The coronavirus pandemic has disrupted the lives of individuals and businesses worldwide. To make matters worse, an outbreak at a manufacturing plant or a seaport snarls the supply chain. The supply shortages have been met with rising consumer demand. Typically, when supply falls and demand grows, prices increase, causing inflation. This time has been no different with consumers in many parts of the world seeing uncomfortable inflation.
Walmart (WMT 0.12%), the world's largest retailer, is experiencing these macroeconomic headwinds firsthand. Inflation is biting into profits. Meanwhile, to counter supply shortages, Walmart ordered more inventory than needed, thinking it was better to overshoot than to have empty shelves. That could challenge the retailer as consumers focus their spending on experiences more than items amid economic reopening.
WMT Inventories (Quarterly) data by YCharts
Walmart has more inventory than it would like
In its most recent quarter, which ended on April 30, Walmart had $61.2 billion of inventory. That was 32% higher than the $46.4 billion inventory it had at the same time last year. This comes at a time when economic reopening is gaining momentum, leading people to spend more on experiences rather than physical goods like electronics.
At an investor conference on June 7, Walmart's International Chief Judith McKenna noted that one-third of the increase in the inventory value was due to inflation. Another significant part was the intentional building up of inventory to keep shelves stocked. However, McKenna admitted that the company has about 20% more inventory on hand than it would like. In other words, it's holding onto about $3 billion of inventory it wishes it hadn't bought.
Earlier in the day, Target (TGT 0.88%) had released a similar warning to investors. The difference with Target was that it announced a bold move to eliminate its excess inventory. Target ended its first quarter with inventories of $15.1 billion, up 44% from $10.5 billion at the same time the year prior.
TGT Inventories (Quarterly) data by YCharts
Target is undertaking a broad discounting campaign to reduce inventory to a more reasonable level. Those discounts are going to hurt Target's profits. It lowered its operating profit margin expectation for the second quarter from 5.3% to 2%.
Meanwhile, Walmart was more measured, saying it would get through its inventory more thoughtfully.
What were Walmart and Target thinking?
Why did Walmart and Target order so much inventory? Each has experienced robust revenue growth since the pandemic's onset. Walmart has grown revenue at a compound annual rate of 2.5% in the last decade, but it grew at 6.7% in 2021. Meanwhile, Target has compounded revenue over 10 years at a 4.3% rate, but over the past two years it was much higher at 19.8% and 13.3%, respectively.
The higher-than-usual sales growth left each retailer with inventory shortages, frustrating customers who would find empty shelves when they visited stores. So they each made bigger-than-usual orders to get ahead of the issue and account for any future supply disruptions caused by COVID-19.
A tough time for retailers could be great for consumers
After a couple of years of skimpy inventory, consumers are walking into fuller stores. In addition to broader selection, the excess inventories could mean folks see more discounts by retailers to induce consumers to buy. This trend may be tough on profit margins, as evidenced by Target's warning, but it could finally be a great time for buyers again.
