How are businesses going to afford higher input costs?

by zh

An Upcoming 30% Price Increase For Cotton Products And Defaulting Chinese Clothing Manufacturers May Soon Test The “Deflation” Thesis

The question of the night is whether Wal-Mart can absorb a 30% price increase in cotton products, because as Bloomberg reports, it will very soon have to. Gap Inc., J.C. Penney Co. and other U.S. retailers may have to pay Chinese suppliers as much as 30 percent more for clothes as surging cotton prices boost costs. Reports Bloomberg: “It’s a little terrifying to deal with cotton suppliers now,” said Vicky Wu, a sales manager at Suzhou Unitedtex Enterprise Ltd., a closely held, Jiangsu province-based clothes maker that counts Gap and J.C. Penney among its clients. This is not an exaggeration – in last week’s What I Learned This Week,‘s Kiril Sokoloff, a China expert, noted: “We bought cotton back at around $0.99 because we thought the fundamentals were still very powerful. We liquidated the entire position on October 26 at around $1.29 because many Chinese clothing manufacturers were nearing bankruptcy and the Chinese government was cracking down on hoarders, speculators and investigating position sizes.” Note the completely unwanton use of the word “bankruptcy” by the otherwise mellow Bulgarian – what has happened in cotton prices is setting off a seismic shift for low-margin retailers, and many traditionally safe and stable companies will soon be forced to attempt to pass on surging costs, or go out of business, especially as the ranks of low-cost vendors goes up in smoke. Bernanke’s inflation exporting model is about to backfire with a vengeance. In this most direct consequences of excess liquidity-driven near-hyperinflation, the best possible outcome would merely a total collapse in margins. If you think a very irrelevant Dick Bove hates Bernanke now, wait until you listen to the Walton family’s thanksgiving dinner…

There are those who see absolutely no inflation in the future. Then, there is Ben Bernanke’s “but he is really not printing money” reality:

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“American consumers better get used to rising prices on the shelves of Wal-Mart and other retailers,” said Jessica Lo, Shanghai-based managing director at China Market Research Group. “China’s manufacturers are getting squeezed not only by rising cotton costs but also soaring real estate and labor costs.”

John Ermatinger, Gap’s Asia president, declined to say whether it would raise prices. “We are going to be mindful of our competition,” he said in a Nov. 10 interview in Shanghai. “We are going to be mindful of our consumer. That’s how we’ll ultimately establish our prices.”

Shandong Zaozhuang Tianlong Knitting Co., which makes Polo Ralph Lauren Corp. T-shirts and track suits for Le Coq Sportif Holding SA, has raised prices as much as 70 percent from a year earlier, said sales manager Fred Hu. “If cotton keeps rising like this, we will need to lift prices by 30 percent by the Spring Festival next year or we lose money.”

Unitedtex, which sells $24 million worth of shirts and jackets annually to Gap, plans to raise prices by 5 percent to 30 percent for products that will be available in April, Wu said in an interview. The supplier plans to increase capacity to meet the retailer’s demand, she said.

“It’s very hard to budget for input cost, if prices are as volatile as they are,” said Peter Rizzo, Sydney-based managing director at FCStone Australia Pty. “It heightens the awareness of Chinese textile manufacturers to look at risk-management tools.’’

Never mind collapse, corporate margins are about to prolapse, possibly turning negative. Guess what that means for record S&P EPS estimates for 2011…

Clothes makers are beginning to lose money on some orders, Unitedtex’s Wu said. “Even if we know we’ll lose money with this order, we’ll still do it, hoping to make up the loss in the next deal,” she said.

Gross margins for clothing retailers’ suppliers are between 10 and 20 percent, and net margin is usually between 3 percent and 5 percent, according to Wu and Hu.

Zhejiang province-based Ningbo Seduno Group, which sells about $30 million worth of men’s and women’s clothes to Hennes & Mauritz AB annually, increased prices by almost 20 percent since July, said sales manager Fiona Xu. Seduno also supplies Adidas AG, Inditex SA’s Zara and Nike Inc.’s Umbro Plc, and will keep raising prices as cotton costs increase, Xu said.

“Losing money on some orders” means that not even Level 10 dark FASB magic can make net income positive. Sorry.


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