Cotton for December delivery is currently just 61.52 cents a pound

Cotton for December delivery is currently just 61.52 cents a pound

With global cotton prices sitting at a five-year low, apparel firms should be benefitting from lower unit costs. That's the theory at least. The reality, however, is that any gains are unlikely to show up until the second half of next year - and more likely than not will be offset by rising labour and compliance costs.  

Already sitting at a five-year low, cotton futures fell even further last week after China revealed plans to slash its cotton import quotas in 2015. The country will now import the mandatory WTO-approved 894,000 tonnes of raw cotton as it tries to boost demand for domestically-grown fibre and cut its huge stockpiles.

Cotton for December delivery is currently sitting at around 61.52 cents a pound on the ICE Futures US exchange in New York, and is an even lower 60.87 cents a pound for delivery in March next year. The prices mirror trader concerns that lower Chinese imports will lead global stocks to languish at a time when world inventories are already at an all-time high.

Indeed, inter-governmental group the International Cotton Advisory Committee (ICAC) has already suggested cotton production will exceed consumption in 2014/15 for the fifth season in a row, with world ending stocks forecast at around 22.2m tons.

It's a far cry from the situation back in 2011 when low cotton inventories, crop damage, and a ban on exports of the fibre by India all combined to push prices to record highs of $2.27 per pound. And it means that the price of cotton today sits around the average of 60 cents per pound seen in the ten years to 2009/10.

All of which should, of course, be good news for apparel manufacturers, brands and retailers, for whom the fabric costs for key items such as denim and T-shirts amounts to roughly 60% of FOB costs (Freight on Board), according to research from Cowen & Company. This, in turn, accounts for roughly 70% of total cost of goods sold (COGS), they add.

Analysts were already studying the implications for US apparel brands and retailers from falling prices and a growing global glut of the fibre before China's most recent decision was revealed. 

But while they agree the declining price of cotton "is a positive", Cowen & Co research also suggests that a mid-teen year-on-year percentage hike in labour and compliance costs in emerging countries, along with other headwinds for factories, "may offset the benefit from cotton's decline, leaving unit costs for apparel flat to slightly up for the first half of 2015."

Indeed, the 9 to 12 month lag of sourced cotton product to flow through the COGS suggests any benefit will not show up in clothing until the second half of next year, they say.

In contrast, analysts at FBR Capital Markets believe that lower cotton prices could result in a "significant input cost/gross margin (AUC) tailwind and estimate that cotton costs realised in COGS could fall by 13% to 15% in 2015."

They also suggest "the recent cotton deflation could be the start of a multi-year trend of favourable cotton prices" and that "2015 could be a recovery year for specialty retail and apparel."

That said, they also note that "while cotton is still a significant component of COGS, usage is likely down versus previous years, driven by increased use of synthetics/blends and prevalence of activewear."

Apparel unit costs
When it comes to apparel unit costs, half of sourcing executives surveyed by Cowen & Co see a low-single-digit increase in the first half of 2015. Another 31% see unit costs flat and only 13% expect a low-single-digit decline.

In terms of unit costs for cotton based product for 2015 in total, there is more variance among the survey respondents, with 63% seeing unit costs flat to up, and 37% seeing unit costs decline.

Outside of cotton based product, 87% of respondents see unit costs for synthetic based products flat to up low-single-digits in 2015.

Increases in emerging market labor costs will play a major role in offsetting the decrease in cotton/fabric costs, with labour costs in China, Bangladesh, Pakistan, Cambodia and Vietnam all likely to increase over 20% year-on-year in 2015 - with Bangladesh labour costs jumping over 50% year-on-year.