Just When You Thought These Retailers Were Safe
Mar 8th 2012 7:03PM
Updated Mar 12th 2012 9:44PM
Just when it seemed as if the price of cotton was heading down and clothing retailers could get back to the important business of style rather than the tedious business of product costs, India goes and drops the hammer on the cotton market. On Monday, the Indian government announced that it will immediately and indefinitely ban all cotton exports, including shipments that had already been scheduled but not yet shipped.
Not this again
Around this time last year, clothing retailers were struggling to survive after the price of cotton had nearly tripled in just one year. Despite a long drought in Texas, where much of the United States' cotton is grown, prices fell by more than 50% throughout the year. The United States is the world's biggest cotton exporter, but the trouble here was outweighed by what is projected to be a record harvest in Australia and softening global demand.
Unfortunately, apparel companies buy their supplies several months in advance, so they were still digesting the high prices of the spring well into fall, just in time to concede their margins again, this time to the discount-heavy holiday season.
That's why only a handful of apparel companies have seen their margins recover, and only barely. Some companies, like VF (NYS: VFC) , chose to protect their margins by raising prices, but because of the weak economy, that strategy proved hard to pull off. In VF's third quarter, the company reported that gross margin had slipped 1.2 percentage points, entirely because of its jeanswear business. Jeanswear revenues were higher in that quarter, but only because of price increases -- actual pairs sold were down.
In more competitive spaces like teen retailing, the damage has been severe. Aeropostale (NYS: ARO) and American Eagle Outfitters (NYS: AEO) have both struggled to sell bloated inventories that were expensive to build in the first place, and their margins have suffered greatly.
Bumper crop, or just bumpy ride?
Despite falling in price all last year, cotton is still twice as expensive as it was just three years ago. Crop analysts believe that current supplies are fairly high, and Australia is forecasting another record crop this year, which may indicate further drops in price.
At the same time, however, the Chinese government recently raised the price it pays domestic cotton farmers far above the going market rate, indicating increased demand from the world's largest cotton importer. But it also seems China might just be stockpiling the cotton, which has some worried that they will eventually release it back into the market and cause further volatility.
Adding to the mess, even India may reverse itself after facing pressure from the agriculture ministry. India is the world's second biggest exporter of cotton, so its indecision on the matter only adds to the volatility of the crop price.
The look, the feel of spandex
If you think you can predict a trio of weather, politics, and fashion, you could make a killing investing in some of the beat-up retailers that live and die by their margins. Or you could avoid the issue entirely and turn instead to manufacturers using alternative fabrics.
lululemon athletica (NAS: LULU) , for instance, manufactures its products from synthetic fibers, the cost of which tends to be cheaper and more predictable than cotton. It's one of the reasons lululemon is consistently lauded for its high margins, which tower over those of competitors.
Other more cotton-dependent companies have turned to natural alternatives. Naturally Advanced Technologies has developed a method of making a cotton-like fabric from flax, which is cheaper and easier to grow, and NAT's process can even make fibers from the byproducts of other flax products like flaxseed oil. The company is still in the process of commercializing but has already signed deals with the likes of Hanesbrands and Levi Strauss.
The Foolish bottom line
Cotton costs may not be set to soar in the near future, but it's clear that the market is hard to predict, and even highly fashionable brands can suffer when something unexpected happens. If you don't have time to stay on top of weather trends and obscure politics, it may be good to invest in more predictable areas.
Rising and falling cotton prices make these companies more exciting to watch that a soap opera. To stay abreast of all the developments as they relate to these clothing retailers, add these companies to My Watchlist to get all of our Foolish analysis:
- Add VF to My Watchlist.
- Add lululemon athletica to My Watchlist.
- Add Hanesbrands to My Watchlist.
- Add Aeropostale to My Watchlist.
- Add American Eagle Outfitters to My Watchlist.
At the time this article was published Fool contributor Jacob Roche apparently thinks highly of his prediction abilities, because he owns calls on Aeropostale. He also owns shares of Naturally Advanced Technologies. Check out his Motley Fool CAPS profile or follow his articles using Twitter or RSS. The Motley Fool owns shares of lululemon athletica and Aeropostale. Motley Fool newsletter services have recommended buying shares of lululemon athletica. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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