By and  on March 19, 2012

Fashion can look forward to a second-half boost from lower cotton prices, which are expected to help return gross margins to 2010 levels, according to a new report from Moody's Investors Service.

Wall Street is certainly looking for big things from retailers this year and pushed shares in the sector to another new high today.

Cotton prices peaked just over a year ago and drove the apparel industry's gross margins down 1.5 percentage points to 42.3 percent in the third quarter and 2.1 percentage points to 40.3 percent in the fourth quarter, said the report, which listed debt analyst Scott Tuhy as lead author.

"The decline in cotton prices over the past year will reverse some of the margin declines in the apparel industry, but not all of them, bringing third-quarter margins this year back toward 2010 levels of about 43 percent and fourth quarter margins to about 42 percent," Moody's said.

Cotton prices are back down to 81 cents a pound after peaking at $2.10 a pound just over a year ago, said Moody's, which does not expect further declines.

The margin reprieve could be brief, though, as labor costs start to come to the fore. "Wages in China, a key manufacturer of apparel, are reportedly rising and, with few countries able to provide abundant, cheap labor, labor costs will be a drag on margins," Moody's said.

"We expect apparel companies to explore lower-cost labor markets, such as Vietnam and Bangladesh; however, the switch to these markets will be a gradual process. We think rising labor costs are a longer-term trend, which is the primary reason we expect apparel companies to begin raising prices at retail in 2013, as the benefits of the fall in cotton prices begin to ease."

The report said companies that buy fabrics in U.S. dollars and sell in Europe could also face a weak euro. This includes The Warnaco Group Inc., Quiksilver Inc. and PVH Corp. "These companies have hedged some of this exchange risk, so the negative impact on margins may take a couple quarters to show up," Moody's said.

For now, stock markets are saying that the future is brightening for U.S. retailers.

The S&P Retail Index inched up 0.3 percent, or 1.79 points, to 607.36 — the highest close ever for the broad measure of U.S. retail. That's hardly new since the sector's closed a fresh high 33 times this year.

The Dow Jones Industrial Average gained just 6.51 points to 13,239.13.

Among the day's gainers were The Talbots Inc., 4.9 percent to $3.23; Movado Group Inc., 3 percent to $22.29; The Jones Group Inc., 2.9 percent to $11.76; Quiksilver Inc., 2.9 percent to $4.30, and The Gap Inc., 2.7 percent to $26.08.

In Europe, stocks were generally down. The CAC 40 in Paris fell 0.5 percent to 3,577.88, followed by the DAX in Frankfurt and the FTSE 100 in London, which each fell 0.1 percent to 7,154.22 and 5,961.11 respectively.

The FTSE MIB in Milan was the exception, climbing 0.3 percent to 17,133.42.

The stocks that lost ground on included PPR, off 1.4 percent to 133.95 euros; Carrefour, 1.7 percent to 19 euros, and French Connection, 2.4 percent to 0.51 pounds.

The euro traded at $1.32 while the pound traded at $1.58.

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