High ESG risk fashion industry continues to threaten investor capital

Luxury apparel faces counterfeit risk

clock • 2 min read
25 out of 36 companies in Morningstar’s coverage have faced controversy over human rights abuses.
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25 out of 36 companies in Morningstar’s coverage have faced controversy over human rights abuses.

The fashion industry is staying true to its reputation as an ESG laggard, as risks abound regarding climate change, human rights abuses and business ethics, according to a Morningstar report.

One of world's largest industrial polluters, the $1.7trn industry accounts for 10% of annual global carbon emissions, outpacing emissions caused by all international flights and maritime shipping combined.

Out of the 36 companies in Morningstar's apparel, luxury, footwear and retail coverage, 25 faced controversy over human rights abuses, with six involved in a category level 3 event (5 denotes those with most severe impacts).

Morningstar said that while it anticipated companies could manage risks over the long-term, it expected short-term volatility around cost and supplier relations will remain.

Industry voice: Fashion consumers want more clarity from retailers on sustainability

One risk at the heart of the luxury apparel sector, traditionally an area facing lower threats, is the rise of counterfeit goods as sales shift to online channels, especially across resale outlets like Poshmark and The RealReal.

Morningstar found that human capital remained a critical issue facing the apparel sector, while retailers continue to work with highly labour-intensive operations.

The apparel and luxury goods sector was still able to boast a high average gender diversity ratio, however, suggesting lower risk of outsized turnover, Morningstar said.

Nevertheless, some individual stocks face threats to their valuation, including apparel manufacturers Hugo Boss and Moncler.

The pair face the highest risk levels given their "near-luxury status", which causes concern from a taxation and anti-competitive standpoint, as does their reliance on labour and brand ambassadors.

Apparel retailers, including fast fashion players H&M and Inditex remain highly exposed to valuation volatility, owing mainly to environmental concerns alongside additional risks from data privacy and security.

Asos and Boohoo among firms investigated over greenwashing claims

"Apparel manufacturers face environmental risks, given the substantial carbon footprint, water usage and emissions waste of clothing construction, and the rising use of polyester materials," said Adam Fleck, director of equity research ESG at Morningstar.

"Efforts to substitute alternative or recyclable fibres could offset this risk, but at a cost. We view companies with brand-led intangible asset driven economic moats as best placed to share this pain with suppliers, such as Richemont, Hermes, LVMH and Nike," he added. 

Morningstar said Nike's "powerful brand and digital strategy" position it well, despite some short-term issues with the stock.

"We do not believe the ESG risks that affect Nike will have a material long-term impact on its investment prospects," the report said.

Nike is one of many fashion retailers to have faced financial ramifications as a result of labour abuses in China.

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