Could Weaker China Economy Derail U.S. Retailer's Plans for Asia?

NEW YORK ( TheStreet) -- A slowdown in the Chinese economy could dent profits for U.S. multinational retailers such as Starbucks ( SBUX) , Abercrombie & Fitch ( ANF)   and Gap ( GPS) .

These companies have been aggressively laying infrastructure in top Chinese markets such as Shanghai, Beijing, as well as second and third-tier cities, and have prospered while sales continue to be robust.



But Chinese retail sales for August were the latest data point to call into question the sunny outlooks and hearty investment plans by these U.S. retail companies. Retail sales growth in both urban and rural Chinese markets has been slowing since May. In August, urban retail sales rose by 11.8%, below July's 12.1% pace, while rural retail sales expanded by 12.8% in August, down from a 13.2% increase in the prior month. 

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At the end of its June-ended fiscal third quarter, Starbucks was approaching 1,300 stores in China, and recently unveiled two new flagships locations, including one in Beijing that is open for 24 hours.

"Once again, comps in China outpaced the region overall, despite concerns around an economic slowdown in China," confidently noted Starbucks Chief Operating Officer Troy Alstead on the third-quarter earnings call in late July.

Starbucks' China and Asia Pacific segment, which includes 11 other Asian countries besides China, had a 35.04% operating margin in the third quarter, up an impressive 480 basis points year over year, according to Bloomberg.
Starbucks China is not only winning as a result of strong traffic in densely populated cities, but further from an estimated 10% to 20% price premium on its offerings relative to the U.S. The China segment specifically is increasing its number of units the fastest from within the China Asia Pacific, or "CAP", segment (+39.53% in the third quarter year-over-year), and represents about 9.64% of Starbucks' total operating income and 6.7% of total revenue based on year to date financials.

But shares of Starbucks have lost 1.8% in the past month as more worrying reads on the Chinese economy have been released.



Although U.S. mall stalwarts Gap and Abercrombie & Fitch have comparatively smaller presences in China than Starbucks, their expansion plans are no less vital to their futures. Apparel retailers view China as a two-part opportunity -- open new stores that add to revenue amid enthusiastic Chinese crowds and peddle merchandise at higher profit margins than in the U.S. Gap has 91 stores in China (87 Gap brand/4 Old Navy), constituting 2.8% of its global store base. The company plans to open 35 Gap stores in China this year (25 Gap brand/10 Gap outlet), along with 5 Old Navy stores.

"We look at the China market, as everybody knows, critical to the future growth for Gap," stated Gap Chairman and CEO Glenn Murphy on the retailer's second-quarter earnings call.

Gap's stock has gained roughly 6% in a month's time, and moderating growth in China could serve as a surprise to investors when third-quarter earnings are released in mid-November.

Abercrombie & Fitch operates two namesake flagship stores in China, the newest one opening in Shanghai in April, and eight Hollister locations. A company spokesman told a Chinese online publication in April the company intends to open "100s" of Abercrombie & Fitch and Hollister stores over the "next decade." On the third-quarter earnings call in August, CEO Mike Jeffries said, "we remained very pleased with the volumes and profitability of our Hollister stores in both China and Japan", underscoring the confident tone expressed by Starbucks' Alstead.

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To get a feel for how U.S. multinationals are faring in China, and if surprising financials are looming, investors could look to Nike's ( NKE) fiscal first-quarter earnings on Sept. 25, particularly as it pertains to unexpected inventory increases due to waning demand.  Greater China represented 9.3% of Nike's fiscal 2014 revenue, and 19.9% of its earnings before interest and taxes (EBIT).

When China's economic growth cooled in 2013, Nike wasn't immune. On Nike's fiscal year-end earnings call in June 2013, Nike brand President Trevor Edwards remarked, "For fiscal year 2013, we grew in every geography except Greater China, and across all of our key categories." He added that Nike's "Q4 results reflect the benefits of higher selling prices and easing material costs, partially offset by the ongoing impact of labor cost inflation, higher discounts, particularly in China." That commentary was followed up by similar reservations in the first fiscal-quarter earnings call in September 2013 when Edwards said, "In Greater China, currency neutral revenue declined 3% in Q1 as growth in sportswear and basketball was offset by declines in other categories."

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At the time of publication, the author held no positions in any of the stocks mentioned.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

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