The Chinese Tariff Fallout On U.S. Retailers

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by: Lipper Alpha Insight
Summary

The Chinese government announced its retaliation on Aug. 23, saying tariffs will be imposed on American goods, including apparel, textiles, agriculture and chemicals.

Most retailers in the U.S. are concerned about the higher costs associated with the tariffs.

To date, there have been 23 negative EPS preannouncements for Q3 2019 compared to 9 positive preannouncements.

By Jharonne Martis

This year alone, retailers have discussed Chinese tariffs in 166 earnings calls, and that might just be the beginning. The Chinese government announced its retaliation on Aug. 23, saying tariffs will be imposed on American goods, including apparel, textiles, agriculture and chemicals.

This announcement is weighing on retail stocks globally and continues to fuel a trade war between China and the U.S. And now tariffs are having a deep effect on both countries.

Retailers Booming in China

The retailers reporting Q2 earnings this month have been vocal about their popularity in China. Walmart (NYSE:WMT) said during its Q2 earnings call that the Chinese consumer loves its Sam's Club format and posted double-digit comps growth.

Nike's (NYSE:NKE) leadership has been bullish on China given the business boom and popularity there. In the latest earnings call, Nike said Greater China grew 22%, which marks the 20th consecutive quarter of double-digit growth in China. "NIKE Digital grew 37% in Q4, fueled by the SNKRS App and the strength of NIKE Brand and experiences with partners such as Tmall and WeChat. For the full year, revenue in Greater China increased 24% on a currency-neutral basis. On a reported basis, FY '19 revenue was up 21%." (Source: Nike Earnings Call, June 27, 2019)

China's business accounts for almost 16% of Nike's total revenue (Exhibit 1). New tariffs on American retailers means higher prices and a possible threat to revenue and earnings growth going forward. Wall Street analysts are paying attention.

Exhibit 1: Nike's Geographic Revenue

Source: Eikon

Since the discussions around tariffs have heated up this year, analysts polled by Refinitiv have become more bearish on Nike and lowered earnings estimates (Exhibit 2). The StarMine ARM model is highly predictive of both the direction of future revisions and stock price movement. In the first quarter of 2019, Nike scored a 95 out of a possible 100, suggesting that analysts were bullish on the retailer. Today, however, that score has dropped to 30, suggesting that analysts polled by Refinitiv are likely to continue revising earnings and revenue downward.

Still, Nike's earnings are of good quality. According to the StarMine Earnings Quality model, the company scores a 96 out of a possible 100. Its high score suggests that profits could be from sustainable sources. The company's cash flow and operating efficiency components also suggest the company is a top performer in these areas. This underlines Nike's strength and also means that it has the financial power to execute properly during a trade war.

Exhibit 2: StarMine Analyst Revisions Model for Nike

Source: Eikon

However, not all retailers have Nike's financial strength, and despite their popularity in China, imposed tariffs could be damaging to their bottom line. Other retailers driving revenues in China including Tiffany (NYSE:TIF), Tapestry (NYSE:TPR), Canada Goose (NYSE:GOOS), Abercrombie & Fitch (NYSE:ANF), Guess (NYSE:GES), Ralph Lauren (NYSE:RL), and Urban Outfitters (NASDAQ:URBN) are likely to take a direct hit from tariffs (Exhibit 3).

Exhibit 3: Q2 2019 Same Store Sales Actuals and Estimates for Vulnerable Retailers in China

Source: I/B/E/S data from Refinitiv

More Negative Guidance

Most retailers in the U.S. are concerned about the higher costs associated with the tariffs. Since most apparel bought in the U.S. is made abroad (mostly in Asia), the trade war will make buying clothes in the U.S. more expensive. When looking at our earnings guidance data, the apparel sector has the most negative guidance. U.S. customers can't just switch to an American manufacturer - there simply aren't many of those around anymore. So higher-cost imports will either hurt retailers' margins or if they pass the costs onto consumers, cut into demand.

One highlight this earnings season was Walmart. The discounter reported another stellar financial quarter and raised its earnings guidance - a bold move in a time when the bulk of retailers are providing negative guidance. Retailers are reporting Q2 earnings and discussing China tariffs, and warning us not to expect much from them in the upcoming quarters. To date, there have been 23 negative EPS preannouncements for Q3 2019 compared to 9 positive preannouncements. Accordingly, analysts polled by Refinitiv have been lowering Q3 estimates.

Exhibit 4: Q3 2019 Guidance

Source: I/B/E/S data from Refinitiv

Better Positioned

In response to China's retaliation, the U.S. government has posted several tweets asking U.S. companies to start looking for an alternative to China. Some retailers are better positioned to move their supply chain out of China.

Walmart and Target (NYSE:TGT) smashed Q2 earnings expectations and are showing strong defensive qualities. They are less vulnerable to the trade war given their wide range of brand categories, and robust supply/vendor relationship. These discounters have the resources and flexibility to make the necessary adjustments to their supply chain more rapidly than their peers. For the full report on which retailers are better positioned, see our previous report here.

Exhibit 5: Q2 2019 Same Store Sales Actuals and Estimates for Tariff Proof Retailers

Source: I/B/E/S data from Refinitiv

Earnings on Deck

Here are the Same Store Sales and Earnings estimates for retailers reporting earnings next week:

Exhibit 6: Same Store Sales and Earnings Expectations/Results - Week Of August 26, 2019

Source: I/B/E/S data from Refinitiv

Q2 2019 Earnings Dashboard

Eighty percent of companies in our Retail/Restaurant Index have reported Q2 2019 EPS. Of the 167 companies in the index that have reported earnings to date, 69% have reported earnings above analyst expectations, 10% reported earnings in line with analyst expectations and 21% reported earnings below analyst expectations. The Q2 2019 blended earnings growth estimate is 3.2%.

Exhibit 7: Refinitiv Earnings Dashboard - Q2 2019

More Repercussions - Chinese Tariffs

Recent trade policies are impacting both China and the U.S. In Q2, China's economic growth rate fell to 6.2%, its lowest reading since the early 1990s. Fathom Consulting's indicator of China's economic growth - the CMI - has now fallen for three consecutive months, to 4.8% in May, suggesting that growth has been worse than that.

Exhibit 8: Fathom China Momentum Indicator 2.0 and GDP

Source: Refinitiv Datastream/Fathom Consulting

Mineral supplies

China also has control over rare earth metals, which are much needed in the global tech industry. Restrictions on the supply of these minerals would have an impact on U.S. corporations. The ChinaScope data below highlights how rare earths are used in such key devices as cell phones. The American companies that could be affected by this include Apple (NASDAQ:AAPL), T-Mobile (NASDAQ:TMUS), Telephone and Data Systems (NYSE:TDS), Microsoft (NASDAQ:MSFT) and BlackBerry (NYSE:BB), among others.

Exhibit 9: Mobile Phones (Down Stream from Touch Screen Display)

Source: ChinaScope data, available on Battlefin Ensemble platform

Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.