Why clothing retail is not a snug fit for our local JSE players
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The relative underperformance of local clothing retail versus the general market is attributable to several factors. General macro conditions such as weak economic growth, stubborn unemployment, and high inflation and interest rate have forced consumers to tighten their belts.
Other leading factors include loadshedding, increased minimum wage, security, and resultant insurance costs. However, one of the most exciting trends gaining more and more traction is increased competition from international players – especially Chinese etail behemoths such as Shein. They have already taken the world by storm, and South Africa is no exception.
Some analysts have documented that the management teams of these local companies should have seen the threats coming for some time and made efforts to digitise sooner and quicker. If you look at Foschini Group, BASH, Shoprite and UNIQ, many have tried. It is difficult to expect these companies to invest heavily in digital infrastructure in an environment not conducive to business. Pick n Pay commented in its last results that it spent more than R500 million on diesel to run its generators for the year ended 26 February 2023.
The reality is that this has caused a lot of them to fall behind, and it is difficult to imagine how they will catch up. This becomes even clearer if you look at the strong moats of their opponents and the escalating adoption of e-commerce since the pandemic, where cash-strapped consumers continue to save where they can due to the current high inflation and interest rate environment. We suspect that about 50% of all retail purchases in SA are now online, which is likely to grow. It is estimated that the global E-commerce market is valued at more than $3.2 trillion already.
Shein (pronounced "She-In")
Shein has become a household name globally, taking the world by storm over the last decade. Started in China by Chris Xu, the Chinese apparel behemoth is operational in over 150 countries and sells billions of items annually. It is the crème-de-la-crème of fast-moving fashion at a decent price and worth almost as much as Zara and H&M combined. It was the U.S.'s second most downloaded shopping app last year (only behind Amazon). It is also fast becoming one of the most popular shopping apps in South Africa.
It capitalises on the opportunity to leverage China's low-cost supply chain, a moat even the biggest global players struggle to compete with. Products at Shein are up to a third or a half of the price you would pay at traditional brick & mortar retailers. For reference, the average cost of a product at Shein is approximately $16 per item, that's 50-60% cheaper than the average cost at Zara or H&M of $35-$60.
Digital platform second to none
Powerful recommendation algorithms analyse user profiles, online habits and historical data to pick up trends in a fashion faster than anyone else. The entire supply chain is digitized, from managing suppliers to marketing trends, which allows the company to have much faster lead times and inventory turnover than its rivals.
Shoppers can take photos of a garment, a top, or any other clothing item from a competitor and load them onto the app. It will find you something similar from its massive database, probably at a cheaper price – this is very difficult to compete with and quite a scary notion for the likes of Mr Price, Pepkor. Truworths and Foschini Group.
Conscience vs convenience
A business model like Shein does not come without problems; it is known as a pariah of sustainability in some circles due to the ultra-cheap disposable fashion. Returned items are thrown away instead of being resold as cheaper – not good for the environment.
The major issue, of course, is unfair labour practices in Guangzhou province and IP theft. The company has been in legal disputes with Ralph Lauren and Levi Strauss. There are also allegations of design theft from young and upcoming designers and artists via social media without compensation.
If I am paying less and able to save, how conscious will I be about environmental effects and where the product comes from? Not everyone has that luxury, especially in South Africa.
Not clothing alone
It's not just our clothing retailers that are under threat. Launched by US-listed PDD (Pinduoduo) last September, Temu is already the number one downloaded US shopping app in 2023. Currently, the company only ships to US customers, but we wouldn't expect this to be the case for too long. With a massive 10 million merchants on the platform, Temu's offering is not limited to clothing alone but includes technology, kitchenware and other merchandise. This will affect other operating segments of our local players and retailers.
Import duties
Local retailers have lobbied against and complained about the likes of Shein not operating on a level playing field, sending small parcels of below R500 bypassing import duties, and paying 10-20% on average as opposed to the 40-45% payable by the larger retailers ordering in bulk. The DTI is investigating this, and these levies will likely be raised to protect local industry.
The sheer pricing power of these companies and the efficiency of the underlying technology makes us feel that even though import duties will have an effect to an extent, it does not extinguish the threat completely.
Stock prices tell a story
All the above is reflected in the share prices of our local retailers. None are cumulatively in positive territory over a 5-year investment horizon, except for Pepkor at just over 2%. Only retailers with proportionately larger product mixes in more inelastic and perishable food components are keeping up with or beating the market, i.e., Shoprite and Woolworths. Interesting to note that the JSE All Share Index (J203) has delivered approximately 32% without accounting for dividends over this horizon.
Fundamentals are not bad, but cheap for a good reason
This is what we like to call a "value trap." These companies are cheap for a good reason, as structural problems will permanently affect earnings in the future. It shows why investors cannot look at fundamentals alone and need to ask why companies are trading at deep discounts to their historical valuations, other sectors, or the market as a whole. The entire picture needs to be unravelled, and for SA clothing retail, it's not pretty.
OPEN AN ACCOUNT NOW to partner with Martin Strauss.
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