Investors should account for raw materials sourcing and resource constraints in their investment decision-making.
Black Friday has become almost as popular as Thanksgiving Day itself. Each year, retailers open their doors earlier. This year, Macy’s announced it would push up its opening hours to 5pm on Thanksgiving Day – perhaps before some have even sat down to eat their turkey dinners.
Investors in apparel and retail companies are surely excited about this day and the approaching holiday season. However, there is one consideration they may not be bearing in mind, but which could have financial ramifications for the companies they are investing in.
Is Fast Fashion Always Profitable?
The problem with fast fashion, and the hype for huge savings on days like Black Friday, is that sustainability issues around raw materials sourcing – which are oftentimes overlooked –could create supply disruptions and result in higher raw material costs over time.
Concerns related to climate change, water scarcity, land use, resource scarcity, and conflict in the supply chain are increasingly shaping the industry’s ability to source materials, including cotton, leather, wool, rubber, and precious metals. The ability of companies to manage potential materials shortages, supply disruptions, price volatility, and reputational risks is made more difficult by the fact that they source materials from geographically diverse regions, usually through complex supply chains that often lack transparency. Further, the type of risk faced for different materials can require different solutions.
Take cotton for example. According to the World Resources Institute, 57 percent of cotton is grown in areas with high to extremely high levels of water stress. Moreover, given that it takes roughly 20,000 liters of water to produce one kilogram of cotton, the crop is susceptible to shifting weather patterns and droughts, while also contributing to increased water scarcity.
Further, innovation to find sustainable alternatives for these materials is lacking. There is currently no commercially viable textile recycling techniques for the major fibers used in apparel, which presents a major challenge to a closed-loop system.
Apparel companies understand this risk, and some are taking steps to ameliorate it. In its FY2013 Form 10-K, Hanesbrands discussed its exposure to shifting cotton prices through a sensitivity analysis. The company concluded that an increase of $0.01 per pound in cotton prices would influence the cost of sales by $3 million at 2013 production levels. In September, the H&M Foundation invested $6.5 million in a four-year partnership fund to research and develop new textile recycling technologies, with the aim of recycling blended textiles into new fabrics and yarns. Patagonia will be the first to use Tencel fiber in its products beginning in early 2017. Tencel is made from post-industrial cotton waste, and producing it uses 95% less water than traditional cotton production.
We know there are risks in each apparel company’s supply chain based on what raw materials they use to make their products. What we don’t know is how much of each raw material the major apparel companies use, and what the risks associated with each of those materials are.
Protect Your Profits
It’s up to investors to engage with companies and ask them questions such as: What risks are associated with the materials the company is most reliant on, and how is the company innovating to mitigate these risks? To make better investment decisions, investors should consider environmental, social, and governance factors (like resource constraints and where companies are sourcing their materials from) in addition to traditional sales numbers and valuation metrics.
This Black Friday, I encourage you to consider these questions and engage with the companies you invest in by asking how they are ensuring the environmental and financial sustainability of their business.
Figure 1. The current state of disclosure on raw material sourcing by the largest publicly traded Apparel, Accessories & Footwear companies. Nine of the top ten companies in this industry disclose on this topic in their annual financial reports– but it is not effective disclosure because there are no comparable quantitative metrics or specific information around each material. More details on how they are managing their raw materials is needed.
Source: SASB analysis performed between May and August 2016 using the latest annual SEC Filings (i.e. Form 10-Ks and 20-Fs) for the top companies, by revenue, per SICS industry (maximum of 10 companies).