Apparel Industry Not Immune to Tensions in Russia

Retail shares dropped last week as financial markets reacted to President Vladimir Putin’s retaliation to the imposition of sanctions on Russia. While the ban was imposed on food and agricultural imports, the apparel industry is unlikely to be immune to the effects of the standoff, with majors like Adidas already suffering long-standing issues in Russia.

The escalating tensions between Russia and the West came to a head last week when Putin ordered a year-long restriction on food imports from countries that have imposed or supported sanctions against Russia, including the U.S., the E.U., Norway, Australia and Canada. The sanctions were in response to the ongoing crisis in Ukraine and the downing of the Malaysian Airlines passenger jet in Ukraine’s rebel-controlled area.

According to the Russian decree, the move was made “to protect national interests.” But, according to industry observers it could potentially damage the country’s economy further as current investors pull back and potential investors reassess their plans.

On top of the Ukraine/Russia crisis, there has been a deterioration in the Russian economy for some time, with GDP slowing to around 1% last year, according to global management consulting firm AT Kearney. The forecast for this year, irrespective of the tensions, are in the range of 1-2%.

“For a developing market such as Russia, this is extremely low,” AT Kearney partner Per Hong tells Just-Style. “Particularly when you’re seeing 4% growth in the U.S. and resurgence in other developed markets.”

Fallout from tensions
This, inevitably, means that companies with a large exposure to Russia will have felt the effects most.

German sportswear giant Adidas has had long-standing issues in Russia — the group’s third largest market where it operates over 1,000 stores and sells its products through third-party retailers.

Last month, the company revealed plans to significantly scale back its store openings in the market for 2014 and 2015, and to increase the number of store closures. It also cut in its earnings forecast for the year.

Adidas cited the falling value of the rouble, as well as increasing risks to consumer sentiment resulting from the current tensions as reasons for the move. Yet it is no secret the company has struggled in Russia for some time.

“Adidas’s announcement was timed together with the announcement of the sanctions, but was less tied to the sanctions themselves,” Hong says. “It’s more related to Adidas’s approach in the market itself and maybe some of the fundamental challenges it’s been having there.”

There is no doubt though that the tensions point to higher risks to short-term profitability from the region for many apparel firms.

Vitalij Vladykin, senior research analyst at Euromonitor International, tells Just-Style: “Apparel specialist retailers are starting to feel the pressure because of this crisis in relationships among Russia, Ukraine and other countries.”

According to Euromonitor, overall retailing turnover increased by 2.7% in constant value terms in the first half of 2014 in Russia, with growth rates lower than a year before.

“It is a natural tendency in a situation where there is much negative news and consumers start losing confidence,” Vladykin says.

Taking a step back
This view is one shared by Hong, who believes the uncertainty around the sanctions and overall economic environment, and the risks this presents, is going to slow investment for new entrants into the market, as well as those players trying to grow business in Russia.

Some apparel firms, he says, are “stepping back and reassessing their willingness to take on the risk associated with the market in the broader geo-political, geo-economic context.”

“Where we saw a number of high profile U.S. and European chains like Abercrombie & Fitch considering entering Russia in 2014, it would make sense if they are putting some of those entrance plans on hold until there is an understanding of where the market will go.”

He offers an example: “If I am going to invest my $100 million in this market or invest it in the Middle East, Africa, or another developing market where I think I can get a higher return, [Russia] has now become a very high risk retail development prospect for many companies.”

One of those is U.K. value fashion retailer New Look, which this week put the brakes on a potential move into Russia, citing concerns over the worsening political situation.

CEO Anders Kristiansen told analysts on its earnings call: “We’re not really looking at Russia, maybe we will later, but at the moment we have certainly paused it.”

Bright spot
Despite this, Hong offers an upbeat view of the current Russian retail sector, which he describes as a “healthy” one. The one “bright spot” from the country’s economy last year, he says, was that retail sales expanded and real disposable incomes increased.

“The overall development of retail as a market itself, even in a broader macroeconomic environment with slowing GDP, is that it still remains a little bit of a small bright spot.”

Indeed, according to Euromonitor, the number of apparel and footwear specialist retailers increased by 6% in 2013, as the channel’s leading players continued to expand their presence.

While Adidas leads the market with a 6% value share through its namesake and Reebok brands, Zara and Mango have also been expanding their presence and hold value shares of 2.3% and 0.6%, respectively.

During 2012, Spain’s Mango initiated the development of its accessories brand Mango Touch, and menswear HE by Mango brands in Russia. At the beginning of 2013, it had 121 outlets in the country, a number which had risen to 176 by the end of the year.

“Mango and many of its rivals have recognized there are limits as to how aggressive their expansion in Russia can be,” Euromonitor notes. “Nevertheless, Mango aims to continue expanding in Russia until it is its second largest territory at global level in terms of revenues. At the end of 2013, Russia was its fifth.”

Spanish retail giant Inditex is another company that sees the potential in Russia.

The number of its retail stores in the country stood at 336 at the end of 2013, with the Zara chain accounting for 71, according to Euromonitor. It also launched an internet retailing website in the country last year.

And it appears undeterred by the ongoing crisis in the country, with reports emerging this week that the company has taken its revamped low-cost brand Lefties to Russia.

According to Reuters, Inditex opened two stores in shopping malls in the outskirts of Moscow and a third one in the suburbs of St Petersburg on August 1.

“Major international companies are still interested in the Russian market, just with lower expectations,” Vladykin says.

Nascent demand
Despite escalating tensions, many western retailers clearly believe the demand for their apparel brands is not going to dissipate.

Hong tells Just-Style: “This is a market where there is nascent demand. It’s a very brand orientated label-focused market. Retailers are able to cater to a Russian consumer that has a propensity to spend rather than save, especially in an environment of economic uncertainty. The financial institutions in Russia aren’t safe areas to hold money, so consumers spend. It’s a different dynamic.”

As for whether any further counter-sanctions are likely to be imposed by Russia on the West that could directly affect apparel, Hong believe this is unlikely.

“While many of these retailers are Western-based, they are sourcing much of their product from the Far East. I would find it a very far reaching scenario where there would be a ban on apparel shipments. That would be a hard scenario to imagine possible. There may be other industries that take a target but apparel retail is probably not one.

He adds: “As long as the demand for [apparel] goods continues to go strong, spending will continue. Russia is a high risk, high reward country in the retail stakes.”

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