Cost Spreads Matter

02/12/09 11:42AM EST
9 out of 10 CEOs can’t tell me within a 20% band how many units of apparel are consumed in the US. That’s why I think monitoring the relationship between unit cost and sales matters so much.

Now that so many are realizing the importance of factoring in a macro view with the (always important) company fundamentals, I am getting more questions about changes in the import price environment.

A common mistake out there is that many people look at the percent change in apparel/footwear CPI vs. the percent change in the import cost. If import costs are off by 1%, but consumer prices are off by 2%, then that’s actually a POSITIVE margin event, right?

No

Think about it. The average retail price for a garment of apparel is about $10, yet the average fully manufactured/imported cost is $3.50. If costs are down 1%, then that saves $0.035 per garment. This might not seem like much, but multiply it by the 23 billion units of apparel consumed in this country last year and that’s $800mm – yes folks, that’s real money. But if consumer price is down by 2%, then we’re talking a $0.20 hit on each of those garments, or about $4.6bn. So net out the two and the industry is in the hole by $3.8bn. Not good… This is the basis for much of the multi-year call I’ve had – and continue to have – on the industry. Most CEOs I talk to cannot tell me within 5 billion units (yes, that’s 20%) how many units of apparel are consumed each year. Macro might not have mattered over the past decade. But now it does.

That’s why I track the chars below so closely. I don’t care as much about the percent change in cost vs. retail sales as I do in the dollar spread. That’s what really matters. The notable point here is that the past 6 months has actually shown a positive trend for consumption vs. manufactured cost. The latest month turned down again meaningfully. The data is on a one month lag, so we’re looking at Dec – which is hardly relevant about what is to come. But straight lining the trend throughout ’09 does not bode well for margins through mid-year.
Unit cost/revenue spreads have been so positive for so long. They even looked good for 2H08 but recently turned down.
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