Retailers had to plan ahead this holiday season in order to avoid paying higher prices for goods. That caused the trade deficit between the U.S. and China to increase dramatically as retailers hoarded goods to avoid the expected increase in tariffs that has been delayed. That's going to cause inventory issues that may impact Q1 results in a negative fashion.
A full transcript follows the video.
This video was recorded on Dec. 13, 2018.
Nick Sciple: Dan, on the back half of the show, as I mentioned, we're going to talk a little about what's going on from a macro perspective affecting logistics and shipping. The first thing I want to talk about is tariffs.
I know, it's a big issue. We've had several rounds of tariffs this year. The most recent news that we got was an agreement between President Trump and President Xi of China to declare a ceasefire in what has been an ongoing trade spat between the countries, which would delay increases on tariffs, which are currently 10% and were set to increase to 25% January 1st. It's going to delay that tariff increase for at least 90 days, to continue negotiations with that trade dispute.
We would have expected to see the trade deficit between the U.S. and China to shrink as a result of tariffs. Actually, we have seen it surge in a very significant way over the past few months. In October, it hit the highest it had ever been at $43.1 billion. Part of that has come because this expectation for tariffs to increase on January 1st to 25% has incentivized a lot of exporters in China and a lot of importers in the United States to front-load their shipments to beat that increase in tariffs. Now that we're not seeing that increase, what does that mean for U.S. retailers and for logistics providers across the world.
Dan Kline: It's a problem. You bought a lot of, I don't know, shovels. You bought a lot of shovels at $10 because you didn't want to pay $12 for them. Now, they might not cost $12, and you've tied up all that money in those shovels. Let's hope they sell. But what if you over-ordered? What if your stockpile doesn't match demand? You're going to have some dead inventory. You're going to have some inventory that maybe they make up a little bit because they sell it after the holiday season at a good price. But people hedged against uncertainty, and there's still a ton of uncertainty.
Sciple: Yeah. We still don't know, when that 90 days comes around, that these aren't going to get jacked up again. Another factor to think about is that it wasn't just one retailer doing this. Large numbers of U.S. retailers, all looking to get their goods to market before this January 1st increase, while there's only a limited supply of logistics infrastructure to make that happen. I'm sure they paid a little bit higher rates to make that stuff and get here that ended up not being necessary.
Kline: When you run a smaller retailer -- as we've talked about, I ran a toy store that did a couple of million dollars in sales a year -- you have to make your Christmas decisions in the summer. You're staking out your inventory, your Legos, your stuff that's going to sell. This is not as big of a problem at Walmart or Target. Let's say I banked on, "I'm going to buy a bunch of Han Solo Star Wars Legos for my toy store," and then the movie tanks. That's what's kind of happening here. Stores that don't normally have to make big bets in advance had to make big bets in advance.
If those bets were right, it won't matter. It'll probably all even out, in terms of the pricing. But the reality is, that's not how it happens. If you're Walmart, you can make a relatively small bet for Walmart and then just order more. Instead, they're chock-full of stuff, and we will probably see a slowdown, a pretty big slowdown, in ordering in the first quarter.
Sciple: Right. This inventory that we had built up is going to have to roll off before we can make meaningful new investments in inventory.
Kline: And without being too political, you can say 90 days, but I think we're at a time where every one of us in this space wakes up in the morning and checks the news to make sure nothing crazy happened. War with Canada, invaded Mexico, who knows? [laughs] That, as a buyer, as a national or global retail chain, that has to weigh very heavily on every decision you make right.
Sciple: Right. As you mentioned, businesses really don't like uncertainty. We see that in the stock market. As uncertainty rises, we see more volatility. And we see that in these logistics infrastructures. Just as an aside, this is not a problem that is unique to the United States. We're seeing a very similar problem in Britain ahead of Brexit. They've had a massive demand increase for storage facilities in anticipation of Brexit, disrupting a lot of the trading relationships in that region. We've seen retailers over there stockpile on inventory and stockpile on storage. It creates a difficult situation for businesses.
Kline: You're getting a one-two punch here. You have all this inventory. You also have all the logistics and the increased trucking of the season. Moving all this stuff around is more expensive. It would be cheaper to order stuff for delivery February 2nd than to get it December 2nd. So, you're adding to the cost. And some items, you can price higher. Some items, consumers are only going to pay what they're willing to pay. If Amazon holds the line and paper towels are $3.99, you're not going to get $5.99 at Walmart for them. That's a terrible example, nobody knows what paper towels cost. [laughs]
Sciple: It's OK, Dan. What we want listeners to take away here from this tariff talk is, yes, it's great news that we're getting a delay in the increase of these tariffs. It's probably going to be good for consumers, they're not going to have to pay higher rates than they would have in the past. However, businesses took steps assuming that these things were going to be in place. They realized some expenses they did not have to to prepare for these circumstances. And the premium they paid for goods, to get them here quicker in anticipation of these tariffs, is extra money they're not going to get back. I heard some of our other podcasts talking about, when weather comes through and restaurants don't get sales. Those sales aren't going to come back. The same way, paying for these goods to get to market, you're not going to get that back in margin. It's something to think about in the context of tariffs and shipping in general.
Kline: As an investor, as you look at these companies, you really want to look at same-store sales and increase of sales. You're not going to look at cost of goods sold because it's an anomaly. We are not going to have this uncertainty forever. At some point, we're going to sort out the tariffs. Now, there's other instability. At times in the past, gas prices have created pricing instability. But this is a real wild card. You probably have to back out some of this expense when you look at the health of an actual company.
