Higher sourcing costs are likely to challenge a range of U.S. companies, according to analysts from the UBS retail, apparel and footwear team.

This story first appeared in the August 23, 2010 issue of WWD. Subscribe Today.

During a conference call last week, analysts concluded the firms most exposed to rising costs were J. Crew Group Inc., Dollar Tree Inc., Ralph Lauren Corp. and VF Corp. because of factors such as higher labor and raw materials expenditures and substantial production in China, where the increases are focused.

The companies least exposed were The Talbots Inc., Limited Brands Inc., Costco Wholesale Corp., BJ’s Warehouse Club Inc. and Under Armour Inc.

Breaking down the numbers, specialty retail analyst Roxanne Meyer said Aéropostale Inc. has high exposure to rising prices for raw materials because of its extensive use of cotton, and Urban Outfitters Inc., with its sophisticated product, has higher labor costs because of “more intensive cut, sew and trim.”

The analysts forecast that increased cotton costs will continue through the first half of 2011. They noted the U.S. crop for fall has mostly been accounted for, keeping tight limits on supply. Flooding in China and, more recently, Pakistan, is likely to continue to have an impact on cotton prices. The shift of production to countries outside China raises quality and delivery risks, and the analysts concluded that production would eventually return to China.

Meyer said retailers will have to decide whether to take the hit now on increased costs or later in the form of markdowns.

Discount analyst Neil Currie said among mass merchants, Target Corp. has the most exposure as a percentage of assortment — about 20 percent — to increased cotton prices because of its softlines categories. However, Wal-Mart Stores Inc., with its consumables business, has the least exposure.

The analysts said firms with the most exposure to high cotton prices as a percentage of their assortment include Aéropostale, 90 percent; American Eagle Outfitters, 80 percent; Abercrombie, 75 percent, and Gap Inc., 75 percent.

J. Crew, Chico’s FAS Inc., Ralph Lauren, Coach Inc., Nike Inc. and VF have the most exposure to China. Although Ralph Lauren has both a high exposure to rising cotton costs and to China, where it produces 50 percent of its product, the analysts said the company also has solid pricing power, due partly to its premium brand distribution. Others with significant pricing power include Nike and Under Armour.

In addition, the analysts hosted a recent investor-relations conference with Wal-Mart in which the discounter said it was open-minded about allowing apparel vendors to raise prices. Its three top vendors, Levi Strauss & Co., Hanesbrands and VF, were working with retailers to take costs out of the supply chain, but would also consider price increases if they had to, the analysts said.

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