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Why Levi’s is Optimistic About Margins Despite Rising Cotton Prices

The general demand for comfortable fashion is evolving from at-home sweats into a wider landscape where loungewear and new denim styles coexist.

And Levi’s is here for the ride.

“The casualization trends that have been accelerated by the pandemic globally are here to stay,” Chip Bergh, Levi Strauss & Co. president and CEO, said during the company’s Q3 2021 earnings call on Wednesday. “In the U.S., both the apparel segment and the denim category are now larger than pre-pandemic, with denim growth outpacing total apparel for the second quarter in a row. We expect these drivers will provide our business with a multi-year tailwind.”

Beating pre-pandemic levels might have been a lofty dream for most jeans brands this time last year, but sales for the Levi’s brand was up 4 percent versus 2019, and even stronger in its top five markets, where sale climbed 9 percent.

The brand is making the most of its gains in the bottoms category. Men’s bottoms returned to growth up 7 percent versus 2019, while women’s bottoms outperformed all categories in Q3 by rising 18 percent, driven by strong performance in high rise silhouettes and fashion fits, Bergh said. In general, the trend toward looser fits now represents almost half of Levi’s women’s and men’s bottoms assortments. “We’re seeing increased demand for iconic products like the 501, which was up 20 percent versus Q3 2019,” he added.

Indeed, the new denim cycle, which the executive declared two quarters ago, is having a positive effect across the entire denim industry as consumers seek to “refill” their closets. In the call, Bergh said the total jeans category on a past nine-month basis is up to $11.2 billion in the U.S., surpassing pre-pandemic numbers.

“I think we could say now quite confidently that these new looser fits [and] new silhouettes are definitely driving a new denim cycle,” he added.

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Denim’s renaissance, however, arrives as the cost of cotton—the fabric’s defining ingredient—increases. The company has negotiated most of its product costs through the first half of 2022 at very low-single-digit inflation and anticipates a mid-single digit increase for the second half.

Though Bergh joined the company during the cotton market’s last major price spike in 2011, he said Levi Strauss is better positioned now to handle the costs, thanks in part to a broader distribution footprint and the 5 percent price increase it implemented in Q2.

In 2011, Levi’s didn’t have the pricing power it does today, Bergh said, adding that the company is now more disciplined and has better capabilities in terms of data, analytics and machine learning. These tools, he pointed out, will also be key in making strategic decisions on incremental pricing adjustments, if necessary.

“But we have taken pricing over the last 12 months in anticipation of costs going up, and that’s part of the reason we’re seeing these incredible gross margins over the last couple of months, as we priced ahead of some of these inflationary pressures hitting us,” Bergh said.