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Cotton Prices Might Be the New Tailwind

If you want volatility, all you have to do is look at the cotton trade.

A farm laborer works at a cotton factory in Korla city, Xinjiang Uygur Autonomous Region, China.
Getty Images
A farm laborer works at a cotton factory in Korla city, Xinjiang Uygur Autonomous Region, China.

In the last week, it shed 36 percent. Despite that, cotton is still up more than 37 percent in the last year.

These are violent moves, and even the professionals have been scorched by this trade.

When it comes to the corporate response, how a company deals with this dynamic will make or break earnings—and stock prices.

For instance, some companies that looked smart by hedging might end up paying more, while others that took the risk of waiting for prices to come down went from boneheaded to brilliant ... in a week!

The ultimate winners will be the companies that bought relatively low and were still able to successfully raise prices.

Obviously, names like Gap and Abercrombie are examples of cotton-sensitive retailers, but you might want to go back to some of the clothing suppliers, like VF Corpand HanesBrands.

VF Corp is up more than 50 percent in the last year, and part of it surrounded how the company dealt with the shocks in the cotton market. The company reports on Thursday, and it will be interesting to see if the company views the current decrease in cotton prices as a tailwind.

That was not the case for Hanes . On Wednesday, its stock fell more than eight percent after reporting unconvincing earnings.

One of the key elements that pushed the stock lower was commentary that, despite the recent pullback in cotton prices, input costs related to it remain a problem.

Another company to consider is Lululemon. The yoga-gear company uses a significant amount of synthetics. Prices for cotton alternatives stayed in a tighter range, helping the company explode its margins. Perhaps if cotton continues to go lower, competitors can close the gap.

And there could be further gyrations in the market because global cotton supply remains a concern. The recent drop stems from the simple concept of demand destruction.

Prices were just too high, and demand waned...quickly.