Cotton prices were previously this high in July of 2011. In 2011, we needed a prayer meeting,” Levi Strauss CEO Chip Bergh said.
Bergh recounted how he had recently joined the denim store and was still getting to know his way around Levi’s operation. However, he was also confronted with an unprecedented increase in cotton prices. Cotton had risen beyond $2 per pound as textile demand recovered from the global financial crisis. India, a major cotton exporter, was limiting shipments to assist its domestic partners. According to National Retail Federation Chief Economist Jack Kleinhenz, the average price of a cotton T-shirt increased by $1.50 to $2. Consumers felt the effect. It also ate into the earnings of businesses.
Bergh agrees with analysts and industry professionals who believe the current cotton price rise will be less harmful to the sector. Manufacturers and retailers hold pricing power. Companies will be able to pass on increasing costs to customers without jeopardizing consumer demand.
Shares of HanesBrands, a clothing producer known for its underwear and cotton T-shirts, have already been impacted by this dynamic. HanesBrands shares have historically fallen as cotton prices rise. Over the last week, the stock has dropped by 7%. Shares fell 5% on Friday alone, closing at $16.23.
Real Pricing Power
Credit Suisse analyst Michael Binetti believes that any concerns or pullbacks in retail stocks due to increased cotton prices are exaggerated.
He claims that direct cotton purchases account for only 2% of HanesBrands’ cost of goods sold. Back in 2012, the figure was higher, at 6%.
Following the rise in cotton costs in 2011, HanesBrands raised the prices of various cotton goods by a double-digit percentage three times between 2011 and 2012 to balance the inflation, according to Binetti. Despite all of the charges, HanesBrands’ profitability continued to decline. However, the corporation will sustain some of the price hikes eventually sustained. According to the Credit Suisse analysis, it is now in a better position with higher profit margins. Retailers have gained pricing power by consciously avoiding discount channels and reducing surplus inventory.
The COVID epidemic has served as a “cover” for businesses to speed this transition. Ongoing supply chain difficulties have also contributed to inventory tightening. Because of this dynamic, firms are rising prices while consumers continue to buy. According to UBS analyst Robert Samuels, the stores specializing in denim will be the hardest hurt by increased commodity prices. Cotton makes up more than 90% of the materials required to create jeans and other denim products.
A More Severe Spike
However, Levi has previously attempted to alleviate any concerns about its denim industry.
Levi noted on its earnings call that it had already negotiated the majority of its product costs through the first half of next year, with very low-single-digit inflation. It anticipates a mid-single-digit increase in the second half of the year. And Levi has stated that it intends to offset the price increase with existing pricing efforts.
Levi has been transitioning from a primarily wholesale base to a mixed base with growing direct-to-consumer sales. And, because of high consumer demand and reduced stockpiles, it has been able to sell more products at a total price. Cotton accounts for around 20% of the cost of making a pair of Levi’s jeans, according to Chief Financial Officer Harmit Singh, with each team having about two pounds of cotton.
Levi was one of the first apparel merchants to openly comment on rising cotton pricing due to the timing of its earnings call. Others will disclose third-quarter fiscal numbers in the following weeks.
Given the timing of contracted cotton purchases, Goldman Sachs analysts believe it will be some time before increased cotton costs appear on retailers’ financial statements. It’s also worth noting that cotton prices skyrocketed to more than $2 per pound in 2011.