With nothing more than a quick glance at the industry's headlines, it would be easy to conclude that most retailers are in a bit of trouble. Target warned shareholders within last month's report of first-quarter results that "additional markdowns, removing excess inventory and canceling orders" would pare second-quarter profit margin rates down to around 2%.
Walmart's assessment of its first-quarter inventory levels was a bit more optimistic, but only a bit. CEO Doug McMillion explained during May's quarterly conference call, "We like the fact that our inventory is up," but added, "a 32% increase is higher than we want. We'll work through most or all of the excess inventory over the next couple of quarters."
Translation: Look for markdowns to chip away at Walmart's margins as well.
It's not just the two biggest general merchandise retailers dealing with the problem, though. Data from FactSet indicates that U.S. wholesalers' and retailers' inventory levels have collectively soared deep into record territories this year, with store chains buying too aggressively coming out of the pandemic in an effort to be ready for consumerism's recovery. Target's and Walmart's discounting is being mirrored by most of its rivals.
It's not all bad news, though. Overstock, second-chance retailers like Ollie's Bargain Outlet (OLLI 0.50%), Burlington Stores (BURL 1.01%), Big Lots (BIG -0.82%), and TJ Maxx parent TJX Companies (TJX -0.06%) are actually benefiting from an inventory challenge that's proving more problematic than most retailers are currently letting on. And they should continue to benefit for a while. Three key dynamics point to this conclusion.
1. Retailers are sitting on too much wrong stuff
Walmart and Target are, arguably, understating their current inventory situations.
It's only anecdotal, but it speaks volumes about how desperate retailers are to curb their current stock levels. A handful of retailers have reportedly already asked liquidation specialists to take merchandise as soon as it arrives at a port, without the store chain ever even taking physical possession of it.
Meanwhile, some retailers are increasingly choosing to refund customer returns without actually requiring a return of the merchandise. With the cost of handling returned merchandise typically around 15% to 30% of the returned item's value in a normal environment, sky-high shipping costs and piling-up inventory have made this the lower-cost, less-complicated solution.
2. A resurgence of store closures
It's curious. While the pandemic initially pushed some already-struggling stores out of business, it actually slowed the overall store closure rate. Coresight Research indicates that the United States saw a (net) 5083 new store openings last year, following 5079 closures in 2020. That's only a fraction of 2019's 9032 shutterings, though, providing a glimmer of hope that the industry may have finally been right-sized.
The closure hiatus is merely rooted in wishful thinking following the COVID-19 funk, however. That's how UBS sees it anyway. The bank and brokerage's research arm predicts between 40,000 and 50,000 stores located in the U.S. will close within the next five years. If and when they do, that inventory will need to be disposed of somehow. And it will likely be at a fraction of its retail value to outfits like Ollie's and discount apparel retailers such as TJ Maxx.
3. Economic uncertainty prompts consumers to seek value
Finally, while it remains to be seen whether the current wave of economic weakness will evolve into a full-blown recession, it doesn't necessarily have to earn the label to become a problem for consumers. People are feeling the price-pinch right now and are already seeking out bargains as a result. That dynamic will only swell as money becomes tighter.
We're already seeing hints to this end, too.
While the Census Bureau's tally of June's retail sales shows a 1% increase from May's figures and a hefty 8.1% uptick from spending in June of last year, a closer look at the Bureau's data indicates that for the second time in three months, spending within the "general merchandise" category actually fell. And even then, retail spending's growth didn't keep up with last month's inflation rate of 1.3% or the 12-month price uptick of 9.1%.
Notably, sales of clothing and home improvement goods fell from May's levels, while sales of electronics and appliances fell an eye-popping 9.1% year over year. The sudden slowdown of these categories jibes with reports that retailers are now particularly overloaded with such goods. Target CEO Brian Cornell even specifically mentioned an excess inventory of televisions and kitchen appliances during May's Q1 earnings conference call.
In this vein, a recent survey performed by First Insight indicates a dramatic de-prioritization of spending on home decor, following a swell of spending on it during the pandemic, with 31% of consumers saying they intend to spend less on clothing while prices are uncomfortably high. First Insight's findings also indicate 42% of consumers are now specifically looking for deals, including shopping clearance merchandise.
Connect the dots
Admittedly, the idea is more abstract than not. There's no way of knowing the sorts of deals that outfits like TJX Companies and Big Lots are finding amid the industry's inventory glut. There's also no way to predict with any accuracy how much inventory will become available as store closures ramp up and order cancellations pressure manufacturers to shed already-made merchandise. The economy's future is similarly unclear.
There's no denying, however, that there's something happening here that's too big to ignore. All of it plays into the hand that second-chance retailers TJX, Burlington, Big Lots, and Ollie's are holding, however -- and that's a very good thing for their shareholders.
