Catch a Profit on Falling Cotton

Earlier this week I dished on falling cocoa prices and how that could help margins at Hershey (HSY) and other cocoa-related companies, such as Tootsie Roll (TR). In response, I received an email asking me what other commodities have been falling, and what companies are likely to benefit. Several have been on a downward trend, and these include corn, gasoline, copper, aluminum and cotton. That last one -- cotton -- had a run similar to that of cocoa, as cotton prices surged in both 2010 and the first part of 2011. A key difference here was that the peak in cotton prices was 37% higher in early 2011 than was the 2010 peak of 168 cents per pound, according to data from the National Cotton Council (see chart below). Similar to the situation with cocoa, that rocket-ship ride in cotton prices caused investor concern about margins, as well as price hikes from companies that counted cotton among their key inputs, such as clothing makers and related manufacturers. Cotton -- Monthly Source: National Cotton Council of America View Chart » But what a difference a few months, and strong cotton crop, can make. Despite one of the worst U.S. cotton crops in 80 years, cotton output from Australia to China to India, coupled with slower economic growth expectations vs. those early in 2011, have led to a cotton glut and a dramatic fall-off in cotton prices. Per data from The National Cotton Council, cotton prices have fallen more than 54% to 104.6 cents in November, from 229.6 cents just this past March. For those who invest in commodities, this has been one of the worst performers of the year, and cotton prices are likely to stay contained, given recent cotton forecasts calling for more 2012 output from China, India and other regions. This led Goldman Sachs to cut its cotton forecast last month, putting the number at $0.85 in six months, down from the prior forecast of $1. Much like the opportunity in Hershey shares, the combination of falling input costs and prior price increases generally bodes well for margins, as long as demand holds up. Thus far that appears to be the case for clothing demand. Retail sales jumped to a record $52.4 billion during the four-day Thanksgiving weekend through Nov. 27, according to the National Retail Federation (NRF), with more than 51% of shoppers buying clothes. In the near term, these trends appear favorable. There are a bevy of companies that count cotton as a key ingredient. Among these are denim makers True Religion Apparel (TRLG) and Ralph Lauren (RL), as well as apparel conglomerate V.F. Corp. (VFC), which offers products under brands such as The North Face, 7 for All Mankind, Lee, Wrangler, and Reef. However, one company I see having a good reward-to-risk tradeoff is Hanesbrands (HBI). Cotton is a key resource for this maker of T-shirts, sweats and underwear -- and, given the company's strong market share position in each of its product lines, odds are that most are familiar with its product offerings. Hanesbrands shares, in recovery from a tumble from their 52-week high just above $33, have made a roundtrip to lows visited last March. That had turned out to be a great time to go long the shares. At 7x Street expectations for 2012 earnings of $2.15 per share -- up 12% vs. the $2.81 profit Hanesbrands is tracking to deliver this year -- the shares are quite the bargain, in my view. While I personally like the products, I'm also very encouraged that management has been growing earnings faster than revenue. Using Street expectations as a guide, the company is poised for more of that in 2012. That's in addition to management's continuing efforts at shoring up the balance sheet, as well as the company's products being well-positioned at key cash-strapped-consumer retailers -- Wal-Mart (WMT), Kohl's (KSS), Kmart and JCPenney (JCP) -- in addition to such retailers as Macy's (M) and Target (TGT). All of this makes Hanesbrands shares are a good value play this holiday season.

Catch a Profit on Falling Cotton

Hanesbrands should continue sharply benefiting, and the shares are currently at a nice price point.

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