Rayon © Baerbel Schmidt/Getty Images

Extra1/11/2011 11:30 AM ET

Why rayon is suddenly back in style

Clothing manufacturers are scrambling for alternatives to pricey cotton, resulting in a spike in demand for rayon's major ingredient. Investors, it's fashion worth following.

By The Wall Street Journal

Cotton prices surged 91% in 2010, leaving designers and clothing makers scrambling to find lower-cost alternatives. One of their favorite replacements is rayon, an 80-year-old fabric whose last golden age was in the 1980s, when it was used in everything from Hawaiian shirts to sequined vests.

The largest ingredient in rayon, a base substance known as dissolving wood pulp, is now in huge demand, boosting stocks of companies that historically followed home starts and newsprint costs.

The result of the rayon renaissance has been huge gains for Fortress Paper (FTPLF, news, msgs), Tembec (TMBCF, news, msgs) and Rayonier (RYN, news, msgs). Fortress stock more than doubled over the past six months to about $44, Tembec spiked 140% to $4.36, while Rayonier jumped 22% over the same period to $55.50.

Global production of dissolving pulp, which is also used in filters, screen films and diapers, grew by roughly 25% to 5.2 million tons since 2008, according to Tembec.

Brokerage analysts say they see more gains ahead for the companies, putting price targets between $50 to $65 for Fortress; $4.25 to $5.35 for Tembec; and $56 to $60 for Rayonier.

"In general, we try to find alternatives to cotton whenever possible," said Sera Coblentz, who develops clothes for New York's Meryl Diamond. "Everyone had it in their lines for the last season."

Clothing manufacturers including Max Azria and Isaac Mizrahi have begun adding rayon into everything from dresses to harem pants. While the cost of the most common rayon fabric has risen of late, it is still relatively cheap -- at $2.35 per yard -- compared with $4 per yard for cotton shirting, Coblentz said.

The knock-on effect on clothing manufacturers became pronounced only in recent months, when rayon prices spiked, too. Sonya Yi, production manager for Los Angeles private label Chris & Carol Apparel, said she now buys rayon at $2.70 per pound, compared with a low of $1.60 last year.

The end result for consumers: Prices for clothes are creeping up, even when lower-cost fabrics are substituted.

"At first we started to eat the increase because we're always controlled by the retail price of the item," said Ira Spiegel, of New York's Dollhouse Apparel, which makes clothes for teenage girls. "Now we're trying to pass half of that to the retailer."

The prices show no sign of retreating, thanks to strong demand from Asia, where an emerging middle class favors the rayon, said Rayonier CEO Lee Thomas. The synthetic "has better drying capability than pure cotton, and its feel is better than polyester," which increases its appeal in hotter climates, he said.

For the first time in recent memory, demand for dissolving pulp has outstripped supply, and buyers are struggling to get orders filled, said Peter Vinall, CEO of Fortress' specialty division. That reflects a corresponding move in the price of dissolving pulp to approximately $2,350 per ton from $1,550 per ton 12 months ago, Vinall said.

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Fortress is spending more than $120 million to refurbish a pulp mill that it says will produce 200,000 tons of dissolving pulp annually. Chinese buyers have already lined up for 156,000 tons of the production.

Tembec manufactures about 300,000 tons of the pulp annually and anticipates a $200 per ton price increase starting this month, said CEO James Lopez during a November conference call. The Quebec pulp and paper manufacturer is emerging from 10 years of cost cutting and debt restructuring that position it well to capitalize, said Stefan Lingmerth, an analyst at Phoenix Investment Advisers, which owns Tembec stock.

Rayon has been a welcome windfall for Tembec. The company restructured $1.2 billion in bonds in 2008, and cut debt by $200 million last year. Lingmerth said the company stock currently trades at approximately 3.5 times forecast earnings before interest, taxes, depreciation and amortization of $180 million against a sector average of five times.

Rayonier produces only a special variety of dissolving pulp, which is not used in rayon but in cigarette filters, flat-screen television screens and paint thickeners. The timber real-estate investment trust still benefits from the rayon frenzy, though, because its rivals are moving out of its market to sell to fabric producers, Thomas said.

This article was reported by Matt Wirz for The Wall Street Journal.

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