West Coast Port Strikes: The Price Of Flexibility by ColumbiaManagement
- Disruption from the West Coast port strikes is likely to continue for several months.
- The situation could pressure both sales and margin for retailers ahead of the Easter holiday.
- Retailers are exploring geographic diversification of their manufacturing base and other supply chain initiatives to improve flexibility and profitability.
Since August 2014, volume through the West Coast ports slowed dramatically, as negotiations between management and the longshoremen stumbled over wage and benefits increases, truck chassis protocols and the arbitration process (Exhibit 1). Once President Obama dispatched Labor Secretary Perez to resolve the dispute at the end of February, the sides quickly came to a tentative agreement, and crews are now working to clear the massive backlog of containers.
Sources: Ports of Los Angeles, Long Beach and Oakland, Wolfe Research
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Most shippers did not anticipate these delays, and with the offshoring of production to Asia, many supply chains that rely on the West Coast ports have broken down. To avoid stockouts, customers are diverting to other ports in North America. In fact, container volume on the western railroads declined while eastern and Canadian loads spiked but have started to normalize since the tentative agreement (Exhibit 2).
Sources: American Association of Railroads, Wolfe Research
For urgent needs, customers shifted from the ocean to air cargo, as shown by the swing in Expeditors’ fourth quarter revenue mix (Exhibit 3). But, some supply chains failed: Honda shut down three assembly plants in February as critical parts were unavailable.
Source: Expeditors company reports
The congestion will linger for several months and disrupt the full-price selling season into the Easter holiday for many retailers. The earlier Easter and unfavorable weather specifically in the Northeast put even greater pressure on retailers to manage the port situation and maximize full-price sales in the first quarter. Many vertically-integrated retailers and vendors are diverting product to the East Coast and air freighting more product. However, these two tactics should come at the expense of gross margin as air freight costs 4-10x that of ocean. More broadly, U.S. GDP will likely disappoint in the first quarter given the significant – but transient – port congestion and weather factors.
Retailers including Steve Madden, Gap Brands, Williams Sonoma Brands and Lululemon have discussed the potential sales/margin impact from the port delays. The expected impact varies by retailer, but averages roughly two points of same store sales and 50-100 basis points (bps) of gross margin in the first quarter. Vertically integrated retailers (specifically those with large children’s and Easter businesses) and apparel vendors (who bear the cost to deliver product in a timely fashion to their wholesale partners) face the greatest sales and margin risk. In contrast, off-price retailers are best positioned to capitalize on the port-related inventory disruption given the flexible nature of their buying processes and supply chain.
Since the 11-day lockout in 2002, the West Coast ports have lost 400 bps of market share, and many shippers will further diversify away from these locations. With a wider Panama Canal in 2016 and new production in Southeast Asia supporting routes through the Suez Canal, many ports are adding capacity. On the East Coast, Savannah, Charleston and New York/New Jersey are dredging to allow larger ships, APM is doubling its terminal capacity at Lazaro Cardenas in Mexico. Prince Rupert, a secondary Canadian port, is increasing throughput by 53%.
Similarly, retailers and vendors are seeking diversification of their manufacturing base in order to better manage costs and improve their flexibility. Specifically, several retailers are moving production to Central/Latin America with cheaper labor rates relative to China. In addition, the proximity to North America results in shorter lead times and increased flexibility for companies to adjust to current sales trends and maximize profitability. Speed to market is a key focus for many companies, including traditional department stores looking to replicate the success seen by off-price retailers. These companies realize that external factors such as the port strike and macro factors including weather impact their business to a greater degree than was seen historically.
In 2018, the contracts for both the East Coast and West Coast longshoremen will expire. With the looming Obamacare tax on their Cadillac health plans and management’s desire for more automation, are retailers and manufacturers ready for what will surely be a contentious negotiation?