A cotton field
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The last time cotton prices were this high was in July 2011.
“In 2011, we needed a prayer meeting,” Levi Strauss chief executive Chip Bergh told investors on a conference call Wednesday.
Bergh recalled that he had just joined the denim retailer and was learning his way around the Levi’s business. But he was also seeing a historic surge in cotton prices. Cotton had climbed above $ 2 a pound, as demand for textiles rebounded from a global financial crisis, while India – a major cotton exporter – restricted shipments to help domestic partners.
The price of a cotton t-shirt has increased from about $ 1.50 to $ 2 on average, said Jack Kleinhenz, chief economist for the National Retail Federation. Consumers have felt the impact. And it has eaten into corporate profits as well.
Bergh is sitting in the camp with analysts and experts saying the current cotton price inflation will be less damaging to the industry. Manufacturers and retailers have pricing power. Businesses will be able to pass on the higher costs without destroying consumer demand.
“It’s a very different situation today,” Bergh explained. “We’ve been able to take the prices over the last 12 months and it’s holding.… We set prices ahead of some of these inflationary pressures that are hitting us.”
Cotton prices hit a 10-year high on Friday, hitting $ 1.16 per pound and reaching levels not seen since July 7, 2011. The commodity price has risen by around 6% this week and is up 47% since the start of the year. Analysts note that the gains are further intensified by traders rushing to hedge their short positions.
The rise is the result of a number of factors. Last December, the Trump administration blocked U.S. companies from importing cotton and other cotton products from China’s western Xinjiang region, fearing it was produced using forced labor by the government. Uyghur ethnic group. The ruling, which remained in effect during the Biden administration, has now forced Chinese companies to buy cotton from the United States, make products with that cotton in China, and then resell it in the United States.
Extreme weather conditions, including droughts and heat waves, have also wiped out cotton crops in the United States, which is the world’s largest exporter of this raw material. In India, insufficient monsoon rains threaten to harm the country’s cotton production.
The momentum has already put pressure on the shares of HanesBrands, a clothing maker known for its cotton underwear and t-shirts. Historically, HanesBrands shares have fallen as cotton prices rise. The stock has fallen 7% over the past week. On Friday alone, stocks fell 5% to close at $ 16.23.
“Real pricing power”
Credit Suisse analyst Michael Binetti said he considered any worries or drop in retail inventories over the rise in cotton prices to be overstated.
He said only 2% of the cost of goods sold by HanesBrands came from direct cotton purchases. In 2012, this figure was higher, at 6%.
After the cotton price spike in 2011, HanesBrands increased the prices of various cotton products by double-digit percentages three times through 2012 to offset inflation, Binetti said. HanesBrands’ profits fell further compared to all the costs it faced. But ultimately, the company maintained some of these price increases. Today it is in a healthier position with stronger profit margins, the Credit Suisse analyst said.
“We think stocks are underestimating the most powerful momentum this sector hasn’t seen in over a decade. Real pricing power,” Binetti said.
Retailers have achieved this pricing power by proactively moving away from discount channels and eliminating excess inventory. The Covid pandemic acted as a “cover” for companies to accelerate this change. Persistent supply chain bottlenecks have also played a role in the inventory tightening. This dynamic has driven costs up so much that businesses are raising prices and consumers are continuing to buy.
“We believe that inventories will remain rational, that margins will remain strong and that retailers will be able to push for larger and more consistent price increases than they have been able to do for more than a decade,” said Binetti said. He expects cotton inflation to be transient.
UBS analyst Robert Samuels said the retailers he expects to be hardest hit by rising commodity prices are those that specialize in denim. Cotton makes up over 90% of the raw materials used to make jeans and other denim items.
“As if retailers don’t have enough to worry about with supply chain constraints and labor shortages,” Samuels said in a note to customers.
A more severe peak
But Levi has already tried to allay fears about his denim business.
In its earnings call, Levi said it has already negotiated most of the costs of its products in the first half of next year, at a very low single-digit inflation rate. For the second half of the year, he expects an average single-digit increase. And Levi said he plans to offset the hike with the pricing measures he has already taken.
Levi has shifted its business from a primarily wholesale business to a blended basis that has a growing share of direct-to-consumer sales. And with strong consumer demand and tight stocks, he was able to sell more products at full price.
Cotton accounts for about 20% of the cost of making a pair of Levi’s jeans, CFO Harmit Singh said, with each pair of jeans containing around two pounds of cotton.
Due to the timing of its earnings call, Levi was one of the first clothing retailers to publicly comment on soaring cotton prices. Others will release their third quarter financial results in the coming weeks.
Goldman Sachs analysts say it will be some time before rising cotton costs even begin to show on retailers’ income statements, given the timing of contract cotton purchases. And it should be noted that in 2011, cotton prices soared to over $ 2 a pound, which is well above the level where the commodity is trading today.
Still, clothing stocks could face some pressure as higher prices persist. As examples, analysts have pointed to companies such as Ralph Lauren, Gap Inc., Kontoor Brands and PVH, owner of Calvin Klein. Shares of Kontoor Brands, owner of Wrangler and Lee jeans, fell nearly 6% last week, while PVH, Gap and Ralph Lauren each ended the week down less than 2%.
– CNBC Michael bloom contributed to this report.