Dive Brief:
- Warehousing costs and U.S. inventories rose for Hasbro in the second quarter of 2019 as the toy brand prepared for the possibility of tranche four tariffs, executives told analysts on Hasbro's earnings call Tuesday.
- Retailers can buy products from Hasbro in the U.S., in which Hasbro is the primary importer, or directly through Hasbro's manufacturing locations, known as direct import. "In the second quarter, some retailers briefly paused direct import orders," CFO Deb Thomas said on the call. "As a result, we expect to see direct import orders decline as a percent of the total this year." Hasbro acting as the primary importer leads to increased shipping and warehousing costs for the brand, she said.
- Thomas said even as Hasbro has diversified its manufacturing locations, "China will continue to be an important part of our global supply network." In 2018, 67% of the products Hasbro sold in the U.S. came from China.
Dive Insight:
In a 7-day streak of hearings about the fourth round of tariffs, which would have imposed duties of up to 25% on $300 billion worth of Chinese imports, many witnesses who testified lamented the implementation of these tariffs would complicate their supply chains, raise costs and erode margins.
What few mentioned was that, even without this fourth tranche of tariffs in place, businesses must plan for the possibility they could be implemented in the future, and that planning carries significant costs.
"While no new material tariffs have been enacted on our products, we did incur incremental expenses to prepare for the potentiality of tariffs in the U.S.," Hasbro's CEO Brian Goldner said on the call.
Risk and resilience planning is a hallmark of Hasbro's strategy, whether it's mitigating the loss of major customer Toys R Us or navigating what executives described as a "dynamic" trade environment.
For years, Hasbro has been diversifying its manufacturing footprint as part of its risk mitigation strategy, according to Thomas, and the toy brand accelerated that effort in the second quarter with the cloud of tranche four tariffs looming. "During the quarter, we increased our resources invested in this program ... and as a result, have taken on more costs," Thomas said.
Goldner said Hasbro has started new production in India and Vietnam, and it sources 20% of its products sold in the U.S. from U.S. manufacturers. The toymaker plans to lower its share of China sourcing for U.S. products from 67% last year to 50% by the end of 2020. Executives did not specify if manufacturing costs are higher for the products it sources from the U.S.
The ongoing trade war has prompted a reduction of sourcing from China (or at least a desire to do so) among organizations that rely heavily on the market for production. In the U.S. Fashion Industry Association's latest benchmarking study, 83% of respondents said they plan to reduce China sourcing, up from 67% who said so in 2018, seeking low-cost alternatives such as Vietnam and Bangladesh.
Still, China remains an important market with the infrastructure and labor capabilities to produce a variety of SKUs, the study noted, a position Goldner echoed. "China continues to be a high-quality, low-cost place to make toys and games and it will continue to be part of our global network in a major way," he said on the call.
Like many other U.S. importers, Hasbro pulled forward inventory during the quarter in anticipation of tariffs, resulting in higher domestic inventory levels and additional warehousing expenses. Overall, inventory declined 7.45% year-over-year.
Storage costs could continue to rise if retailers' buying patterns shift as a result of tariffs and move away from direct imports, Thomas said. "While we can build other programs over time, in the near-term, Hasbro will be the primary importer. This increases shipping and warehousing costs," she said.
Despite challenges related to rippling effects of the trade war, Hasbro had a strong quarter with revenue up 9%, and it expects "profitable growth" for the rest of the year, according to Thomas. The implementation of tranche four tariffs, should it occur, would likely impact gross margins and be "very disruptive to our business and consumers in the near term," she said.
