Teen Denim Craze Meets the China Panic

Retailers face restrictions on what they can import.
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Updated from July 14

Some of the hottest fashion items imported from China have been embargoed by the U.S. in an action that raised concerns on Wall Street on Thursday about some of the market's best-performing stocks.

Last week, the Commerce Department barred U.S. business from importing cotton pants, tops and socks from China after safeguards were imposed under rules promulgated by the World Trade Organization. Though the move was widely anticipated by importers, Morgan Keegan analyst Holly Guthrie said the embargoes could wreak havoc on prices during the all-important holiday season.

"It's hard to be sure of the magnitude of the increases, but I think pricing in general will increase in the fourth quarter because of higher supply demands on factories outside of China," Guthrie said. "A lot of apparel stocks have already priced earnings through 2007 into their valuations, and the prices don't allow for much risk. I think this raises the level of risk for some of them."

Guthrie downgraded

Bebe

(BEBE)

,

Guess

(GES) - Get Report

and

Urban Outfitters

(URBN) - Get Report

to market perform. She also lowered

Hot Topic

(HOTT)

to underperform.

She warned, too, that many other retailers, particularly big discount chains such as

Wal-Mart

(WMT) - Get Report

and

Target

(TGT) - Get Report

, could be affected, since they are dependent on Chinese apparel imports. On the other hand, seasoned veterans of the industry could easily anticipate the embargoes and probably are prepared for them. In fact, the high levels of denim inventory that were observed this summer at retailers throughout the industry may be the result of a mad scramble to build up supply before the rules went into effect.

"We've anticipated much of what has been happening, and our sourcing strategy is very diversified," said Lee Antonio, a spokeswoman at

Sears Holdings

(SHLD)

. "So, we're not seeing any impact on our business from the government's embargoes on Chinese imports."

Trade quotas are a thing of the past for members of the WTO, but China's admission to the organization was predicated on a special provision that allows nations to impose "safeguards" on certain product categories that are threatening or disrupting domestic markets.

In the U.S., domestic textile producers have long complained about the devastating effects that foreign competition has had on their industry. In response to their lobbying efforts, the Commerce Department imposed safeguards on a number of Chinese textile and apparel items in May. This action essentially imposed a quota on those items, and the quotas were filled rapidly in some cases.

"The quotas have been filled on these items, so any further imports have been embargoed," said Commerce Department spokeswoman Meredith Williams.

In this case, the embargoes imposed on the textile and apparel items will be removed at the end of this year. However, a number of other categories are expected to suffer a similar fate in the next few months, including sweaters, robes, bras, skirts, pajamas and swimsuits.

All this takes place against a backdrop of increasing angst in the U.S. against the rise of China as an economic powerhouse. Considering that the country's GDP is growing at a blistering 9% a year, and that it has a population of roughly 1.3 billion potential consumers, many economists have concluded that China is destined to overtake the U.S. as the world's leading economy as it opens up markets to the forces of capitalism.

In retailing, the recent rebound in the value of the dollar is taking away a crutch for American companies. That has only exacerbated calls on Capitol Hill for the Bush administration to force China to unhitch the value of the Chinese yuan from the greenback.

The current arrangement allows Chinese exporters a significant pricing advantage over domestic companies. Guthrie said the safeguards on textile and apparel products could be designed as a political message to the Chinese government.

"The U.S. government and the WTO want China to play on an even playing field, but how do you go about doing that?" Guthrie said. "Some of the constituencies in Washington have just gotten fed up with waiting. Some import levels of these embargoed products are up 300%, 400% and 500% over last year, so they've decided that textiles and apparel is the group to spearhead."

Brenda Jacobs, an attorney with Sidley Austin Brown & Wood who represents the U.S. Association of Importers of Textiles and Apparel, said the moves are all politics.

"This whole thing has always been all about politics, and that's what we're stuck dealing with," Jacobs said. "The result is that orders will shift elsewhere in Asia. This won't bring a single job or order back to the U.S., but it will force companies to spend the extra time and money on logistics, and they will look elsewhere in Asia."

Despite the controversy surrounding trade policies, the effects of the measures on retailers is difficult to quantify. A spokesperson reached at Urban Outfitters, a teen apparel retailer that has long been a Wall Street star, declined to comment. A Wal-Mart representative didn't return calls from

TheStreet.com

.

Meanwhile, the S&P Retail Index has rallied 16% since early May, and teen apparel retailers selling Chinese imports, such as

American Eagle Outfitters

(AEOS)

,

Pacific Sunwear

(PSUN)

and

Abercrombie & Fitch

(ANF) - Get Report

, have been a big part of the strength.

Pacific Growth Equities analyst Andy Graves said quotas on Chinese goods are not likely to be overly disruptive to retailers.

"We believe after speaking with trade negotiators from both the Chinese and U.S. delegations that a negotiated agreement is forthcoming in coming months," Graves said.