China's Retail Sales Growth Slows

When you hit a speed bump at 15 miles an hour, your car makes that little bumpy noise and you think about getting your CV joints inspected. When it hits the same bump at 120 miles an hour, you take your bumper home in a sandwich baggy.

It's not surprising that a new report on the growth of Chinese retail sales for the first two months is having an effect on fast-moving retailers with operations in the country. Michael Kors (NYSE: KORS  ) , Coach (NYSE: COH  ) , and Fossil (NASDAQ: FOSL  ) are all exposed to China, and each faces a separate problem if sales stay low.

Slowdown in Chinese sales
Taking industrial output as the signifier, China is having the worst start to a year since 2009. The company increased output by 9.9%, compared to 10.3% in December of last year. That decrease in the rate of production was layered on top of an increase in inflation, which rose 3.2% in January, driving up the cost of food and hitting its highest point since April 2012. Those issues combined to push sales growth down to 12.3% -- analysts had been expecting 15%.

The worrying part of the equation for investors -- because 12.3% growth isn't exactly bad -- is that the slowdown may continue. Analysts are starting to detect a pattern in China, one of investment-driven growth with lagging consumption growth. That's clearly bad news for companies that are trying to sell things in China. That bad news may be amplified by a downturn in lending, with signs pointing to a shorter leash in the hands of the central bank.

What it means for investors
The market is worried that Kors is going to get sunk on a slowdown. Shares were down 5% yesterday, which is only adding to the woes of Kors' investors, who have seen the stock flounder over the past month. But it's not all bad news in China. The company recently came out on top of a study of online brand demand in China, with handbags taking a full 51% of searches for fashion items. Kors has said that there's a lot of growth potential for the brand in the region. Right now, it operates 65 stores in that part of the world, and CEO John Idol has said that the company plans to expand that up to 150 stores .

A slowdown in China is not going to be the end of the line for Kors. It is expanding everywhere and had 41% comparable-sales growth in the U.S. last quarter and 58% growth in Europe. The news isn't great, but I'd be surprised if it translated into anything meaningful in three months. The brand is simply too strong right now to be damaged by minor macroeconomic headwinds.

Coach and Fossil are in slightly different places. Coach is already heavily invested in China, operating 117 stores as of January with a plan for another 10 in the near future. The company gets about a third of its total revenue overseas, and growth in China has been a big driver of that. Last quarter, sales were up 40%, driven by a double-digit comparable-sales increase. But while Kors has the benefit of being the hottest thing in town, Coach is still working at gaining share.

Coach is spreading itself out, expanding into men's and non-bag accessories in all its markets. In China, it's hoping that the expansion of its footprint and its new lines drive $400 million in revenue in the coming year. There's a lot riding on that growth. Sales in the U.S. lagged a bit last quarter, and the only thing keeping everyone's chins up was the strong international showing. A slowdown in China could mean that that buffer shrinks or disappears, which would put a lot of pressure on an uptick in the U.S.

Fossil is in a similar boat, with North American and European sales doing well but not as well as sales in China. The company is also expanding its footprint, but is doing so in a way that it admits is fragmented. That's caused the expansion to take longer than planned and hurt profitability. As a result, Fossil really needs to show some strength in the Asian market. Luckily, it is going to be helped by the fact that it's working with Kors as the brand's official watch provider.

The bottom line
Kors, Coach, and Fossil all have money on the line in China and a slowdown is going to hurt. Having said that, the slowdown isn't yet large enough to spell disaster and all of these brands have the strength to weather a small storm. If the trend continues, though, I'd start to be worried about long-term growth and for Fossil, about the time frame for real profitability. Overall, I think Kors is best placed, but its high P/E makes it a high-stakes bet.

Michael Kors is one of today's hottest high-end fashion brands, and that's translated into one of the best-performing stocks in retail -- since its debut on the market in late 2011, the share price has more than doubled. But with all that growth, has the stock finally become too expensive, or is there still room left to run? The Motley Fool's new premium report on Michael Kors gives investors all the information they need to make the right decision. We cover the key must-watch areas, opportunities, and threats to the company that investors need to know. To claim your copy, simply click here now for instant access.


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  • Report this Comment On March 13, 2013, at 5:40 AM, ChinaInvestorCFA wrote:

    Perhaps you should head on over here to China to get a sense of what's really going on. Retail sales are slowing for two reasons: One being that during the Chinese New Year, a record number of Chinese traveled overseas to buy things in America, HK and Europe where products are so cheap compared to the Mainland. Meaning they weren't spending as much on retail IN China. The second being that Xi Jinping's new crackdown on corruption is softening Mainland demand. Businessmen/officials don't want to get caught buying out stores of luxury products for gift-giving during the cny holiday this year. Note that within the retail sales calculation, catering sales growth slowed to 8.4% from 13.3% last year. Whether or not that's true, surely the gov must show it to prove to it's people that officials are no longer spending the tax dollars on lavish things (ie. high-priced Moutai or shark-fin soup)

    The Chinese are still spending, they just aren't spending as much IN China. Travel restrictions are loosening and consumers are far more savvy these days (they know better than to pay 2 to 3X the foreign prices) so overseas spending is a booming trend for Chinese consumers.

    Companies aren't going to hurt from the "china slowdown" you mention...they just need to strategize properly with their Chinese consumers. Of course people still shop at Mainland stores, but many stores here are used for the purpose of advertising and branding. So that the consumer gets to know the brand and then buys it outside of the Mainland. Believe me, the Chinese are hungry for American/European products, they just won't be buying as much as it here in the future unless import/luxury taxes are lowered and prices deflate to a level closer to that of HK. I suggest you do a little more due diligence next time...

  • Report this Comment On March 13, 2013, at 9:02 AM, TMFRedRam wrote:

    Thanks for reading, ChinaInvestorCFA.

    I appreciate the well thought out comments, but think I must be missing something. You seem to be suggesting that the Chinese are spending less on the mainland because they're buying things abroad and because corruption is decreasing.

    I'm having a hard time seeing how that wouldn't be bad news for companies investing in China. While the storefronts do increase brand awareness, that's not a good reason to spend millions investing in physical locations that people are going to buy less from. It would also be bad news if you're right, and one of the main drivers of growth was corruption. How is that sustainable?

    If China's population really is buying overseas then surely it would make more sense for KORS and others to build locations in the places that the Chinese visit, instead of in China. What you've implied is that these brands are doing fine by building stores in places that people will continue to avoid due to high tariffs. But I can't see how that's a smart business move.

    Also, thanks for tacking on the suggestion that I do 'more due diligence'. That's helpful and not at all insulting.

    Cheers, Andrew

  • Report this Comment On March 13, 2013, at 12:20 PM, ChinaInvestorCFA wrote:

    Apologies, didn't mean to be insulting. Just too many people reporting on China who aren't on the ground here and don't understand the the true market. I've been here for years and admittedly still have trouble analyzing the situations sometimes. Just suggesting if you write on China, to maybe reach out to sources here who know what's going on.

    The point I'm trying to make is that the slowdown in sales is not necessarily bad news for retailers investing in China because they still have a market with Chinese, just not always in the Mainland. I agree that some stores are expanding too much and getting too glitzy here, but in some cases, it is worth the millions they spend because it works. Of course they shouldn't continue growing their stores rapidly here, and they should think of the stores as marketing schemes. But they still have a Chinese consumer to rely on. My point is that retailers need to continue investing in the Chinese consumer (not necessarily in the form of China stores). The sales won't always take place in China, which creates a slower headline retail sales growth in China and makes it looks like Chinese consumers are spending less, which could hurt US retailers investing there. But that's a wrong way to think. Hope that clarifies. And again, sorry if I came across rude.

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