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Mar 27, 2014

H&M sees rising Asian wages squeezing profit margins

Looking at buying garments from Africa
By Mia Shanley and Helena Soderpalm
    
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STOCKHOLM (Reuters) — A drive to increase wages for Asian clothing workers is likely to hit profit margins at world no.2 fashion retailer Hennes & Mauritz (H&M) as weak consumer demand and stiff competition make it hard to pass on the cost to shoppers, it said on Thursday.

The Swedish group issued its warning after missing first-quarter profit forecasts, due in part to investments aimed at catching up with rivals in fast-growing online fashion sales.

Asian factories, which churn out the bulk of clothes for the world's budget fashion market, have come under international pressure to improve wages and working conditions following a string of accidents, including the collapse of a Bangladeshi factory last year that killed more than 1,100 people.

Late last year, factory owners in Bangladesh agreed to a minimum wage of $68 a month, up from $38.

Hennes & Mauritz, which buys about 80 per cent of its stock from Asia and is one of the biggest customers of Bangladeshi garment factories, said rising wages in that country and elsewhere were likely to hit profit margins.

"For purchases made now, wage increases in Bangladesh, Cambodia and China have a negative effect because we are not charging our customers higher prices," chief executive Karl-Johan Persson told Reuters. "That will affect gross margins negatively, all else equal, ahead."

H&M, which says it supports paying clothing workers a living wage and has criticised governments for moving too slowly, has recently been exploring options to buy garments from Africa.

But it is likely to remain heavily exposed to Asia for the time being — moreso than bigger Spanish rival Inditex which sources a greater proportion of products closer to home.

At 1205 GMT, H&M shares were down 4.1 per cent at 277.90 Swedish crowns, one of the biggest falls by a European blue-chip stock.

Missing expectations

Both H&M and Inditex weathered the recent economic downturn in Europe better than many clothing firms, thanks to their focus on fast-changing fashions at affordable prices.

But competition has picked up, with discount rivals such as Britain's Primark and U.S. group Forever 21 expanding across Europe and online firms such as ASOS grabbing market share, making it harder to pass on any extra costs.

H&M said pretax profit rose eight per cent to 3.5 billion Swedish crowns ($542 million) in the three months ended Feb. 28, below even the lowest estimate in a Reuters poll of analysts.

This was partly due to investments in IT and online — where H&M went live in France this month — as it tries to recover from a slow start in growing Internet sales.

Inditex, which owns the Zara chain, last week reported solid annual results, helped by online sales and its greater exposure than H&M to emerging markets.

Some analysts were disappointed by the 12 per cent rise in H&M's quarterly sales at local currencies, which continued at rate level in March, and were concerned higher-than-expected stock levels could lead it to cut prices in the months ahead.

"While part of this miss can be attributed to long-term investments, we believe it is also indicative of weak like-for-like sales performance and price investment, as the company tries to compete in the fast-growing and increasingly populous value apparel world," Bernstein analysts said of the results.

"Sales performance does not seem to have improved in March, and the comps (comparative figures from last year) only get more difficult in April and May. Furthermore, the high inventory levels suggest H&M may see further margin pressure from increased levels of markdown."

Margin pressure

H&M's Persson said trading conditions remained difficult.

"Many still face a difficult economic situation in many parts of Europe, even if it looks a bit brighter in places such as Spain, Italy and Greece," he said. "Then, you have places such as the U.S., where it has been very cold and also a bit challenging economically."

H&M's first-quarter gross profit margin fell to 54.9 per cent from 55.2 per cent the same time a year earlier and against a forecast for 55.3 per cent. Inditex managed to keep gross margin flat in the three months to end January at 57.9 per cent.

H&M, which has almost 3,200 stores, about half that of Inditex, is targeting Australia, the Philippines and India as new markets this year and plans to roll out online services in Spain, Italy and China.

It is also responding to competition by broadening its product offering and rolling out new mid-market brands such as COS and & Other Stories, which it said will open stores in several new countries this year, including the United States.

The group also said it would roll out its well-received new sports line to more stores and countries.

    
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