NEW YORK — When June sales results come out Thursday, Wall Street — with crystal balls and calculators in hand — will try to divine if second-quarter bottom lines will be rosy or just red.
The answer will speak volumes about prospects for the second half of the year and to what degree retailers will have the cash, the space and the will to creatively merchandise their stores over the next six months.
The sector started off with a mark against it, though, as many retailers began the second quarter with inventories that were higher than either they or shareholders would have preferred.
Broadline retailers ended the first quarter with 6.2 percent rise in total inventories, despite a meager 0.6 percent rise in sales, a 5.6 percentage-point differential, according to Goldman Sachs. Of this group, national chains carried the heaviest burden with a collective 12.1 percentage point gap between inventory and sales.
June sales picked up a bit later in the month, but not enough to offset the earlier shortfall, said Smith Barney broadline analyst Deborah Weinswig, in a sales preview.
“Retailers have been focused on clearing seasonal merchandise to make room for back-to-school,” she noted. “We are expecting excess inventories to be predominately seasonal and discretionary in nature, especially in apparel. July is traditionally a clearance month, especially for apparel retailers, and we are expecting to see aggressive promotional activity to continue.”
While too much inventory can financially strain retailers, its effects can also reverberate throughout the marketplace.
VF Corp., which produces Lee, Wrangler and Riders, recently warned its second-quarter profits could fall by as much as 25 percent from a year ago amid inventory concerns up and down the supply chain. Originally, the firm planned earnings at flat to down 5 percent, excluding the effects of year-ago restructuring initiatives.
Chief financial officer Robert Shearer, on a conference call, said VF’s inventory by the end of June could be up by as much as 20 percent, although some of that increase was planned. “The issue here is the tough retailing environment and the inventory reductions taken by our customers,” he said. About 50 percent of VF’s business is based on replenishment orders, which have declined partially due to the inventory reductions under way at retail.Likewise, Levi Strauss & Co. recently acknowledged it had begun selling some excess inventory — including its Red Tab products — to Sam’s Club, but said the move had nothing to do with the upcoming launch of the Levi Strauss Signature mass market brand at Wal-Mart Stores Inc.’s 2,000-plus U.S. stores.
The firm started selling to Sam’s because it had more inventory than anticipated coming off of the holiday season, according to a spokesman. “Many of our retail customers had larger-than-expected inventories in January after the holidays,” he noted, which caused them to order less merchandise than Levi’s had anticipated.
So far, much blame for the poor retail sales and mounting inventory has fallen to the weather. Cooler-than-usual temperatures this spring left consumers uninterested in warm-weather offerings gracing the shelves of many stores.
Excess inventory, though, is usually a confluence of factors. In addition to a disinterested consumer, stacks of goods crowding the retailers’ back rooms can be the result of poor planning, less than fashionable merchandise or an inefficient supply chain.
Whatever the cause, too much inventory strikes terror in the hearts of stores and their suppliers. Eventually, the goods need to be sold at steep markdowns, which can make for significant losses on sales that come too late. This, in turn, raises Wall Street’s blood pressure and can accelerate a fall in a stock’s price. Retailers can also reduce their product buys, but too severe a cutback on new merchandise can leave stores flat and depleted of fashion newness. The term “vicious circle” comes to mind.
Don Harris, Wal-Mart’s executive vice president and general merchandise manager, last month told attendees at a Credit Suisse First Boston conference that the firm was “a lot nervous” about inventory levels at the beginning of May, specifically in seasonal merchandise such as summer apparel.
While inventory has yet to be worked down to the retail giant’s preferred level, Wal-Mart seeks to grow inventories at about half the rate of sales, and Harris said “a lot of progress” has been made.
“We’ve put a full-court press on trying to make adjustments on price where we need to to get inventory levels down and certainly put the breaks on replenishment where we can,” said Harris. “It’s one of those things where you work on out-of-stocks in the morning and overstocks in the afternoon.”Wal-Mart, though,is often ahead of the retail pack. If it was “nervous” about inventories last month, other companies were likely scared stiff. Considering the discounter’s traffic, driven in part by food offerings, and its ultra-low prices, Wal-Mart is better positioned to move excess inventories than many of its competitors.
While the national chain retailers have not commented on the status of their inventories since reporting first-quarter results, and declined to do so for this article, stock levels going into the second quarter indicated that they had some work to do.
According to Goldman Sachs, J.C. Penney’s department stores and catalog had a 6.9 percent rise in inventories on a 7.1 percent drop in sales in the first quarter, while Kohl’s Corp.’s inventories rose 26.2 percent on a 13.2 percent rise in sales and Sears, Roebuck & Co.’s stocks were up 8.7 percent on a 2.3 percent fall in sales.
“Managements have reacted to the spring inventory bubble by cutting receipts of goods and maintaining high promotional levels — although perhaps no higher than a year ago,” wrote Goldman Sachs analyst George Strachan in a research report earlier this month. Despite the sales improvement in May, he noted, the mountain of inventory has not melted away. When they arrive on Thursday, reports on June sales will afford observers a clearer view of the second quarter, which ends at the conclusion of August.
A.G. Edwards & Sons analyst Robert Buchanan said excess inventory has been a problem throughout the industry, including broadline and specialty players.
Federated Department Stores Inc., he said, hit the promotional button early while others, such as May Department Stores Co. and Kohl’s Corp., have been slower to attack the excess goods on hand.
“Retailers in hindsight made a huge mistake by being too optimistic on their inventory commitments,” said Buchanan.
The inventory backups so far have been in women’s, he said, where retailers made their largest purchasing bets.
Buchanan tracks the industry’s inventory-to-sales ratio. That ratio in the first quarter of fiscal 2004 rose to 0.1352 for retailing overall, representing inventories worth $89.89 billion on sales of $655.08 billion. This compared with a ratio of 0.1332 in the fourth quarter with inventories of $87.9 billion on sales of $659.92 billion.While retail inventories have risen recently, they’ve also fallen significantly over the last decade with the help of management determination coupled with technical advances. In the first quarter of fiscal 1994, off of a base that included fewer stores, the industry’s inventory-to-sales ratio weighed in at 0.1664, with $28.3 billion in inventory and $170.19 billion in sales, according to Buchanan.
Despite the recent inventory increases, Northeast Securities analyst Eric Beder expects inventory levels to trend down through the rest of the year. “One of the real triumphs in retailing is that inventory management has gotten very, very sophisticated,” he noted.
The SARS crisis, with the accompanying rise in videoconference sourcing efforts, might make the supply chain even more efficient and reduce the amount of inventory needed, he said, since it caused firms to realize more fully the potential of electronic communication, as they had started to do after the Sept. 11, 2001, terrorist attacks.
Beder also noted stock levels would fall simply because retailers would rather chase sales now than be faced with steeper markdowns at the quarter’s end: “They just don’t want to get stuck with it.”
While inventory levels are apt to fluctuate, waiting too long to mark downand clear goods could hamper second-quarter profits. While May’s comparable-store sales offered mild hope that sales were returning, if the consumer doesn’t pick up enough to allow retailers to move their excess inventories at some kind of profit, June and then July comps could bring with them second-quarter profit warnings.
Of course, retailers could hold onto the merchandise, avoid a second-quarter hit and hope to eventually move the merchandise at closer to full price, but this cuts back on a store’s newness quotient.
“After a year of down inventories there was an effort to build inventory and this spring perhaps wasn’t the season to start building inventories with the inclement weather,” said UBS specialty retail analyst Richard Jaffe.
While sales driven by slight markdowns are good, the heavier the markdowns, the more costly those sales are to the bottom line.
Retailers have been able to move the goods, but less profitably than anybody hoped, said Jaffe.Consultant Emanuel Weintraub said excess inventory is a result of a lot of things, both large and small, gone wrong.
In addition to undue optimism and poor forecasting, Weintraub said retailers can accumulate extra inventory by losing touch with the consumer, having too long a product development cycle or bad systems.
“When enough different things compound, you have a headache,” he said. “Some of that inventory is because you’re putting into the store what the consumer doesn’t want and those are the goods that don’t move and eventually lead to heavy markdowns.”
North American managing partner for Accenture’s retail industry group Angela Selden said the retailers have committed a lot of inventory in the wrong places.
Retailers are “perpetually” out of stock on promotional items, she said, pointing out that some items advertised for Father’s Day weren’t on the shelf by the time that many shoppers made it into the stores.
“The big call to action for retailers today is being aggressive in liquidating things that are not selling, but being aggressive on staying in stock on the things that are going to keep the customer coming into the store,” she said.
Retailers need to take a paring knife and not a blunt axe to their inventories, said Selden. They also can’t stop bringing in new goods altogether or their offers will go stale and traffic will wane.
Woes over inventory felt by retailers can often be traced back to supply chains, she said. “The more nimble the supply chain, the more responsive you can be to changes in demand.”
There’s a huge opportunity, she noted, to better manage inventories, particularly through gearing supply chains towarditems and not categories. While this is a level of sophistication retailers generally haven’t reached, it has the potential to more specifically target customers’ needs in stores and free up resources for other projects.
“Every dollar that retailers spend on inventory that isn’t necessary is a dollar that can be spent on refurbishing stores, opening new stores or increasing the effectiveness of their technology,” said Selden.
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