After nine months of fruitless negotiations, the International Longshore and Warehouse Union and the Pacific Maritime Association agreed to a tentative agreement to re-open 29 West Coast ports.

 

The deal, which came three days after the arrival of Labor Secretary Thomas Perez, must still be ratified by both sides. It will be a huge relief for importers, with nearly half of all U.S. maritime trade and 70% of Asian imports offloading at the ports.

 

Economists may also be breathing a sigh of relief. A prior 10-day shutdown in 2002 cost the economy $1 billion per day, or nearly 4% of the nation’s output over the period.

 

Yet it’s too soon to celebrate the news: Clearing out the backlog of shipments will take several months, which likely portends weak results for many firms in the first and second quarters.  

 

Not Soon Enough
Even when the ports have been cleared of delayed freight and operations return to normal, serious problems will remain. The increase in super-sized freighters has overwhelmed dock workers and bottlenecks for rail and truck transportation are becoming a persistent theme.

 

That issue played a direct role in the contract impasse. Work stoppages increased as union representatives demanded greater training and compensation to handle the increasing volumes.

 

The slowdown has already hit the auto sector — particularly Asian car makers. Honda Motor Co. Ltd. (NYSE: HMC) will slow production for a week at plants in Ohio, Indiana and Canada. Toyota Motor Corp. (NYSE: TM) has said it will reduce overtime at some factories. Fuji Heavy Industries said that the need to transport some parts by air would cost an additional $59 million a month.

 

The $7 Billion Hit
Consulting firm Kurt Salmon estimated last week that the shutdown could cost retailers as much as $7 billion this year. While the tentative agreement may help minimize the final impact, a study of the 2002 strike shows the consequences to the retail sector.

 

Martin Associates estimated in 2002 that, “Under a work stoppage of 10 days or greater, it is assumed that 75% of the daily containerized imports will be lost from the system since a majority of the imports are time sensitive retail cargoes destined for retail sales (many are seasonal in nature or sold under contract with a fixed delivery date), resulting in a direct loss in sales revenue.”

 

Even as operations get back up to speed, fashion retailers could be facing inventory delays for their spring and summer product lines. While some retailers may be able to catch up on sales later in the second quarter, the risk for others is that stock-outs on seasonal products will not be recovered.

 

Michael Kors Holdings Ltd (NYSE: KORS) CEO John Idol said fiscal third quarter (December) results were not impacted by the strike, but Q4 (March) results will be hurt a decision to use costly airfreight services to keep stores stocked. That factor partially explains why shares are down 30% from its 52-week high.

 

David Jaffe, CEO of Ascena Retail Group, Inc. (Nasdaq: ASNA), said in December the port delays have been a “major challenge for us,” with two- to three-week delays on a significant portion of the company’s brands. Shares are off 30% over the last year.

 

While the slowdown has already hit some retail names, bringing valuations down to attractive levels, the broader sector does not seem to have been affected — yet.

 

Shares of both Michael Kors’ and Ascena Retail now sport more reasonable mid-teens forward earnings multiples. The SPDR S&P Retail ETF (NYSE: XRT) is trading at 20.8 times forward earnings and is up 19% over the last year.

 

While not all of retail will be hit by the port slowdown, the fund holds its largest weighting (23.6%) in apparel, followed by specialty stores (16.6%) and automotive retail (13.4%). Full valuations and the prospect of slowing growth for key portfolio holdings means that the fund may become a short sale candidate.

 

 

Risks To Consider: As an upside risk, the brokered settlement could lead to a rally for some of the names in the retail space. The retail fund does not appear to have weakened on the shutdown, so it may not rebound much, but any short position should be offset with a long in other retail names.

 

Action To Take –> The tentative agreement at West Coast ports doesn’t mean retailers are out of the woods just yet. Inventory delays could still spell trouble and investors should consider hedging their position with a short in the relatively expensive retail ETF.

 

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