Record high prices for cotton are cutting into the profitability of the apparel industry and will soon start showing up at the cash register.
Cotton has soared in recent months, closing Wednesday at $2.05 (U.S.) a pound, compared with less than 80 cents a year ago.
Floods in Pakistan, drought in Russia, bushfires in Australia and hail in Texas have all hurt cotton crops. At the same time, demand from emerging markets such as China has surged and speculators have piled into the market, sensing a commodity in play.
There is no significant relief in sight. "Although cotton prices are expected to decline from current record levels, it is likely that prices will stay substantially higher than the average of 60 cents per pound that prevailed during the past decade," the International Cotton Advisory Committee said in a recent report.
"Factors such as competition from food crops, limited available resources (including land, seeds, water and equipment), and government policies are preventing [cotton-growing areas]from rising further."
Companies that use cotton as an ingredient have felt the pinch and are responding by passing costs on down the line.
Gildan Activewear Inc. recently reported that its gross margins took a hit due to higher cotton, energy and other input costs, declining to 24.7 per cent last quarter compared with 29.8 per cent in the year-earlier period.
The Montreal-based company has increased its prices by a total of 27.5 per cent through five hikes over the last year, said Laurence Sellyn, executive vice-president and chief financial officer.
While admitting manufacturers and retailers face a fine line between maintaining profit margins and keeping customers, he said cotton accounts for almost half of Gildan's production costs and the increases need to be passed on.
"So far, demand has not been adversely affected," he said, adding that with the latest price increase the company should be able to cover cotton costs of up to $1.50 a pound. It takes about six months for cotton to find its way from the mills to the retail racks, meaning today's products were manufactured when spot market prices for cotton were about $1 a pound.
Gildan doesn't publicly announce price increases, but the latest one probably occurred as recently as March 18, Jessy Hayem of TD Securities Inc. wrote in a note. Other apparel companies, including Hanesbrands Inc. and Berkshire Hathaway Inc.'s Fruit of the Loom, have not yet delivered matching price increases, but distributors fully expect them to, as they have in the past, he said.
Any unexpected decrease in cotton prices would give a lift to these companies' share profit, he added.
"I can tell you in this environment, all apparel companies are raising prices, and retailers are seeing it everywhere," Rich Noll, chairman and chief executive officer of Hanesbrands said on an earnings conference call last month.
He predicted moderate price increases for the sector during the first half of the year, ranging in the mid-single digits. "It's really not until back-to-school … that you're going to start to see these larger increases working their way through," he said.
Reitmans (Canada) Ltd., the country's largest specialty apparel chain, also warned about the effects of rising cotton prices during its last quarterly presentation in December. "A recent surge in the price of cotton to record high prices, an important component in clothing fabrication, along with a significant shortage of supply is anticipated to place strains on certain product margins," it said.
The Montreal-based company is scheduled to post its latest earnings results next Wednesday, when analysts expect an update on the effect commodity prices are having on the business.