NEW YORK — The footwear market is undergoing a rapid transformation as new deals change the playing field and sourcing pressures intensify.
And the next 12 months could bring more surprises as uncertain improvement in the economy and erratic consumer behavior continue to pressure firms, said analysts during a Footwear News roundtable held last month.
Price hikes will escalate in this environment, said the panelists, who included Kate McShane, director at Citi Investment Research; Scott Krasik, senior research analyst at BB&T Capital Markets; and Sam Poser, managing director at Sterne Agee. As a result, vendors need to continue to make fresh product that consumers want to buy at full price.
“The issue is really who’s going to fall on their face first with a crappy product and not be able to pass price along, or who can pass price along because they make great, iconic stuff people want,” said Poser.
The analysts also explored growth areas, which they said exist in both the online and international markets.
“[Internationally], there is still a lot of territory that is underpenetrated, such as Brazil, [and] India is the last frontier,” said McShane. “There is still a fair degree of growth for even the largest athletic companies in the emerging markets.”
Other topics included mergers and acquisitions, best management practices and the analysts’ stock picks for the year.
FN: Heading into fall, pricing pressures are the biggest issue for many firms. How will this change the landscape?
Sam Poser: The pricing issues are here to stay. How much margin pressure it puts on the firm [depends on] how innovative they can be. The worst pressures will happen at the lower end. Say it costs 75 cents to ship a shoe. [On] a $20 shoe, it means a 5 percent increase in price, but it’s much less impactful on an $80 shoe.
Kate McShane: The worry is justified because elasticity is a big question. Once we get into fall ’11 and spring ’12, there will be a much more notable price increase [than in this past spring]. There is an added risk of possible markdowns if demand really does slow because of higher prices.
Scott Krasik: The footwear industry is at a disadvantage compared with apparel. Roughly 85 percent of U.S. footwear is made in China, [where] costs aren’t going down. [Whereas] you can take [a process like flat sewing] to Bangladesh, India, and various other lower-cost countries to produce, what we’ve seen from guys trying to manufacture footwear in India and Indonesia is that there are delays and the product quality hasn’t been as good. That’s something the footwear industry [has] to figure out in the next three to five years. For the non-athletic segment, China is almost the only answer.
FN: Are there firms that are better equipped to weather the inflationary environment than others?
KM: Wolverine World Wide Inc. has been a good example of a company that has taken pricing a little bit earlier than others. They probably have the best margin guidance of all the companies I cover. [With respect to innovation], I have to highlight Nike, Reebok and Adidas. Reebok, especially, got its foot back in the door with toning. The Zigtech has been very successful, and retailers can’t say enough about that particular product.
SK: The Steve Madden brand, which is turning inventories 13, 14 times a year, [is] introducing newness and [will see] higher price points be accepted. They are able to interpret whatever fashion is relevant and have consumers accept it. If you’re trying to raise prices on the same basic shoe, that’s not going to be acceptable.
SP: Look at Ugg. Back in 2003, the Classic tall and short [styles] represented [about] 90 percent of the business. Now there is so much more, from cold weather product to men’s product and slippers. There’s innovation with both product and how they market it. The pressure is [on how to] keep the value and keep the brand [integrity] intact. Pricing isn’t the issue, it’s aiming correctly.
FN: Are retailers going to fare better than vendors?
SK: The consumer decides. If consumers make the decision that they are interested in the higher prices, everybody will share in the gain. If the customer determines they don’t want to pay more, then the retailer will get hit, but the vendor is going to share some of that pain. The [problem] is it’s too soon to tell based on the multiple stages of price increases that are set to go into the market over the next six to 12 months.
SP: You have to see who you’re talking about. Vertical retailers in general are more at risk than branded retailers because they don’t have the power or the fallback. Factories can’t afford to negotiate. Prices are going up for everybody. There’s not going to be one company with a secret sauce that can get prices to go down while all the other ones go up.
FN: What is your overall earnings outlook for 2011?
KM: We are optimistic on the athletic footwear side. [Retailers such as] Foot Locker and Finish Line are now getting into a second year of solid comps, [and] the product cycle has a lot to do with it. Product cycles work when there is innovation. Adidas and Reebok are healthier brands after five or six years of not being participatory in the category. But how much more room do we have in the product cycle?
SP: I don’t think we understood how bad the economy was in 2008 and the beginning of 2009, and while things are better, they aren’t that much better. We could have a slight moderation in innovation, an acceleration in the improvement in the economy, and see these comps continue for another year. If people keep doing things right, I’m optimistic.
SK: What we saw after 2008 was that the comps were huge but up only on [the weekends and not moving] Monday through Friday. There was inconsistency in consumer shopping patterns and just building that consistency back can create potential further comp increases. I would say we’re cautiously optimistic [if not] a little bit more conservative in our outlook.
FN: Can consumers be reprogrammed to pay full price again?
KM: In athletic, I’ve seen a decrease in markdowns, the percentage of the store on sale and percentage of what’s being promoted. That’s testament to a couple of things: One, retailers are selling things that people want and will pay full price for; and two, there’s much better inventory control.
SP: The customer who wants the best running or basketball shoe knows they are going to have to pay for it. If prices continue to go up, the shoes just have to be that much better.
FN: Should we expect mergers, acquisitions and consolidations to continue for the rest of 2011?
SK: The deals so far have been bolt-on types, [so yes,] consolidation is alive and well [because] every big company has said it’s looking. Historically, vendors traded around [a multiple of] seven times [their EBITDA], and better players such as Wolverine traded around eight [times]. Now you have Deckers Outdoor Corp., Crocs Inc. and Timberland Co. at 10; Steven Madden Ltd. and Wolverine at nine. That has to incorporate some market speculation.
SP: There are a lot of small, private companies that are good but that can’t afford with their small size to get the production they need. They need a big guy to come in and consolidate their stuff to make it work. What’s also happening is that there are a lot of battles going on because there are some companies that everybody wants. The only ones that are easily out of play would be companies such as Kenneth Cole Productions Inc., K-Swiss Inc. and Skechers USA Inc., but that’s because they are so closely held by one person who could just say no.
KM: [Yes, but] people want small companies where they can leverage their back office and sourcing and go global. They don’t necessarily want to combine or be partners with a bigger brand. [We won’t see many] transformational acquisitions that are a big deal in terms of execution and synergy and everything that goes along with it in terms of managing the deal. VF Corp. has not done more than a $500 million acquisition.
FN: Which firms have the best management teams?
SK: The combination of Ed Rosenfeld and Steve Madden at Steven Madden has been tremendous. It’s the creative energy Steve brings to the company, [plus] the fact that Steve really listens to what Ed says. [That makes] that a very dynamic team.
KM: Polo Ralph Lauren Corp., too, has a creative head in Ralph Lauren and the business mind in [COO] Roger Farah. [Look at] how well they bought back the [brand’s] licenses. It’s taken a little while to get footwear right, but footwear seems like it’s really starting to gain some traction.
SP: The guys at Deckers have been making great progress [with Ugg, despite] the recession. Granted, they have a hot product, but they’ve kept the hot product alive through a time [when] everyone said [the trend] was over. The key there is everyone feels empowered.