Why Walmart and Target Will Win the Freight-Rate War

Date: Friday, October 15, 2021
Source: Sourcing Journal

Fashion and freight are fickle foes.

LVMH CFO Jean-Jacques Guiony lamented the “rising cost of shipping” as a “fact of life” this week, the latest industry executive to sound off on cash-draining logistics fees plaguing companies large and small. Boohoo reported first-half shipping expenses $35 million higher than pre-pandemic comparisons. And Drewry’s “Container Forecast” report last week sees little chance that cargo disruption will abate anytime soon. The maritime and shipping research and consulting firm doesn’t expect the ocean freight sector to normalize until the end of next year, though it projects 2022 will bring a much-needed decline in spot rates along with a significant increase in contract pricing. That could translate to a 6 percent uptick in average global pricing.

Though many retailers are currently absorbing the costs, UBS retail analyst Michael Lasser believes sporting goods and grocery retailers are best positioned to raise their prices, based on Consumer Price Index (CPI) data on inflation trends over a two-year basis. Sporting goods saw inflation rise 6.6 percent, while grocery climbed 5.4 percent. Household major appliances saw the largest CPI increase at 12.2 percent.

At the other extreme, apparel was at minus 3.3. percent, reflecting the lowest level of CPI on a two-year basis in 2021 and meaning the category would have a harder time passing along the higher freight costs to consumers, Lasser said.

That could mean that retailers such as Walmart and Target might not be able to raise clothing prices but might get away with it in grocery. And dollar stores as a distribution channel might find that shoppers balk at the prospect of paying more.

“Ultimately, we believe that retailers like Dollar Tree and Five Below may struggle to pass on prices to consumers due to their fixed-price structures,” said Lasser, who expects the companies he covers, including Walmart and Target, to offset a portion of the freight increases by wielding their vast purchasing power.

“We expect most of the hardline/broadline retailers will lean on pricing power to at least partially offset shipping headwinds. That said, if sales begin to moderate in [the second half of 2021] and in 2022, shipping headwinds would likely be more evident, regardless of retailers’ ability to pass on prices,” Lasser said.

Citing Journal of Commerce data for fiscal 2020, Lasser noted that Walmart imported the most 40-foot equivalent containers in at 465,000, followed by Target at 325,000, Dollar Tree at 90,000, Williams Sonoma at 44,855, Dollar General at 34,523, Costco at 23,130, and Amazon at 20,650.

Walmart and Target were also the top two for imports of 20-foot equivalent containers last year, at 930,000 and 650,000, respectively. Dollar Tree imported 180,000, with Williams Sonoma at 89,710, Dollar General at 69,046, Amazon at 46,259, and Costco at 28,831.

Lasser pointed out that the average 40-foot container rate from Shanghai to Los Angeles cost $4,100 in the fourth quarter of 2020, rising to $4,300 in Q1 this year. By Q2, the rate leaped to $7,500, then to $11,000 in the third quarter to date. Contract rates have been rising, too, increasing 28 percent month-over-month in July and up 85 percent year-over-year in August, according to the Xeneta Index’s data on long-term contract rates.

“Regardless of whether retailers are having their contracts honored, they are likely still experiencing pricing pressures,” he said, citing a demand-supply mismatch, ongoing labor challenges and holiday season pressures are reasons why the disruption and steep fees will continue.

Dollar Tree expects 60 to 65 percent of its product to be fulfilled by contracts. Forecasting inventory enables retailers to lock in contracts and skirt the costly spot-rate market.

“Even retailers that have had more of their shipping contracts honored are still likely experiencing contract pricing pressures, or will experience them soon when their contracts come up for renewal,” Lasser said. For the near term, retailers could look to offset the freight pressures through sourcing changes and price increases.

Walmart’s size means it imports a significant number of containers. However, a “larger percentage of its contracts are likely being honored, keeping it out of the more expensive spot market. Plus, it has the ability to pass on some of the increases to the customer. Further, it has a significant amount of sales to counteract increased prices across its the supply chain,” Lasser said.

Walmart CFO Brett Biggs revealed in August that the retailer was chartering vessels to avoid out-of-stocks during the critical third and fourth quarters, following Home Depot’s example earlier this year.

Because retailers import so much each year, even a slight shift in pricing—or movement in the ratio of contract to spot rates—could materially impact their bottom lines.

Walmart averages 125 40-foot containers for every $100 million in U.S. sales, while Target averages 347 40-foot containers by comparison, Lasser said. Dollar Tree said it imports 405 40-foot containers for every $100 million in sales for Dollar Tree, while Family Dollar imports 144. Lasser described Dollar Tree as being at the greatest risk of seeing elevated headwinds from increased shipping rates due to its fixed $1 price points.

Lasser projected how retail might contend with contract prices and spot rates.

Using an 80 percent contract rate/20 percent spot rate ratio as a starting point, with contract rates at $2,000 and spot rates at $8,000, Lasser said a 5 percent shift in contracts would move that ratio to 85 percent at a $3,000 contract rate and 15 percent at a $10,000 spot market rate.

For retailers, that translates to more than a 25 percent increase in container costs from the base scenario. If contract rates move to $3,500 and the ratio shifts to 90 percent of shipments fulfilled by contracts, and presuming spot market rates of $12,000, retailers would see an additional 7 percent in container costs. But if rates dip in 2022, using a 90/10 ratio, and a rate of $1,750 for contracts and $7,500 in the spot market, Walmart could potentially save $400 million.

Shipped has sailed for holiday

A day after President Biden received a commitment from top retailers, delivery firms and the major twin ports to step up processing of containerized goods, JOC by IHS Markit warned that due to the delays at U.S. ports, consumer goods from Asia will need to have cleared U.S. ports by now compared to the usual early November cut-off date or risk not making it onto store shelves in time for Black Friday.

The warning comes as 1.59 million TEU (20-foot containers or equivalent units) arrived in the U.S. in September from Asia, up 13.8 percent from pre-Covid levels in September 2019, according to PIERS by IHS Markit. The elevated imports levels from Asia send a clear message that the port-related congestion problems are like to continue into 2022, according to HIS Markit and other experts.

High import volumes contributed to the port congestion, including taking longer to move containers off the pier and unload them at distribution centers, removing significant capacity from the system over the past few months.

“Given the delays in the supply chain and ongoing port congestion, most retailers have prioritized their holiday goods this year, aiming to get them into the country earlier than usual,” Mark Szakonyi, executive editor of The Journal of Commerce by IHS Markit, said. “Unless importers shell out for significantly higher air cargo rates, consumer goods that are not in the country by now are unlikely to make it under the tree.”

This comes as the latest Port Performance Data by IHS Markit shows that the time vessels spend in key West Coast ports waiting and unloading cargo deteriorated significantly in August to 348 hours for Los Angeles versus 255 hours in July, and 268 hours for Long Beach versus 190 hours in July. These numbers are around triple what they would have been before pre-pandemic in August 2019, the data showed.

The global supply chain is also being impacted by the recent Covid outbreaks in China and Vietnam, as well as power outages in China leading to more delays in shipments, IHS Markit note.

“What’s happening in the container shipping market is not entirely a demand-driven phenomenon anymore,” Rahul Kapoor, vice president of maritime and trade at IHS Markit, said. “Months of Covid-19-induced stress has led to the container supply chain being broken, while the distress continues to be accentuated by congestion, landside restrictions and lack of equipment.”

Any slowdown in imports could be short-lived, as retailers need to re-stock their warehouses after the holiday sales.

“Despite some short-term let-up, we see the global container and import bottle necks continuing well into the next year,” Szakonyi said. “Shipping costs remain elevated and with so much dislocation of containers and port delays, importers and retailers will need to get used to things taking longer and being more expensive to reach the shops.”

On Wednesday, the Port of Los Angeles followed the Port of Long Beach’s move to a 24/7 schedule. Commitments also came from several major players to utilize the new, expanded hours.

Walmart said it would use night-time hours, which the White House said could raise the retailer’s throughput by up to 50 percent over the next several weeks. Target, which currently moves about half of its containers at night, committed to increasing that by 10 percent over the next 30 days. UPS said planned changes would allow it to move up to 20 percent more containers and FedEx estimated it could double the volume of cargo it moves out of ports at night.

“This is a big first step in speeding up the movement of materials and goods through our supply chain, but now we need the rest of the private sector chain to step up, as well,” President Biden said. “This means the terminal operators, railways, trucking companies, shippers and other retailers, as well.”

The port congestion crunch is also being felt on the East Coast. CMA CGM told customers this week that its AMERIGO service connecting the western Mediterranean to the U.S. East Coast will temporarily stop calling on the port of Savannah, Ga., “due to severe congestion in this port” of eight to 10 days and “in order to protect schedule integrity and weekly sailing frequency.” Savannah-bound shipments will be directed to a new call at Charleston, S.C.

Hapag-Lloyd alerted customers last week that their “cargo planning might be affected by the changes in our Atlantic Loop 3 (AL3) service.”

“In our continuous efforts to optimize our service portfolio, stabilize schedules and adapt to market needs, we will adjust the AL3 service by temporarily removing the port of Savannah…from its rotation,” Hapag-Lloyd said. “The call will be replaced by adding the port of Jacksonville” in Florida to its rotation.

Flexport chief economist Dr. Phil Levy said in a separate commentary that the unusual pandemic-era demand for goods has exceeded the effective supply capacity for far longer than the system is designed to handle, “but supply capacity is very hard to change quickly.”

“It takes time to build new ships, expand ports or recruit and train new truck drivers,” Levy said. “In opening the Port of L.A. full-time, the next question will be whether or not there are enough trucks to carry out the additional volume and how efficiently they can get in and out. The administration can and should make the system more efficient, but the core problem will still come down to demand, which our Flexport Platform data doesn’t forecast to recede anytime in the near future, barring an income shock.”


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