Levi’s Won’t Be Unraveled by Cotton Price Surge

This year, the cotton price has increased by 200%, and many brands are feeling the pressure. Levi’s is one of them. To avoid losing business, they have decided to release new lines that are made out of synthetic materials instead of cotton.

Levi’s stock was down 2.5% after the company announced that it would raise prices on its products due to a surge in demand for cotton, which is used in the production of their jeans.

Cotton is back in style, and investors in clothing companies aren’t pleased about it.

Cotton prices have risen 18 percent in the previous month and 42.5 percent year to date, reaching highs not seen in almost a decade. Shares of clothing firms, notably Levi Strauss LEVI -5.13 percent, have plummeted as a result. Levi’s stock was down 5.1 percent on Wednesday, while the S&P 500 index was up 0.4 percent. H&M and Inditex, two fast-fashion retailers, were down 4.9 percent and 4.6 percent, respectively, while Gap shares were down 2.2 percent.

Given how strained clothing business investors’ nerves are, the share price losses make sense. Container shortages, plant closures in Vietnam, and rising labor and shipping expenses have already hit clothing retailers.

Levi’s comments on cotton price should allay some of those concerns, at least for the time being. The clothing firm stated on its results conference Wednesday evening that most of its own cotton pricing for the first half of 2022 have already been negotiated, and that it anticipates its cost of goods sold to rise 1% in the first half of 2022 compared to 2021 levels. The business believes it will be able to negotiate pricing in the second half of 2022 that will result in a mid-single-digit percentage rise in expenses above 2021 levels. Cotton makes up approximately a fifth of the cost of Levi’s jeans production.

High cotton prices are definitely worth keeping an eye on, particularly if they continue to rise and have an effect on future delivery agreements. For example, the commodity’s record rise in 2011 ate into certain clothing businesses’ gross margins and profitability that year and the next year. In 2011, Levi’s gross margins decreased 2.2 percentage points, while Gap’s dropped 3.8 percentage points.

However, those drops occurred during a time that BMO Capital Markets analyst Simeon Siegel refers to as “promotional warfare.” It’s possible that this made it more difficult for clothing retailers at the time, particularly those selling lower-cost items, to pass on those costs to customers. Many clothing companies, like Levi’s, have recovered pricing power in recent months, partially as a result of retailers’ inability to overstock inventory and as a result of last year’s stimulus, which has made many consumers’ wallets fatter. Some companies, such as Levi’s, feel they have greater cachet now. Its average selling prices have increased by more than 10% year over year, and its gross margins are approximately 10% greater than they were a decade ago, during the previous cotton price rise.

Levi’s remarks seem to have calmed investors’ concerns, as the company’s stock rose in after-hours trade. Of course, this isn’t an all-clear signal. Companies who offer lower-cost clothing or those that have lost popularity with consumers may not be so lucky. Gross margins at Hanesbrands, which sells essentials like T-shirts and underwear, rose by only 0.6 percentage points in the previous quarter compared to the pre-pandemic period, while Inditex, the parent company of Zara, increased by just 1.5 percentage points. When compared to pre-pandemic levels, Levi’s gross margin increased by almost 5% last quarter.

Although today’s rising cotton costs aren’t as difficult as they were a decade ago, not many clothing businesses will be able to enjoy the same level of comfort that Levi’s has.

Jinjoo Lee can be reached at jinjoo.lee@wsj.com.