Lower Cotton Prices Should Spin Higher Margins For Retailers Next Year
December 15 2011 - 11:45AM
Dow Jones News
After crimping retailers' margins by rising to record prices,
cotton may provide some relief.
Retailers are still forming financial plans, but a number have
noted that they expect cotton costs to be significantly lower in
the second half of 2012, which should provide a boost to
margins.
As cotton prices spiked in the last 18 months, retailers raised
prices to cover inventory costs. If they maintain those prices as
cotton prices decline, as many analysts expect, profits will rise
once the higher-cost stock is sold.
The price of cotton, a key component of everything from jeans to
sweaters to t-shirts, has already fallen significantly. Cotton
peaked at $2.15 per pound on a closing basis in March, more than
three times its average price of about 65 cents over the past 10
years. The fiber is now down around 60% from that high to around
85.55 cents a pound.
Higher cotton costs have created pressures on gross margins,
which is the selling price of a product less the cost of goods
sold.
"Retailers will try to maintain as much pricing as possible
because 2011 was a rough margin year for them," said Edward Yruma,
retail analyst with KeyBanc Capital Markets.
Some retailers have been hurt more than others. Speaking on the
company's third-quarter conference call, Jim O'Donnell, chief
executive of American Eagle Outfitters Inc. (AEO), said the teen
retailer experienced "significant pressure" from higher cotton
costs in its third quarter and cotton prices will continue to
affect merchandise profit in the fourth quarter. It will be "well
into the spring" before it starts to see a pullback in prices. "We
do expect to benefit from lower cotton costs" beginning in the
second half of next year, O'Donnell said.
Lower-end retailers like American Eagle Outfitters have felt the
strain because price increases are more obvious by their customers.
There are also more dramatic cases, like Gap. Inc. (GPS), which
said its product costs rose dramatically, putting the retailer
behind the eight-ball in part because lower-end customers at its
Old Navy stores demanded promotions.
But others appear to have skirted major difficulties. PVH Corp.
(PVH), formerly Philips Van-Heusen, didn't see any significant
customer resistance to the price increases it adopted for Calvin
Klein and Tommy Hilfiger merchandise that it sells through
wholesale channels, Chief Executive Emanuel Chirico said earlier
this month.
PVH is likely to keep the higher prices even as the cost of
cotton comes down, said Evan Mann, senior analyst at Gimme
Credit.
"It's hard to get a price increase and once you get it you don't
want to give it back," Mann said.
Carter's Inc. (CRI), meanwhile, may be an example of an apparel
company that is able to profit from lower cotton prices. Goldman
Sachs earlier this month upgraded the children's clothing maker to
buy from neutral, seeing opportunities for gross margin growth. The
benefits will come through Carter's offsetting higher raw material
costs by raising prices in its wholesale business, which accounts
for 50% of sales. And since cotton costs are expected to be lower
and, assuming Carter's keeps its prices higher, gross margin would
also benefit, Goldman said.
-By Karen Talley, Dow Jones Newswires; 212-416-2196;
karen.talley@dowjones.com
--Leslie Josephs contributed to this article
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