With the cost of materials, transportation, and labor rising—and the U.S. economy still limping toward recovery—manufacturers of everything from clothing to food are struggling to preserve profitability.
Despite recent pullbacks, a rally in commodity prices is pressuring corporate profits. That rally will probably continue, says Standard & Poor's (MHP) analyst Alec Young, aided by the Federal Reserve's goal of keeping interest rates near zero. Most commodities are denominated in U.S. dollars, which is likely to decline as the Fed prints money to finance bond purchases. The Thomson Reuters/Jefferies CRB Index of 19 raw materials climbed 15.3 percent in the past five months, led by agriculture commodities, but has pulled back 6.6 percent in the past week and a half on concerns that China will raise interest rates and slow economic growth. Corn futures for March delivery rose 56 percent from June 30 to peak at $6.04 per bushel on Nov. 4, before slipping 12.3 percent, to $5.29 per bushel, on Nov. 22. Since June, wheat futures have spiked 28.3 percent, sugar prices have increased 60.0 percent, and cotton futures for March delivery have surged 51.6 percent. Crude oil has risen 5.2 percent and copper has jumped 26.4 percent in the past five months.
Companies with strong brand recognition—such as General Mills (GIS)—or truly differentiated products, such as Crocs (CROX) shoes, are likely to raise prices in 2011, analysts say. For others who find themselves unable to pass along higher costs, the alternatives consist largely of forcing suppliers to eat costs, switching to higher margin materials, or cutting labor costs.
The holiday sales outlook is better than it has been in several years, but cash-strapped shoppers are still hunting for bargains, says Robert Plaza, a consumer staples and discretionary analyst at Key Private Bank in Cleveland. "No industry has pricing power," he says. "Even the aspiring type of consumer is still going to be a little cost conscious because of what's happened over the past few years. Nobody's going to start spending money they don't have to."
Many large-cap apparel vendors recognize how little room they have to raise consumer prices. To date, V.F. Corp. (VFC), Nike (NKE), Polo Ralph Lauren (RL), and Phillips-Van Heusen (PVH) have successfully squeezed suppliers by refusing to absorb the full impact of higher costs, Plaza says. Retailers that serve middle-income consumers will try to sell more higher-margin products, such as clothing made with rayon or polyester instead of pure cotton. Despite rising prices for crude oil, from which synthetic fibers are derived, those have not risen as much as cotton, he adds. Some retailers sourcing for their own labels likely won't have the same leverage. Gap (GPS) and J.C. Penney (JCP) may have to pay Chinese suppliers up to 30 percent more due to surging cotton costs, Bloomberg News reported on Nov. 15. Children's apparel retailer Gymboree (GYMB), which is being sold to buyout firm Bain Capital, said last week that its gross margins may be squeezed by high cotton prices.
Attempts by apparel and footwear retailers to boost prices will be especially difficult after a decade of falling prices. Even as overall retail prices jumped nearly 28 percent from 1998 to 2008, clothing and footwear prices declined 10 percent and 4 percent, respectively, during the same period, due to tighter competition among manufacturers and the opening of several new retail channels that forced aggressive pricing, says Nate Herman, vice-president for international trade at the American Apparel and Footwear Assn. Although demand has dropped, supply has fallen more dramatically, thanks largely to the shutdown of more than 20,000 apparel and footwear factories in China over the past two years, he says. That has led many manufacturers to conclude they'll need to raise prices starting next spring, since "there's just not any room left to take it in margin," Herman says. He expects mid-single-digit price hikes in clothing and shoes in 2011.
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