A cotton field

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The last time cotton prices were this high was in July 2011.

“In 2011 we needed a prayer meeting”, Levi Strauss Chief Executive Chip Bergh told investors on a conference call Wednesday.

Bergh remembered just going to a denim dealer and finding his way around Levi’s store. But he was also staring down a historic rise in cotton prices. Cotton had skyrocketed to over $ 2 a pound as textile demand recovered from a global financial crisis, while India – a major cotton exporter – curtailed supplies to help its domestic partners.

The price of a cotton T-shirt rose an average of $ 1.50 to $ 2, said Jack Kleinhenz, chief economist for the National Retail Federation. Consumers felt the effects. And it also eats away at companies’ profits.

Bergh sits in the camp with analysts and experts who say current cotton price inflation will be less damaging to the industry. Manufacturers and dealers have pricing power. Businesses can pass the higher costs on without destroying consumer demand.

“It’s a completely different situation today,” said Bergh. “We have been able to accept the pricing for the past 12 months and it remains.

cotton Prices rose to a 10-year high on Friday, hitting $ 1.16 a pound, reaching levels not seen since July 7, 2011. The price of the commodity rose about 6% this week and is up 47% since the start of the year. Analysts note that profits are further boosted by traders rushing to cover their short positions.

The start-up results from a number of factors. Last December, the Trump administration did blocked companies in the United States from importing cotton and other cotton products which originated in the western Xinjiang region of China, as it was feared that it was made with forced labor by the Uyghur ethnic group. The ruling, which remained in effect during the Biden administration, has now forced Chinese companies to buy cotton from the US, manufacture goods with that cotton in China, and then sell it back to the US

Extreme weather, including droughts and heat waves, has also wiped out cotton crops in the United States, the world’s largest exporter of this commodity. In India, poor monsoon rains threaten to affect the country’s cotton production.

The momentum already has shares of Hanes brands, a clothing manufacturer known for its underwear and cotton t-shirts. Historically, HanesBrands stocks fall when cotton prices rise. The stock is down 7% over the past week. On Friday alone, stocks lost 5% to close at $ 16.23.

“Real pricing power”

Credit Suisse analyst Michael Binetti said he felt any worries or setbacks in retail stocks due to soaring cotton prices were exaggerated.

He said only 2% of HanesBrands’ cost of goods comes from buying cotton directly. In 2012 this value was higher at 6%.

After the rise in cotton prices in 2011, HanesBrands had raised the prices of various cotton goods three times by a double-digit percentage by 2012 to offset inflation, Binetti said. HanesBrands’ profits were still shrinking from all of the costs that faced them. But ultimately, the company sustained some of those price increases. Today the company is in a healthier position with higher profit margins, said the Credit Suisse analyst.

“We believe stocks are underestimating the strongest momentum this sector has not had in over a decade. Real pricing power,” said Binetti.

Retailers have achieved this pricing power by proactively deviating from discount channels and reducing excess inventory. The Covid pandemic acted as “cover” for companies to accelerate this change. Persistent bottlenecks in the supply chain have also played a role in the depletion of inventory. This dynamic has driven costs so high that companies are raising prices and consumers are still buying.

“We believe inventory will remain rational, margins will remain strong, and retailers will be able to enforce bigger and more consistent price increases than they have been in over a decade,” said Binetti. He expects cotton inflation to be temporary.

UBS analyst Robert Samuels said the retailers he believes will be hardest hit by soaring commodity prices are those who specialize in denim. Cotton makes up more than 90% of the raw materials used to make jeans and other denim items.

“As if retailers don’t have to worry enough about supply chain constraints and labor shortages,” Samuels said in a message to customers.

A stronger tip

But Levi has already tried to allay fears about his denim business.

In his earnings call, Levi said the majority of its product costs were already being negotiated by the first half of next year amid very low single-digit inflation. A mid-single-digit increase is expected for the second half of the year. And Levi said it plans to offset that increase with the pricing measures it has already taken.

Levi has shifted its business from predominantly wholesale to a mixed base that has a growing share of direct sales to consumers. And with strong consumer demand and tighter inventory, the company was able to sell more products at full price.

Cotton accounts for about 20% of the cost of making a pair of Levi’s jeans, said CFO Harmit Singh, with each pair of jeans containing about two pounds of cotton.

Given the timing of his conference call, Levi was one of the first clothing retailers to speak out publicly about rising cotton prices. Others will publish their third quarter results in the coming weeks.

According to analysts at Goldman Sachs, given the timing of the contracted cotton purchases, it will be a while before rising cotton costs even show up in retailers’ profit and loss accounts. And it’s worth noting that cotton prices rose to more than $ 2 a pound in 2011, which is well above where the commodity is traded today.

Still, apparel stocks could come under pressure as higher prices persist. As examples, analysts cited companies such as Ralph Lauren, Gap Inc., Office brands, and Calvin Klein owners PVH. Shares in Kontoor Brands, which owns Wrangler and Lee jeans, fell nearly 6% over the past week, while PVH, Gap and Ralph Lauren were each down less than 2% for the week.

—CNBCs Michael Bloom contributed to this reporting.