An inflated inventory led to a tighter cash position at Target.

For the next two months, credit managers, analysts and factors will be keeping a close eye on retail inventory levels and other balance-sheet items at mass retailers as spending in the channel may be softening.

NEW YORK — For the next two months, credit managers, analysts and factors will be keeping a close eye on retail inventory levels and other balance-sheet items at mass retailers as spending in the channel may be softening.

Mass retailers are already feeling some pressure. Overstuffed shelves at Target Corp. put the squeeze on the retailer’s historically high liquidity levels in the first quarter and Wal-Mart Stores Inc. boosted its cash position due to inventory reduction efforts.

Michael Stanley, executive vice president at factoring firm Rosenthal & Rosenthal Inc., said the recent tightening of cash flow in retail has been driven in part by retailers stocking up heavily — maybe too heavily — for the summer selling season. He said a majority of broadline retailers are now “overinventoried,” because the “sell-through is not there.” This is partly due to slowing sales on rising fuel costs, higher interest rates and the softening of the real estate market. To respond to this, some retailers have slowed their ordering of merchandise in recent weeks, he added.

The quick ratio is considered to be the acid test of a company’s liquidity and balance sheet strength. To calculate quick ratios for this story, WWD took retailers’ current assets, subtracted their inventories and then divided the results by current liabilities. A quick ratio above 1 general indicates a relatively cash-rich retailer. However, an extremely high ratio may mean a company is failing to reinvest idle cash.

For Target, an inflated inventory created a tighter cash position. As a result, the company logged a 0.78 quick ratio for the most recent quarter compared with 0.98 for the year-ago period. “Our balance sheet inventory position grew 21 percent from a year ago, reflecting the natural increase required to support additional square footage, same-store sales growth and our strategic focus on increasing direct imports,” said Doug Scovanner, Target’s executive vice president and chief financial officer, during the company’s earnings call.

Target, which improved its working capital by about $177 million in 2005, faces difficult liquidity comparisons this year, said Mark Husson, analyst with HSBC. He said the retailer’s 8 percent increase in square footage this year, which required an inventory boost, made for even more difficult comparisons over 2005.

This story first appeared in the July 10, 2006 issue of WWD. Subscribe Today.

Wal-Mart is trying to free up cash by taking a significant amount of inventory out of its system and has been accused of “de-stocking” by some of its vendors, said Husson. Some vendors fear that this de-stocking activity could kick into full gear at Wal-Mart for the coming back-to-school season, added Stanley.

Wal-Mart’s inventory reduction efforts is paying off, as the company recorded a 0.21 quick ratio for the most recent quarter compared with 0.17 for the year-ago period. While these liquidity levels pale in comparison to those of its nearest competitors, Wal-Mart’s liquidity is somewhat of a phenomenon, as it generally moves inventory at such a rapid pace, it can be equated to having cash.

On the department store side, Sears Holdings Corp. eased up cash in the most recent quarter by reducing its debt. The retailer reduced its long-term debt and lease obligations by about 71 percent to $215 million and its short-term borrowings by about 46 percent to $134 million. The result: a quick ratio of 0.50 for the first quarter compared with 0.46 for the year-ago period.

During a recent Retail Marketing Society meeting, Dana Telsey, chief research officer and chief executive officer of Telsey Advisory Group, noted that retailers tend to be strong cash generators. For 2007, Telsey is expecting department stores and discounters to use their cash position for share buybacks and to pay out dividends.

For hardline retailers, Telsey expects companies to launch new concepts and engage in store remodels. For the luxury goods sector, she predicts the cash to be used for acquisitions, new concepts and store growth in emerging markets.

Telsey expects the specialty retailers to continue launching new concepts as well as remodel their existing stores.

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