Cotton's Decline is these Retailers' Gain
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Apparel retail, especially with the high degree of industry fragmentation and the propensity of consumers to be fickle about fashion trends, is not an extremely favorable business in terms of the relevancy a given enterprise can enjoy for a prolonged period of time. The industry becomes even more difficult, and has over the past several years, when macro events intervene. Many non-fad driven brands with almost ubiquitous relevance, including Gap Inc. (NYSE: GPS), Aeropostale (NYSE: ARO), Abercrombie and Fitch (NYSE: ANF), and American Eagle (NYSE: AEO), have been hit by a dual punch from both weakened consumer spending and rising commodity costs.
There have been more positive signs recently that both of these forces are beginning to loosen their squeeze on these apparel brands, however. Such a reduction in tension on top line growth and gross margins could lead to a new prolonged period of above average (as compared to the past several years, that is) profitability.
There can be no doubt that consumer confidence and spending patterns are strengthening – the improved performance of discretionary spending stocks like Tiffany’s, Disney, and foreign luxury automakers including BMW and Mercedes highlight this fact. The same naturally holds true for non-big ticket, discretionary income-driven apparel brands.
Figures calculated as four-quarter revenue runs. Gap (GPS) figures put on right axis to maintain scale.
Despite the increased organic demand for the apparel and the simultaneous shift from the use of discount pricing tactics, selling margins have continued to be hit by strong input material prices.
All four apparel retailers have stated on their most recent quarterly calls that a slight easing in material costs will help to bolster strengthened gross margins over the mid-term. Recently released data from the International Cotton Advisory Committee tend to agree with these projections. Worldwide farmers are expected to reap more than 123 million 480-pound bales in the twelve-month period ending this July, which will exceed demand by more than 15 million bales. Cotton futures, which rose to a high of around $2.20 per pound last year following inclement weather and ruined crops in key growing regions, are expected to continue their drop throughout 2012 to a projected 75 cents/pound by December 31.
Such a bear case for cotton prices will lead to naturally expanding margins alongside the resurgence in mall spending. Aeropostale, which has seen some of the most troublesome margin contraction since mid-2010, has attributed more than two-thirds of the most recent quarter’s 1,000 basis point margin drop to the increased commodity costs.
Some of the issues these retailers are facing are not driven by the larger macro forces, however. Abercrombie and Fitch, which experienced a four-quarter streak of double-digit same store sales declines in 2009, has since gone on to increase same store productivity by nearly 65%.
Although competitors Gap and Aeropostale experienced much less intense mid-recession demand hits than Abercrombie, both stores are now entering a less certain period of apparel style shifts that are taking their toll on same store sales and merchandise turnover metrics. The young adult core consumer group, especially the generally more fashion-conscious females, have recently been targeted by “cheap chic” apparel retailers including Forever 21, H&M, and even Target (NYSE: TGT), which has partnered with famous designers including Italian-based Missoni to sell relatively affordable and highly coveted apparel designs.
Retailers including Gap and Aeropostale, which have traditionally followed a “universal” approach with muted colors and conservative designs, have experienced a brand confusion of sorts in the shift to the more in-style apparel trends. Although such a miss is undoubtedly easily cured with boosted ad expenditures to raise consumer awareness, it will prevent both chains from realizing the full effects of increased consumer spending and decreasing materials costs if it should persist over the mid-term.
The Motley Fool owns shares of Aeropostale. gibbstom13 has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools may not 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.