Are retailers finally solving inventory problems? (NYSE:UAA)
According to research by Gordon Haskett, the period of high sales for retail due to high inventories may be coming to an end.
Recent earnings report from Under Armor (NYSE:UAA), Capri Corporation (CPRI) and Adidas (OTCQX:ADDYY) once again rekindled the inventory obsession that has been a consistent chorus in 2022. Under Armor (UAA), for example, note that its margins plummeted during the Q4 holiday sales season as it sought to tackle high inventory.
“We have certainly seen that the advertising environment has grown a little deeper, and we believe it will grow a little longer. And a lot of that involves some existing building inventory with all the brands,” Under Armor Chief Financial Officer Dave Bergman told analysts on a call Wednesday. “That’s something that all retailers will need to address in the coming quarters.”
While Adidas’ recent warning is clearly binding for a product linecommentary from Under Armor, Capri Holdings (CPRI), and VF Corp. (NYSE:VFC) shows a lingering problem in the garment industry. For example, later see an increase in inventory more than 100% annually for its fiscal third quarter despite advertising activity.
“Inventory is a challenge. CEO of VF Corp. Benno Dorer told analysts for the week.
However, he added that these problems were largely driven by supply chain challenges that lasted longer than the company anticipated. Moving into 2023, Dorer said he expects most of the bottlenecks weighing on the industry to ease. Additionally, industry-wide promotional activity is expected to limit commodity levels and ease margin pressure in the future.
This line of thinking was echoed in recent research by Gordon Haskett analyst Chuck Grom, who forecasts inventory levels will return to good levels by 2023. In a research note published on Friday , he noted that the industry’s overall retail level is indeed normalizing, prompting the issues raised by Under Armor (UAA) and VF Corp. (VFC) are more indicative of company-specific performance issues within a retail group than are general industry trends. In short, while these reports give the company “a little pause,” the bullish argument isn’t dismissed by just a few reports.
“For most of 2022, retailers have endured and resorted to drastic price cuts to free up excess inventory,” he told customers. “As we move into 2023, it looks like inventory gains are more in line with sales with 3-month year-over-year inventory gains trending -2.8% in December vs. retail sales trended down -3.8% in December. If current trends continue and inventory discipline remains a key focus going forward, then we could see an inventory ratio on revenue drops and less pressure on margins in 2023.”
In Grom’s view, lighter inventory levels, coupled with lower freight and freight costs, should act as key favorable factors for the industry. He added that he expects a wave of earnings reports from Walmart (NYSE:WMT), Home Warehouse (HD), Lowe’s (SHORT), Target (TGT), the year below (YEAR), TJX Company (TJX), Macy’s (m), Ross Store (ROST) and Burlington Stores (BURL) in the coming weeks to reflect this broader trend. In fact, Grom upgraded both Five Below (YEAR) and Walmart (WMT) for Friday’s Buy and Accumulate ratings respectively, due in part to their inventory management improvements.
That said, Grom advises continuing to be selective as he sees the potential for “management teams to establish very cautious guidelines” in upcoming reports. Therefore, investors should focus on retailers that get traffic, discount opportunities, and retailers that address consumer needs rather than desires.
Grom explains: “From a portfolio approach based on a combination of moving parts, we think it is appropriate to adhere to our Barbell Strategy, where we seek to hedge between names with more defensive properties than names with more offensive characteristics”. “In the past, we have found the Barbell method to be extremely useful in balancing risk, especially in times of uncertainty.”
Buy-rated “offensive” names include Ross Stores (ROST), Dick’s Sportswear (DKS) and TJX companies (TJX). Top defensive names include BJ’s Wholesale Club (BJ) Costco Wholesale Corporation (VALUE), Supply of tractors (TSCO) and the Year below (YEAR). common dollar (FIRE) was removed from the Buy Rating list and moved to an Cumulative rating on Friday despite its defensive nature due to the competitive risks and reduced tax benefits covered by the stock.
Read more about Grom Downgrade of Floor and Decor Holdings.