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 -0.27% , 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 +0.27% , 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 +1.50% , 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 +2.19% , 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.