Hering’s Top Return Ranking Threatened by Gap’s Arrival

Cia. Hering, the clothing retailer with Brazil’s best-performing stock offering since 2007, is bracing for slower sales growth and increased competition with the arrival of Gap Inc.

The Brazilian chain known for affordable jeans and T-shirts plans to increase its Hering Kids stores more than 10-fold to 250 outlets even as the company confronts a cooler domestic economy, Chief Financial Officer Frederico De Aguiar Oldani said in an interview. Hering ended 2012 with more than 500 stores.

Renovations and celebrity marketing campaigns financed by Hering’s offering helped more than triple sales in the past five years. Now, a Brazilian retail clothing market valued at 100 billion reais ($49 billion) is drawing in Gap, the largest U.S. specialty-apparel merchant, with its first local store in 2013 and the prospect of more to come.

“What you can’t do is get left behind,” Oldani said by telephone from Sao Paulo. “You have to keep attracting your client to the store, showing that you are evolving.”

Hering, whose stock was held largely by its namesake family, was managed as a private entity before the 2007 offering valued at $312 million reais ($153 million). The capital, which also helped pay for a wider array of apparel rotating through stores, was needed to fuel a comeback after what Oldani described as major financial difficulties since the 1990s.

Biggest Advance

Hering climbed 10-fold afterward, the largest gain among 250 Brazilian companies in the period, according to data compiled by Bloomberg. The shares surged 25 percent in the past 12 months, beating the 5.7 percent advance on the benchmark Bovespa index.

Investors embraced gains in earnings and sales that the company says it probably won’t be able to replicate.

Hering’s margin on earnings before interest, tax, depreciation and amortization, or Ebitda, widened to 29 percent in 2011 from 8.1 percent in 2007. Revenue jumped 41 percent in 2010 before tapering off, as inflation and a slowing Brazilian economy muted the sales increase to 13 percent in the 12 months that ended in September.

Going forward, “growth probably will not be as strong, and we have a certain worry because inflation is high and should continue to increase, and labor costs are also increasing,” Oldani said. “The scenario continues to be good, but not as good as the last five years.”

‘Growth Curve’

Brazil’s retail clothing market, which had “positioned itself on a strong growth curve,” will probably align more closely with the national economy in 2013, said Marcelo Villin do Prado, director of IEMI Inteligencia de Mercado, a research institute that specializes in textiles.

Gross-domestic product will probably grow just 3.3 percent in 2013, according to a Dec. 21 central bank survey of about 100 economists. Economic expansion may have slowed to 1 percent in 2012, the median forecast in a Bloomberg survey, from 7.5 percent in 2007.

The arrival of Gap further complicates the landscape for Hering. San Francisco-based Gap disclosed its Brazil store plans last month and signaled that more outlets may be on the way.

The U.S. retailer, and potential followers including Uniqlo Ltd. and Hennes & Mauritz AB, mark “the beginning of the possibility of a long term trend of new competition,” said Francisco Chevez, a New York-based analyst at HSBC Holdings Plc.

Outside Competitors

Brazil has been a battleground before for home-grown companies facing outsiders trying to tap Latin America’s largest economy.

Local lenders such as Banco do Brasil and Itau Unibanco Holding SA still dominate Brazilian retail banking amid pressure from rivals such as Spain’s Banco Santander SA. Citigroup Inc. formed a partnership in 2012 with Elavon Inc., a U.S. payments-processor that says the venture seeks to capture 15 percent of Brazil’s market for card transactions in its first five years.

In food retailing, Cia. Brasileira de Distribuicao Grupo Pao de Acucar has retained its No. 1 position amid competition from Wal-Mart Stores Inc. and Carrefour SA of France. Saint-Etienne, France-based Casino Guichard-Perrachon SA gained control of Pao de Acucar in 2012.

‘Great Potential’

Hering and Gap want to take advantage of an increase in consumers’ disposable income, which HSBC says tripled to $10,000 a year in 2011 from six years earlier. Gap plans to achieve its goal in part through competitive pricing and is willing to accept lower profit margins because of it, said Stefan Laban, the company’s managing director of strategic alliances.

Gap sees “great potential” in Brazil, said Laban, who declined to discuss sales projections. The retailer’s international revenue reached $2.1 billion last year, compared with $12.4 billion in North America.

Gap has been “very clear” that global franchises are vital growth areas because they provide among the highest returns, Richard Jaffe, an analyst at Stifel Nicolaus & Co., said by telephone from New York.

“Much of the risk, the investment in the bricks and mortar stores, is incurred by the partners in those countries, so that becomes a very low risk-return venture for them,” Jaffe said.

‘Many More’

Gap has seen “very strong” sales in the other Latin American countries where it has operated since 2011, Laban said in a telephone interview from London. The company studied Brazil for five years before agreeing to franchise its first local store with Tudo Bom Comercio.

“We don’t come to Brazil to open three stores,” he said. “It’s going to be many more than that.”

Oldani, the Hering CFO, said Brazil’s retail market already was highly competitive even before Gap’s arrival. The Hering Kids expansion, from 20 stores today, is part of the effort to prevent stagnation -- and fend off new rivals.

“We don’t have the level of penetration that we think we can reach,” Oldani said.

Hering’s changes also won’t stop with the growth at Hering Kids, he said. “You have to be able to reinvent yourself without losing your DNA,” he said.

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