Lands' End (NASDAQ:LE) reported fiscal third-quarter results on Dec. 2, only to see shares decline 10% the same day. This sell-off came despite year-over-year revenue gains and growth over 2019 as well. However, investors were focused on its guidance, as well as ongoing supply chain struggles, which may override bullish signs for the clothing retailer going forward.

Why Lands' End may be doing better than the market thinks

Though Wall Street was initially unimpressed with the latest earnings, Lands' End appears to be performing well. Its $375.8 million of net revenue was up 4.4% year over year and 10.5% on a two-year basis.

The interior of a Lands' End store with assorted clothing on display.

Image source: Lands' End.

E-commerce revenue fell 6% year over year "as a result of inventory constraints driven by supply chain challenges" as gross margin shrank 100 basis points. Revenue did increase 9.3% from the same quarter in 2019, and international e-commerce made a particularly strong showing, up 27.6% over the same two-year period. Many retailers have seen declines in their e-commerce operations as people return to reopened brick-and-mortar stores, a trend supported by the fact overall revenue increased -- the company's physical stores more than made up for the online sales slump. At the same time, the solid two-year gains show Lands' End is expanding the digital side of its business long term.

For full-year fiscal 2021, management's guidance calls for $1.640 billion to $1.655 billion in revenue, which represents about 15% growth at the midpoint. Adjusted earnings per share (EPS) of $1.04 to $1.13 are up significantly from the $0.34 to $0.58 range the company shared at the end of fiscal 2020. The midpoint of the latest outlook is up 82% and 230% from fiscal 2019 and 2020, respectively.

While industry headwinds may temporarily put a ceiling on the company's growth, it's showing steady progress nonetheless, so why the bearish reaction to earnings?

Why caution is still in order with this stock

First, the threat of shrinking inventory and extended supply chain issues could leave Lands' End unable to keep up its current pace of growth due to insufficient merchandise in its warehouses.

Large retailers and competitors have built up inventory for the 2021 holiday shopping blitz by chartering container ships or extra air freight to bypass supply chain bottlenecks. For example, American Eagle Outfitters expects to spend an additional $70 million to $80 million on freight services, but in exchange, it expects "to nicely exceed $600 million of operating income for the year, well above the $550 million 2023 target," according to CFO Mike Mathias. 

On the other hand, Lands' End has not disclosed taking such extraordinary steps, and this is likely contributing to the cut it had to make to its full-year guidance. During the earnings call, CFO James Gooch described the "supply chain challenges" as "difficult to navigate." Inventory declined 4% year over year to $479.8 million.

This dynamic could leave the company with a reduced ability to seize the opportunity offered by the 7.4% greater holiday sales Mastercard is forecasting for 2021. While Lands' End's inventory is dwindling right before the most important retail period, industry giant Walmart boosted its inventory 12% ahead of holiday shopping.

Even after declining 53% from its 52-week high in the past few months, the stock is still trading close to its highest levels in the past five years. Lands' End's revenue and earnings performance may merit some optimism, but volatility will likely remain high. For those with a lower risk tolerance, there are plenty of other quality retail stocks to choose from. 

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.