For those who thought the price of denim jeans was already too high, the bad news is that the appreciation will likely continue. On Monday, the price of cotton reached its highest levels since the fiber began trading 140 years ago with the creation of the New York Cotton Exchange.
The most recent push higher in cotton prices is being blamed on a massive weekend storm that hit areas of Texas where cotton picking is prevalent, as well as unexpectedly cooler temperatures in China that have damaged the harvest. However, on a more fundamental level, cotton demand has been significantly outpacing supply, as demand from emerging economies continues on a rampant pace. In addition, U.S. farmers have moved away from cotton and into more profitable crops as domestic textile manufacturers gave way to cheaper low-wage countries. China has become the world's largest producer of cotton, with India trailing behind as the second largest producer. This year India has also restricted exports of the fiber in order to maintain prices domestically.
Apparel manufacturers increase prices
The price increase in cotton is not favorable for many businesses, unless of course your business is cotton farming. On a July conference call, Levi Strauss CEO John Anderson said, "It's a pressure on the business. We have already taken some price increases for the second half of this year."
However, some businesses are better able to weather the price increase. VF Corp. (NYSE: VFC ) is one of the largest apparel manufacturers in the world and has a portfolio of more than 30 brands, which include premium jeans 7 for All Mankind as well as lower priced Wrangler and Lee. While VF's lower price point brands have fared well, CEO Eric Wiseman said on the company's most recent conference call that the premium market is struggling. Wiseman said, "In tough economic times, consumers are more value-conscious than ever, more focused on savings and spending and looking for something new as a trigger defense."
The diversification of VF's brands across several price points gives the company a significant competitive advantage over other upscale jean makers such as Joe's Jeans (Nasdaq: JOEZ ) and True Religion (Nasdaq: TRLG ) . Often, upscale makers' margins are actually more sensitive to higher cotton prices, as they tend to hold the line on wholesale price increases despite rising costs.
While many garment manufacturers and retailers have had to take on price increases, passing on the cost to cash-strapped consumer has proved difficult.
Retailers have tougher time
American Apparel (AMEX: APP ) has certainly felt the effects of the price increases. The company has more than 280 retail locations in 20 countries and produces more than 1 million items of clothing each week, including jeans, T-shirts, sweatshirts, and other cotton-rich consumer goods. The price increase in cotton has added close to $250,000 a week in additional costs over the last several months. Unfortunately for American Apparel and other retailers, the weak economic environment and cash-strapped consumers make it difficult for them to pass on the cost to customers.
American Apparel CEO Dov Charney recently said, "We did raise our wholesale prices a little bit and it seems to be sticking. But on retail, we haven't done it. Not yet." The company remains in better shape than some retailers, in part because of its wholesale business. In 2009, American Apparel derived more than 25% of its $558 million in revenue by manufacturing clothes for other fashion apparel makers. While the company has not been able to raise retail prices, its wholesale prices have increased by 3% to 5%. Other retailers such as Gap (NYSE: GPS ) , Aeropostale (NYSE: ARO ) , and American Eagle (NYSE: AEO ) that rely solely on retail and online sales will be hurt more by cotton's price appreciation if the companies are unable to pass on the price increase to customers.
It will certainly be interesting to see how the retailers handle the situation as we head into the holiday season. Holding prices steady will squeeze margins, but price increases may turn consumers away.When looking for stocks in the apparel and retail sector, I recommend focusing on companies with diversification in their business and brand portfolio that are better able to handle the price increase in cotton.