce as needed.”
DCD Capital’s Bienstock is keeping close tabs on technology companies and what they disclose about future orders. “Technology will play a big part in leading us out of the economic doldrums. I expect to see a definite fourth-quarter pickup as companies invest in replenishing and updating their computer hardware and software.
“I also expect that discounters will continue to be the shining star at retail, particularly during the holiday season. We’ll probably also see less promoting than last year, as inventory levels remain leaner and consumers see fresher assortments at retail,” he predicted.
So far, the expectations for apparel manufacturers remain positive, based on earnings reports from some big-name vendors such as Liz Claiborne, Jones Apparel Group and Kenneth Cole, all of which indicated a cautiously optimistic outlook for the balance of the year. Inventories, executives at these firms said in numerous conference calls with investors, were at improved levels, with product being shipped to the retailers closer to season than before.
Roger Farah, president and chief operating officer of Polo Ralph Lauren, said in a recent interview, “I think the bigger overriding factor impacting various wholesale and retail companies is an economic one. The economic turbulence and more Enron-like accounting issues are likely to have a negative impact on the consumer.”
Farah expects that apparel and retail companies could see an improved holiday period that will be less promotional because of decreased inventory levels, with the season possibly paving the way for improvement by next spring.
Page, of Perry Ellis International, observed that “lots of areas in our business look better than last year. Our bookings through October and November look good, and the indications that we have for bookings for spring are strong.” The chief financial officer said that the projections for an improved spring 2003 did not include those for PEI’s newly acquired Jantzen business. The company, which attributes only about 20 percent of its business to replenishment, sells mostly to midtier department stores, such as Sears, J.C. Penney, Mervyn’s and Kohl’s, and mass discounters such as Wal-Mart and Target.
Based on acceleration in his business in the past two months, Steve Sutton, president of Accessory Corp., a hanger manufacturer, predicts that retail sales will be up for the second half. “I’ve seen from my business that retail is heating up. We’re up about 25 percent compared with last year.”
Despite the strength of Ecko Unlimited’s young men’s and Ecko Red women’s lines, David Panitz, executive vice president, continues to expect a slow recovery and no end to the current conservative tendencies of retail management, especially with issues from Enron to Afghanistan hanging over the public’s consciousness.
“The good news is that we have a lot of momentum coming out of spring as we move into the back-to-school season,” he said. “Still, I haven’t heard of any firm planning on increases in their capital expenditure budget. From what I’ve heard, most will continue to outsource work.”
Anne Maxfield, president of Project Solvers, an employment resource firm for the apparel industry, observed that jobs may be in greater supply than optimism within the apparel industry.
“In some areas, there are more jobs than qualified candidates,” she said. “Then there are certain key areas where it is a really tight labor market. Right now, technical designers are in demand. When J. Crew announced layoffs recently, not one of them was a technical designer. Generally, the more specialized the individual is, the easier it is for them to find a job.”
According to Maxfield, there are “tons and tons” of jobs for children’s wear designers. She expects the women’s market to remain stable, but noted that there could be a pickup because companies are “starting to develop real active sportswear” divisions.
Generally, salaries have been nudged up because of the need for qualified workers. “In the garment industry, no one wants to pay for anything. Companies are starting to take a deep breath and paying for what they really need. Many firms have lived for the last six months with big holes in their head counts and are realizing that certain divisions are understaffed.”
The trend, said Maxfield, has been and continues to be the increased use of freelancers to ensure an accurate match between an applicant’s skills and the job’s requirements before the employer makes a full-time hiring commitment.