U.S. Retail Share Slide Since Black Friday Shows Margin Squeeze

The era of cheap jeans may be ending as U.S. apparel retailers take advantage of the economic recovery to boost prices on some products for the first time in more than a decade.

The increases may contribute to a slowing in consumer spending, while not fully offsetting record cotton costs, higher wages in China and rising freight charges that are squeezing margins. As companies juggle how much more they can charge without losing sales, New York-based AnnTaylor Stores Corp. (ANN) is reducing production costs and Abercrombie & Fitch Co. (ANF) is closing one of two distribution centers in New Albany, Ohio, its hometown, to trim expenditures.

“For all retailers and all wholesalers, we’re flying into unknown territory, because we haven’t seen price increases, we’ve actually seen price decreases, in the past 10 to 15 years,” said Blake Jorgensen, chief financial officer of Levi Strauss & Co., which supplies jeans to retailers in more than 110 countries. The San Francisco-based company raised spring prices on some namesake pants and plans increases for fall, said Jorgensen, who declined to provide details.

Americans paid less on average for jeans in 2010 than the previous two years, according to a consumer survey by NPD Group, a Port Washington, New York-based research firm. The average price was $19.32 last year, down from $19.64 in 2009 and $19.73 in 2008.

Photographer: JB Reed/Bloomberg

As companies juggle how much more they can charge without losing sales, New York-based AnnTaylor Stores Corp. is working to reduce production costs. Close

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Photographer: JB Reed/Bloomberg

As companies juggle how much more they can charge without losing sales, New York-based AnnTaylor Stores Corp. is working to reduce production costs.

The Standard & Poor’s Retail Exchange-Traded Fund has risen 4.2 percent since Black Friday on Nov. 26, the start of the year’s biggest selling season. That trails a 12.4 percent gain for the SPDR S&P 500 ETF, even though holiday sales were the strongest in five years.

‘Taking From Peter’

Since then, consumer spending cooled more than forecast in January as rising food and fuel costs caused Americans to cut back on trips to malls and restaurants. Higher price tags on apparel might exacerbate that trend, creating a “taking from Peter to give to Paul” phenomenon, said Michael Feroli, chief U.S. economist at JPMorgan Chase & Co. in New York.

With wage growth weak, consumers have “a shrinking amount” for discretionary items, “so if they have to spend more on apparel, they will spend less on other goods and services,” he said. Consumer purchases account for about 70 percent of the U.S. economy.

Cost pressures have intensified since November and may accelerate in the second half of 2011, prompting Citigroup Inc. to trim annual earnings forecasts as much as 8.5 percent for seven retailers, including Bentonville, Arkansas-based Wal-Mart Stores Inc. (WMT) and Target Corp. (TGT), the biggest U.S. discounters, as well as Plano, Texas-based J.C. Penney Co. (JCP) and Kohl’s Corp. (KSS) in Menomonee Falls, Wisconsin, according to a Feb. 17 note by analyst Deborah Weinswig.

Cost Forecast

Apparel costs may rise between 4 percent and 6 percent in the first half of the year, followed by a jump of 13 percent to 15 percent in the second half, Weinswig wrote in the note.

“Everybody’s margins are going to be under pressure,” said Randal Konik, a retail analyst at Jefferies & Co. in New York. He recommends buying only five of the 20 stocks he follows: Body Central Corp. (BODY) in Jacksonville, Florida; Abercrombie & Fitch; American Eagle Outfitters Inc. (AEO) in Pittsburgh; Los Angeles-based Guess? Inc. (GES) and Richardson, Texas-based Fossil Inc. (FOSL)

Consensus earnings estimates for the eight multi-line retailers in the S&P 500 may be too ambitious, said Douglas Cliggott, U.S. equity strategist at Credit Suisse in New York. Per-share profits for Minneapolis-based Target and the seven other businesses are forecast to climb 13 percent this year on revenue growth of 3 percent, according to a Feb. 4 report by Credit Suisse, which rates the category “underweight.”

‘More Realistic’

“What looks like a stretch is the 3 percent revenue generating 13 percent earnings,” Cliggott said. A profit increase of 3 percent to 5 percent is “more realistic. All of these factors are going to make it just that much more challenging,” he said.

Record cotton prices are one of the challenges. A men’s dress shirt that sold for $40 in a department store a year ago may sell for $44 or $45 now, said Jeremy Rubman, a New York-based retail strategist for consulting company Kurt Salmon.

“The world has gorged on cheap cotton for a long time,” said Levi’s Jorgensen. This has shifted as the commodity topped $2 a pound in New York on Feb. 17 for the first time ever, after prices surged 92 percent last year, the biggest annual gain since 1973. Prices extended the rally this week, to $2.057 a pound March 3, on signs that global supplies will remain limited this year amid increased demand from China, the world’s biggest cotton consumer.

Low Wages

China is also the world’s largest importer of cotton, partly because the country’s low wages relative to the U.S. and Europe have lifted demand for garments made there. Now the Asian nation is embracing higher pay for workers, with all 31 Chinese provinces and regions likely to boost their minimum wages in 2011 for the second consecutive year, according to Credit Suisse Group AG.

Labor represents about 20 percent of the cost of a garment, and “these wage pressures are not going away, they are actually getting worse,” said Jefferies analyst Konik.

Retailers also are coping with tight shipping capacity, which is raising the expense of moving apparel from the manufacturing site to the point of sale in the U.S. Freight accounts for about 10 percent of garment costs, said Konik, who added that some freight charges are jumping as much as 100 percent.

Graphic T-Shirts

Teen retailer Abercrombie & Fitch, which reported gains in December same-store sales as customers traded up to dresses from graphic T-shirts, is boosting international store openings as it holds down costs and raises some prices, Chief Executive Officer Michael Jeffries told analysts Feb. 16, without providing details.

“We are comfortable that we can pass some of these increases on to the consumer,” he said. “The question is how much. That’s the question of the day.”

To contact the reporters on this story: Anthony Feld in New York at afeld2@bloomberg.net Chris Burritt in Greensboro at cburritt@bloomberg.net

To contact the editors responsible for this story: Chris Wellisz at cwellisz@bloomberg.net Robin Ajello at rajello@bloomberg.net

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