UPDATE: Concerns About Rising Cotton Costs Weighing On Retailers

Fears that retailers may have a tougher time than thought with rising cotton prices are reverberating throughout the group and causing a mass sell-off Friday in apparel stocks.

Gap Inc. (GPS), the largest U.S. apparel-specific retailer by sales, spurred the alarm late Thursday by saying raw-material costs are rising faster than expected and that the company will be unable to fully counter them with price increases. Gap gave what is seemingly the highest, and clearest, estimate yet, saying cost per clothing item will be up 20% in the second half of the year.

The magnitude of the increase is notable considering the buying power that Gap's size gives it. Pegging off of Gap, questions are being raised about what kinds of increases other apparel retailers will have to deal with.

"It's almost like Gap made everybody reassess what the potential cost impact is for all the apparel retailers and apparel manufacturers," said Mark Montagna, retail analyst with Avondale Partners.

In comments starting last year, retail executives spoke of coming price increases. But many were vague. Macy's Inc. (M) Chief Financial Officer Karen Hoguet said last week she felt concerns about price inflation were "overstated," at least for her company. As one of the biggest department stores, Macy's has the ability to play one merchant off of another to get better pricing, Montagna said. The company can also add more detail to apparel, resulting in less need for cotton. Target Corp. (TGT) this week was one of the most definitive, saying it sees double-digit percentage increases for both apparel and soft home merchandise, like towels and bedding, this fall.

Cotton prices touched a high of $2.27 a pound in early March after bad weather hurt output in major producers India and China, and mills rushed to stock up on the fiber. Prices have retreated but are still more than double the 10-year average of 62 cents a pound.

Retailers have also generally said they felt comfortable they would be able to pass the cost increases along to customers to a large degree.

If this isn't the case, it becomes more complicated for retailers because their customers are already struggling with rising gas and food prices as well as still-high unemployment.

Gap was the largest decliner in the Standard & Poor's 500 Index Friday, recently down 17.1% at $19.30. Teen retailer Aeropostale Inc. (ARO), which gave an extremely weak second-quarter view late Thursday, also saw a large loss, with shares off 14% at $18.30.

Aeropostale did indicate that cost increases are "somewhat" below its previous 10% to 15% range, but that may not help the company much because it is so promotional. Aeropostale's women's products have failed to entice buyers, and the retailer said its second-quarter outlook reflects plans for "aggressive markdowns" to clear through spring merchandise before the back-to-school season. Janney Capital Markets also expressed concern that cost inflation may impact Aeropostale disproportionately compared with retailers that target a higher-income market given its more price-sensitive customers.

Other retailers selling off Friday included American Eagle Outfitters Inc. (AEO), down 6.5% at $13.67, and Abercrombie & Fitch Co. (ANF), off 2.1% at $73.93. Meanwhile, shares of department stores also declined, with J.C. Penney Co. (JCP) sliding 4.1% to $36.41 and Macy's Inc. (M) off 2.3% at $28.83. Among apparel manufacturers, Phillips-Van Heusen Corp. (PVH) is off 5.2% at $65.51 and Lee and Wrangler maker VF Corp. (VFC) is down 4.5% at $97.63.

But shares of Zumiez Inc. (ZUMZ), which sells action sports-related apparel and equipment, bucked the weakness plaguing the retail sector. Zumiez is seen as somewhat of a safe haven from the pressure of rising raw materials costs, as about half of its products are not cotton-based and it carries unique brands that can often command higher prices. Zumiez's shares were up 5.7% at $27.80 after it posted better-than-expected first-quarter results and issued what was generally considered a conservative second-quarter view.

Overall, retailers' stocks had been faring well until recently, outpacing the broader market. The S&P 500 Retail Index had risen nearly 12% over two months through the middle of May, doubling the gain in the main S&P 500 during that period. Friday, though, the retail index was down 0.9%, while the S&P 500 was off 0.2%.

-By Caitlin Nish, Dow Jones Newswires; 212-416-2076; caitlin.nish@dowjones.com

-By Karen Talley, Dow Jones Newswires; 212-416-2196; karen.talley@dowjones.com

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