As high demand and COVID-19-related shutdowns snarled the global supply chain, Urban Outfitters (URBN 1.61%) was able to get the inventory it thought it needed. Now, inventory at the company is at an all-time high. Inflation or a slowing economy could cause one of two problems for the retail apparel maker. Here's what it means for investors.
Too much of a good thing
Though the initial onset of the COVID pandemic was scary for everyone, the Federal Reserve decreased interest rates, and stimulus checks were sent out to help avoid a financial Armageddon. In addition, stay-at-home restrictions left folks with extra cash that would normally be spent on things like dining out or traveling. The situation fueled consumer demand later in 2020 and 2021.
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Spikes in virus cases in the countries making goods to meet feverish U.S. demand caused shutdowns as U.S. consumers continued to buy. Also, U.S. truck drivers and warehouse workers did not return fast enough to meet the demand. These factors caused severe bottlenecks in the global supply chain.
Big U.S. retailers like Urban Outfitters were able to get the items they wanted. For instance, inventory in the company's first quarter stood at the highest level in its history by far. Now, Urban Outfitters' sky-high inventory -- combined with inflation and a potentially slowing U.S. economy -- could present one of two risks.
First, the elevated inventory could mean the company has too many items. If the U.S. economy slows, as many economists predict, Urban Outfitters may have problems selling the items it has, especially if spring fashions are no longer in style as the season changes to summer. If this is the case, costly write-downs may hit the income statement over the next few quarters.
Having too much inventory is not be isolated to just Urban Outfitters. Retail behemoth Target (TGT -0.26%) warned investors in June about a pile-up in its inventory. Target CEO Brian Cornell said the company would take drastic measures to get its inventory back on track. In the meantime, it estimates its operating margin would fall to 2% in its second quarter from 5.3% in the first quarter.
The second risk is that Urban Outfitters' eye-popping inventory level may be caused by inflation. In other words, the company has the right items in its inventory, but they cost more than they have in the past. With inflation at multi-decade highs, this might be the case.
On the bright side, the company's first-quarter earnings press release noted record-high revenue. On the release, however, Urban Outfitters CEO Richard Hayne commented, "Unfortunately, the impact of inflation on our costs of doing business more than offset the benefit of record revenues." If inflation is the culprit, its operating margin may take a hit in the coming quarters as the high-cost inventory flows through the income statement.
Now what?
The statements in Urban Outfitters' first-quarter earnings report could indicate that if Urban Outfitters has an inventory or a gross margin problem, it may already be hitting the company. The company has not announced its second-quarter earnings date, but potential risks embedded in the stock could be revealed at that time.
Urban Outfitters stock is down 34% year to date, which is in line with the SPDR S&P Retail ETF. Beyond retail, stocks in many sectors of the market are getting trounced this year. Though there are many great stocks available at mouthwatering prices, Urban Outfitters might not be one of them.
