Dillard's Bloated Inventory Comes Back to Haunt It

In November, department store operator Dillard's, Inc.  (NYSE: DDS  ) reported a surprisingly large year-over-year increase in inventory. At the time, Dillard's executives did not seem very concerned by this issue and projected that gross profit would increase for the full year. However, I warned investors the inventory increase was a significant risk that could force Dillard's to take margin-killing markdowns.

Dillard's posted weak Q4 earnings on Monday. Source: Wikimedia Commons.

This is exactly what happened last quarter. Holiday sales did not quite live up to management's expectations, and as a result, Dillard's had to take higher markdowns to clear merchandise. The resulting drop in gross margin caused Dillard's fourth-quarter EPS to fall 10% short of the average analyst estimate.

The inventory risk
As a general rule, retailers' inventories should grow no faster than the rate of sales growth. During the Great Recession, retailers learned the tough lesson that having too much inventory leads almost inevitably to margin erosion. As "aging" inventory goes out of season, retailers have to take increasingly high clearance markdowns to sell it.

Through the first three quarters of its 2013 fiscal year, Dillard's sales rose just 1%. However, the company ended Q3 with inventory up 6% year over year.

Part of that increase could be attributed to a calendar shift, as the third quarter ended in early November last year, as opposed to late October in 2012. Still, the discrepancy between sales growth and inventory growth was larger at Dillard's than for other major department stores.

For example, Nordstrom's inventory was up 8.8% year over year at the end of Q3, but it had grown sales at a much stronger 4.7% rate in the first three quarters.

Time to pay the piper
Nordstrom, with a smaller discrepancy between sales growth and inventory growth, still saw gross margin pressure last quarter. Overall, its gross margin dropped by 55 basis points in Q4.

For Dillard's, which came into the holiday season with a bigger disconnect between sales growth and inventory growth, the gross margin problems were that much worse. The company's revenue momentum actually improved last quarter, with comparable-store sales up 2%. Still, retail gross margin fell by 180 basis points, more than offsetting good expense control.

The net result was a double-digit decline in Q4 net income compared to fiscal year 2012. This was partially offset by heavy share repurchases, which reduced the number of shares outstanding. Nevertheless, adjusted EPS fell from $2.87 to $2.69 for the quarter.

The coast is not clear
Dillard's stock fell about 6% on Monday, after the earnings report. Shares have now dropped more than 10% since reaching an all-time high near the beginning of the year. However, the coast is not clear yet for Dillard's investors.

DDS Chart

Dillard's 1 Year Stock Chart, data by YCharts.

Dillard's ended Q4 with inventory up 4% year over year, which is still outpacing sales growth. Furthermore, there is no longer a significant calendar shift to explain the extra inventory: Q4 ended on Feb. 1 this year and on Feb. 2 last year.

Dillard's executives are notoriously tight-lipped, giving investors hardly any information aside from what is required by the SEC. The Q4 earnings report didn't provide any detail about the quality of the company's inventory or sales trends in the first few weeks of the new fiscal year. As a result, there's no reason to believe Dillard's margin troubles are over yet. Investors would be wise to stay away until the company proves otherwise.

Here are some stocks with more potential than Dillard's
As every savvy investor knows, Warren Buffett didn't make billions by betting on half-baked stocks. He isolated his best few ideas, bet big, and rode them to riches, hardly ever selling. You deserve the same. That's why our CEO, legendary investor Tom Gardner, has allowed us to reveal The Motley Fool's 3 Stocks to Own Forever. These picks are free today! Just click here now to uncover the three companies we love. 


Read/Post Comments (0) | Recommend This Article (0)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

Be the first one to comment on this article.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 2852318, ~/Articles/ArticleHandler.aspx, 9/2/2014 6:11:56 PM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...


Advertisement