By  on November 19, 2007

NEW YORK — Weatherproof Garment Co. is not leaving its fortunes up to Mother Nature anymore. In a novel move that could change how seasonal apparel manufacturers do business, the outerwear manufacturer has signed a form of weather insurance that will offset costs in the event of slow sales due to mild winter temperatures.

Weatherproof, known for its microfiber coats, could stand to receive as much as $10 million in the month of December if warm temperatures hit the Northeast like they did last year. The investment, the first by an apparel maker, lessens the impact of unseasonable temperatures by allowing companies to “bet” on the weather. For instance, Weatherproof can wager that the average daily temperature for the month of December will be 40 degrees or over. If it’s more than 40 degrees, Weatherproof will receive a payout. If it’s under that, the company loses its bet, but reaps the rewards of jacket sales.

This investment, known among bankers as a “weather hedge,” could omit a huge liability for the company, whose sales depend on chilly winter temperatures. Last December when the Northeast was sweating through 70-degree days, sales of Weatherproof’s jackets tumbled 30 percent at retail—a considerable slump given that more than half of all outerwear is sold during the last two months of the year. With coats still on the hangers after Christmas, retailers either shipped goods back to the company, canceled orders or marked down the existing goods—all at Weatherproof’s expense.

“It’s clear looking at our sales that weather plays a huge role,” said Freddie Stollmack, president of the privately held Weatherproof. “We needed to take the Mother Nature factor out of it.”

Weather has long been considered both boon and bane of the seasonal apparel business. Retailers and vendors have used weather forecasting services to benchmark sales for years, and bad weather is a favorite scapegoat when sales dive. But weather hedges take a different tack by quantifying the relationship between sales and weather, and providing a way to pass on that risk.

It’s a relatively new form of risk management. It was only 1997 when Enron put one of the first weather hedges together. The energy sector, which can be walloped when consumers turn off air conditioners or furnaces, was the first to adopt the practice, but Hurricane Katrina did much to export the strategy to other industries. In 2006, a year after the hurricane, trading of weather hedges in the secondary market topped $45 billion. Today, other sectors have begun to dabble, including agriculture and construction.

Brian O’Hearn, managing director of environmental and commodity markets for Swiss Re, the leading broker in the weather derivatives market, said a few retailers have tried weather hedges during the holidays when a snowstorm can put holiday shopping on ice, but he’s never heard of an apparel vendor’s taking out a contract.

“Education is a problem. This market is not aware of these products,” he said, adding that Swiss Re is currently working on hedge programs specifically for the apparel industry.

After another month of warm temps and poor sales this October, Weatherproof wanted to look into staving off another bad winter. Company executives approached Storm Exchange, a weather risk manager, to explore a possible deal. That firm, founded by David Riker in 2006, has been among the first to target the apparel industry by publicizing the relationship between sales and weather. It recently released a study of nine specialty retailers that found that for every two-degree increase over September’s historical average temperature, same-store sales, reliant that month on sweaters and outerwear purchases, fell 1 percent.

“From a retail perspective and the vendors that manufacture apparel, weather is a huge risk,” said Paul Walsh, Storm Exchange’s chief strategy officer.

For the Weatherproof deal, Storm Exchange compared industry and company sales data with historical temperatures to arrive at a benchmark. In this case, it’s 50 degrees. This is the temperature at which most people begin to put on or purchase heavier outerwear, Walsh explained. For sweaters, he said, the tipping point is 60 degrees.

Weatherproof’s contract for this coming December is betting that the average daily minimum temperature will be about 12 degrees lower than the benchmark, or 38 degrees. This is called the strike. If the average temperature for the month is warmer than the strike, Storm Exchange will pay Weatherproof a certain amount for every degree over 38 degrees. Those funds will go to defray the costs of canceled orders, chargebacks and markdown money if the company’s coats don’t move.

The cost, or premium, for this coverage depends on the proximity of the strike to the benchmark. So a strike set at 40 degrees will cost more than one set at 25 degrees. However, Storm Exchange CEO David Riker said most premiums range between 7 and 12 percent of the value of the contract.

While Weatherproof has agreed to a contract for the month of December, its size will depend on its upcoming pitch to Macy’s East, one of the largest retailers of Weatherproof goods, scheduled for this week. In addition to covering canceled orders, the payout, Stollmack hopes, could be used to fund what he calls the first-ever weather rebate program. “If it’s warm out and we don’t sell at the stores, we’d give them money,” he said. “It’s a totally free incentive for them, and an easy way to insure our product,” Stollmack said.

If Macy’s East agrees to the program, Weatherproof may opt for a contract with a top value of $10 million. If not, Stollmack said, the contract could be as small as $200,000.

Even without the rebate program, he’s cautiously hopeful that weather derivatives could put an end to the days when apparel makers’ bottom lines are vulnerable to weather. “This is just a test,” he said, “but at least we know we’re going to be protected.”

But not everyone is welcoming the strategy. “It may be warmer earlier in the year than it used to be,” said Joe Gordon, senior vice-president of George Weintraub & Sons. “But it’s got to get cold sometime.” Even with the protection of a hedge, Stollmack said he’s not hoping for unseasonably warm weather this winter. “I’m still praying for miserably cold weather. I don’t want to have to take a payout,” he said. “I just want to eliminate the weather as an excuse.”

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