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Quarter-End Insights

Consumer Cyclical Stocks for Your Radar

Consumer cyclical firms are still planning for top-line gains but are bracing for margin pressure, particularly in the second half of the year.

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As we detailed in our consumer cyclical industry-level analysis, we still see signs for near-term optimism as it relates to the first half of 2011, and we recognize further signs of an improving economy. Today we are somewhat less concerned about sustainability of the top line, and instead believe there could be downside risk to operating margins in the back half of the year.

Most, if not all, retailers have expressed some level of awareness surrounding rising input costs in recent months, hoping to set (lowered, yet achievable) expectations without raising the fear level among investors. Transportation, labor, and raw material cotton costs remain at the center of these conversations. Put into perspective, the price of cotton has doubled since August 2010, and the cost of WTI crude oil is up nearly 40% over the same time period. Shipping rates, in tandem with the recovering global economy, are up 30% year-over-year. For example  Vera Bradley (VRA), a small-cap firm that sells cotton handbags and accessories predominantly manufactured in China, expects a 30% increase in its cotton costs for the year.  Guess (GES), another global fashion retailer is seeing "double-digit increases" in apparel. The not-so-comforting news is that even the large-cap consumer sector firms such as  Nike (NKE) are experiencing rising costs, which suggests that the impact is being felt at all levels. Since the lead time for apparel manufacturing is typically about six to nine months, apparel retailers will start to see the impact of higher cotton prices hit financials in mid-2011, with further sourcing cost pressures projected for the fall season.

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Peter Wahlstrom has a position in the following securities mentioned above: AAPL. Find out about Morningstar’s editorial policies.