Why You Should Avoid the Surf/Skate/Snow Sector

15 Jan, 2013

The last five years have not been favourable to the surf/skate/snow industry. The major players, including Burton, Volcom, Quiksilver, Billabong, and Nomis have had a hard time competing.

Recently, Burton shut down three of its brands: Special Blend, Foursquare, and Forum Snowboards.

Yes, you read that correctly, they shut them down; there was no buyer. Volcom sold out to PPR
International for $24.50 per share, significantly less than its all-time high of over 50$ per share in
2007. Since going public in 2009, Billabong (BBG) shares have steadily dropped to the current price of $0.88 per share. Quiksilver (ZQK) has endured a massive downturn since 2010, and holds $1.4 billion in debt after an effort to open corporate-owned stores across the globe all at once. Shares trade at around $5.00 today, while debt exceeds book value by 50%. One thing remains true in the surf/skate/snow sector, the cool factor sells, but can it be a source of sustainable profitability?

A number of factors have caused economic hardship for most of the players in the sector. At the
most basic level, the economic recession reduced consumer spending. The recession took a toll on the industry specifically, because the wholesalers and retailers in the sector tend to be
small firms. The customers, who value the cool factor of authentic brands, shop at smaller, cooler retailers. When spending decreases, retailers automatically cut back their purchases, reducing revenues for the entire value chain of the sector. For the last two years in the Northeast, the lack of snow from October to December, the key winter shopping season, has hurt the snow companies as well.

Nomis Streetwear recently filed for bankruptcy and was acquired by a Montreal-based competitor. According to its new President, “the reason industry sales are dropping is because there are way less small, authentic shops than ever before. The sheer size of these stores makes it very difficult to survive during tough economic cycles. As more stores close up shop, the brands are forced to compete for the remaining customers.” Many of these brands sell to big-box retailers as a way to strategically manage inventory. The idea is that the brands can over-purchase from their suppliers and never lose sales to shortages, knowing they can sell their overstock to big-box retailers at near-cost prices at the end of the season.

Today, in order to sustain operations, the brands are selling more and more to these big-box retailers, and being less selective in what they offer them. While this may be the only way for small brands to survive, selling at discount prices outside of edgy stores harms the brand image. What used to be a strategic move for these brands to avoid overstock is becoming part of the core business. The brands are shifting from selling to many, small stores, to fewer, larger discount stores, and losing market power in the process.

From an economic perspective, the industry is in profit-declining mode. “As we compete for market share, the industry enters a price war, driving prices lower and lower,” says the President of Nomis Streetwear. To increase sales, individual firms continually lower their prices to become the most appealing brand to the retail stores. This causes revenues and profits to decline across the industry.

As a result, some firms shut down as profit opportunities seem bleak. The exit of these firms reduces the competition and supply of product, eventually driving prices back up over time. Once profits begin to rise again, firms will re-enter the industry, thus continuing this never-ending cycle of market exit and entry. Therefore, in economic terms, the surf/skate/snow industry is experiencing the waning side of a cycle that all monopolistically competitive markets face; one where profits are lower in the short-term, but should restore to normal levels in the long-term.

For the time being, I would recommend a ‘hold’ position for stocks in this industry. I expect the
industry index to sustain further losses prior to rebounding. In the long-term, as many small firms
are pushed out of the market, revenues and profits should rise. However, there is a risk that overall market demand for surf/skate/snow products has dropped permanently. In such a case, the market prices for these stocks may never fully rebound.

Disclosure: I have no financial position in any of the aforementioned publicly-traded stocks, and
no plans to initiate a financial position in the next 72 hours.

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