In this podcast, Motley Fool senior analyst Sanmeet Deo joins Motley Fool producer Ricky Mulvey to discuss:

  • Which retailers are tackling inventory challenges well.
  • An overlooked metric for retailers.
  • A compelling opportunity for long-term investors.

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.

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Sanmeet Deo: There's an Accenture survey of retail executives that was released in October and found nearly all of them, 99 percent. They'd increase their promotional activity as part of their holiday plans. Another 35 percent said their companies are deeply discounting or taking measures to get rid of excess inventory. Like we said at the earlier part of the podcast, if you're looking for some deals, go out there and shop and see what's out there. If you're in the market for TV, apparel, something, check it out.

Chris Hill: I'm Chris Hill and that's Motley Fool's Senior Analysts, Sanmeet Deo. As shoppers are gearing up for Black Friday, Ricky Mulvey caught up with Sanmeet to discuss how retailers are navigating inventory pileups and how one real estate investment trust is showing how malls aren't dead.

Ricky Mulvey: It seems that it's cheaper to put things onto a ship. But also a lot of these retailers have a lot of stuff that they're dealing with already. That's the big theme I'm seeing. How about you?

Sanmeet Deo: Yeah, inventory excess is the theme going to the holiday season right now. Just recently in and about late September, Nike's discussion on their earnings call about their inflated inventories spooked the market a little bit. US retailers are sitting on a record 732 billion of inventory as of July, which is a 21 percent increase from a year ago according to the Census Bureau data. This might be a good time to start looking for some deals as consumers, for the holiday season, if you're looking for TV, electronics, apparel, all kinds of things. Inventory has been high. It's been challenging for retailers over the past couple of years with the pandemic and then the rise and fall of the pandemic and managing through that crisis. I don't envy them in trying to figure out. Inventory is the name of the game for retailers and for this industry and managing it is really the most key critical element of their businesses. Managing a crisis like a pandemic was probably never in their playbook. They had to call an odd ball, as you could say in sports analogy terms. But during the pandemic at the time when everyone was shut down. Everyone looked online to shop and they continued to shop, they got some stimulus money, they had some cash set aside from not going out and eating and doing other things, so they went shopping online. These retailers started to build up inventories to prepare for that and build that up. Then as things started easing off the pandemic, people started going out again, started shopping out, like in stores, and then just also doing other things. Retailers started to see, "Well, now we have too much inventory." So now they're trying to manage through that and figure out what's the next step.

Ricky Mulvey: One thing that stood out for me is for a lot of the pandemic, the big story where these backups at the Port of Los Angeles and it was impossible to get anything overseas. Now a 40-foot container from Shanghai to the West Coast of North America is going for about $2,100. That was in late September, and that's down from a high of $8,100. Just this February, Maersk, which is the largest global shipping container firm, says that they believe ocean operations will come down in the coming months. You got a lot of things going on. Europe, energy crisis, let's name Ukraine, softer consumer, all that stuff.

Sanmeet Deo: Anytime there's any of these economic metrics and things we're looking at. There's so much complexity to it. While freight costs and input costs are coming down, that's a silver lining for some of these retailers. The downside is some of that unwinding could be partly because of lower consumer demand and retailers selling less therefore shipping less. That was something that was pointing out in a report I saw by some analysts at Cowen. Metrics are complex in any economic analysis. Just to take a step back about inventories and retailers, just to understand why it's so critical, higher inventory levels, could mean that gross margins will take a hit. Forward estimates of gross margin for some of these retailers might be too high. That could be setting themself up for lower expected numbers as they start reporting in the earnings season that's coming up. There's a few retailers that are reporting this week that are on the higher-end of the spectrum in terms of prices and stuff. You have Ralph Lauren, Capri Holdings, which is the owner of Michael Kors and Tapestry, which is the owner of Coach. It'll be interesting to see how they report and see what they're saying about their consumers trending, even trading down from higher-priced goods to maybe some of the lower-priced goods that they offer or going elsewhere.

Ricky Mulvey: Yeah, the narrative I heard, I think it was a few weeks ago from the National Retail Federation to the point of the consumers, they said that they're expecting about $950 billion in holiday spending. That was up 6-8 percent from last year. Granted, I take all of these forecasts with a grain of salt, but their point was that people with lower incomes were going to be significantly cutting back inflation. You know the reasons. But if you had a higher income then your spending is going to be at best unchanged. I wonder how that holds up now that you're starting to see more layoffs at a lot of these more white-collar tech firms. Because you're going to see people a little bit more. Even if you're not getting laid off, you might be a little bit more concerned into your point, either trading down or just cutting back spending.

Sanmeet Deo: I think with all the gloom and doom and then layoffs, hearing about layoffs also possibly experienced a layoff, maybe experiencing the higher prices at the pump, at everywhere you go on the grocery store. All that feeds into the consumer psyche of, "All right. Things are tight, I need to pull back." Then once they decide they're going to pull back, they're going to go for the cheaper leggings versus the little lemon leggings like we were talking about prior offline. Once that mentality sinks in, that's how consumers might proceed with the mindset they have for the shopping season. Yeah, when I saw those National Retail Federation forecasts, I was a little skeptical. It seems a little high to me, but we'll see how the season plays out and we are also seeing a lot of Christmas stuff out already even before Thanksgiving. We were having a chat with some other Fools about this. The earlier and earlier stores are starting to sell Christmas stuff, or like shopping and discounting, that means that they're really trying to get rid of some of this inventory, and starting the shopping season earlier means they're probably in a little bit of fear of what's going to happen, or uncertainty, at least.

Ricky Mulvey: As I was looking through some of the retailers earnings calls, that was one of the big themes, is just how like pricing has changed. For a company like Nordstrom. They were saying that even consumers are; Why do I say consumers? You are shopping right now. You are less receptive to things on clearance racks and you want to see more new inventory and private label isn't working as well as they thought they would. That was according to Nordstrom. I'd also argue that that's the same thing going on for a company like Dick's Sporting Goods. Dick's wasn't too keen to talk about their private label business in their latest call, but if you look at their website, they're setting the prices of a lot of things like hoodies. In some cases, 40 bucks going down to 10 bucks if you just look at the website. Then they were trying to sell one hoodie for 120 bucks. Then that was getting cut to 20. Now when I looked before this recording, I think that was for either an XXL or a small, so you're sizing may vary on that. But it's interesting to see how these retailers are in some cases struggling to adapt to changing preferences quickly. Then the other thing that they're facing is this macro headwind of a very strong dollar if they're trying to do business overseas.

Sanmeet Deo: Yeah, just to put a data point to what you're saying is there's an Accenture survey of retail executives that was released in October and found nearly all of them, 99 percent, so they'd increase their promotional activity as part of the holiday plans and another 35 percent said their companies are deeply discounting or taking measures to get rid of excess inventory. Like we said, at the earlier part of the podcast, if you're looking for some deals, go out there and shop and see what's out there. If you're in the market for TV, apparel, something, check it out.

Ricky Mulvey: But if you're a company like TJ Maxx, you probably celebrating these problems right now.

Sanmeet Deo: TJ Maxx, Ross Stores, Burlington Coat Factory, Burlington factory, I think it's called, those are off-price retailers and what those are, they buy a lot of the excess inventory from retailers at a cheaper price, and then they go around and sell that to their customers for a reasonable price, bargain hunters that really want to go out there and look for brand name items at lower costs. They thrive in an environment where there's excess inventory because they can get those and then start selling those, and that had been tougher for them over the course of the pandemic and It seems like it might turn now.

Ricky Mulvey: TJ Maxx is killing it, and I have to admit, I'm very biased against this company because I spent most of my childhood trying to get my mom out of the TJ Maxx store more quickly. But Scott Goldenberg, their vice president in the latest call said, overall store inventory turns are better than pre-pandemic levels, and they know how to play that shopper, they don't put their stuff online and you really got to go through and bargain hunt and take upwards of 90 minuets to two-and-a-half hours for your shopping trip. I wish them well.

Sanmeet Deo: The other thing about the off-price retailers, as well, I'm very interested in seeing how they perform. The other thing is their inventories have actually gone up, according to a UBS analyst's report, off-price chains have increased their inventories in second quarter by 48 percentage points more than their increase their sales during the third quarter. It'll be interesting to see how they're managing their inventory as well. Valuations for off-price retailers aren't extremely attractive right now. TJ Maxx, Ross Stores are trading for about a forward PE of about 23 times, it's not cheap when the market is trading for I think around 15 now.

Ricky Mulvey: By just cursory look at it, it seems like Ross is having a little bit more trouble handling their inventory than TJ Maxx. They said that their consolidated inventory levels are up about 55 percent from the prior year. Granted, you got all the shipping and concerns, yadda yadda, but that still seems like a lot of merch to go through. Any other retailers with inventory issues you want to chat about?

Sanmeet Deo: Yes, so some of the big ones: Target, Walmart and Home Depot are big ones to watch for the next earning season well, and they have had big inventory growth over the year-over-year period. Target has grown their inventory 36 percent versus their 3.3 percent sales growth. Walmart 25 percent inventory growth versus 8.2 sales growth, and Home Depot, 38 percent growth over 6.5 sales growth. That inventory growth to sales growth gap is something that I look at to see, is their inventory growing well ahead of their sales growth? Because if their sales isn't keeping pace with the growth of their inventory, there might be discounting ahead, pressuring margins which could affect their stock prices.

Ricky Mulvey: Consumer spending, it's 2/3 of the American economy. Probably should put some of your investments in these companies that handle that consumer spending. What are the metrics you really look at as an investor? You got your same-store sales, you get your gross margin and you got your gap between inventory growth and sales growth that we just talked about. I didn't just talk about it. You did. Any others you think that the regular old investors should pay attention to?

Sanmeet Deo: Those are like the business metrics and then obviously like the valuation metrics or something I'm keeping an eye on like while off-price retailers like TJ Maxx, and Ross Stores or I'm intrigued by how this could be an environment they might thrive in, their valuations aren't reasonable enough to take that plunge. Ironically, I think Target is trading at a reasonable valuation, and if the valuation is low, but you can see that there's storm clouds that you can see through, like Target is a phenomenal company that might be facing some headwinds now but if you're a long term five-plus year investor, valuations that are reasonable for a company like Target might be worth taking management now for your long-term investments.

Ricky Mulvey: Speaking of retailers going after, especially that high-end consumer that the National Retail Federation says is healthy, we'll see about it in this upcoming year. You want to talk about Lululemon.

Sanmeet Deo: Lulu is a great company. Everyone knows them by their leggings and they're pioneering a bit of the athleisure market, and it's a solid company. It's one that I'm interested in, but also a little bit worried about going into earnings season because they have also, again, theme of the day is the excess inventory. They've grown their inventories by lot and they're not typically a retail that does much discounting if at all. They sell their products at full-price. People are willing to pay those products for full-price because they do like the brand, like the products that they offer. They have very high-quality products that they do offer. But given an environment like this, going into it, if they have excess inventory that they can't sell, it's going to be interesting to see what they do and how that plays out, especially for stock that is on higher valuation end. If they aren't able to manage that situation than the stock could take a little bit of a hit given the gross margin pressures that they could face.

Ricky Mulvey: It's a tough one.

Sanmeet Deo: No. For the long term though it's definitely an interesting company, and also what is hard to ferret out from their results is that inventory growth apparel base, like are they growing their apparel in excess. They also bought Mirror, so is some of their inventory, the Mirror products that they haven't been able to sell because connected fitness has been slower to sell products like that. That's another thing that I don't know if they'll say much on their earnings call about, but we don't, it's hard to see what's actually happening there.

Ricky Mulvey: Lululemon is one, so I'm a shareholder and I also I struggle with it. For me, Mirror was always, I was like thumbs down, but I really hope you can continue your growth story of selling more pants and shoes, especially internationally. Because when I work out, I really don't want to stare at myself the whole time. I think that would be a big hurdle for me to use Mirror, but if people like it, they like it. The thing with discounting though, it's really interesting with Lululemon because they've started to open up outlet stores and enter your point like they've really prided themselves on being this, let's call it full-price luxury brand. When they do sales, it seems to be pretty rare, and I was an outlet store over and over in Castle Rock Colorado, and the ABC pants, which is like their premium products, they are discounting. Now, the store itself seemed to be a retail war zone. There aren't a ton of these outlets opening up, they're trying to move through this excess inventory. I think they even have a sale going on right now that's called like, whoops, we made too much stuff sale and a lot of the pants there were like, you really have to dig through some, I'll just say an extraordinarily widening degree of sizes. But this is a very long-winded way of saying, I wonder how Lululemon is going to handle discounting while also maintaining the periods of being a premium brand. Nike has done a similar thing though, which is that they have very premium products and then they also play in the outlet discount space.

Sanmeet Deo: They might have to take a little page out of the Nike playbook because, when I go shopping for Nike, I love Nike products and I'll go searching at the outlet stores for reasonable price Nike stuff, and if I find it there, that's awesome. But then, they also come out with new stuff that's still very exciting and very cool. I would still pay full price for some of those things too, that will be interesting to see how they do. Then one note is, I think a lot of the growth story for Lululemon is international growth. When I bought the stock, a lot of my thesis was based on, there's not a big presence in China and this seems to be like a very good market where they can expand, selling their stretchy pants for $128 a piece. They opened eight new stores in Q2. They have 40 total stores in Mainland China. But I'm feeling less confident about that specific growth story because you're playing a game called guess what the Chinese government is going to do. You know what? I'm pretty bad at playing that game, Sanmeet.

Sanmeet Deo: I think everyone is. That's definitely a hard nut to crack. I think though if outside of China of Lulu can get good growth internationally, outside of that market, people across the world do love American brands and there is a fascination and enjoyment from American brands and Nike has proven that very well. There's still a lot of growth opportunity there that I think they can take advantage of as long as their brand name holds up well on a strong and other markets.

Ricky Mulvey: International revenue was quadrupled between 2017 and 2021, so I really hope they continue to prove me wrong. I'm going to throw some fundamentals at ENC, if any of them stand out to you for our friends at Lulu. They've got a price to sales of about 5.6. That seems to be relatively low historically, price to free cash flow through the trailing 12 months is 183, got a 40 percent return on equity, 24 percent return on invested capital, market cap $42 billion. Nike, on the other hand, is about 147 billion, Adidas is 18 billion, and you've got some strong Glassdoor reviews, 87 percent would recommend the company to a friend, 92 percent of the CEO, Calvin McDonald. I just threw a word salad and a number salad at you. You're the analyst, any of those stand out to you in particular?

Sanmeet Deo: ROIC of 24 percent is great, like any ROIC above 20 percent. I believe if I look back historically, they've done pretty close to that, like consistently. Any metric like that above 20 percent is definitely a great metric. Great management. Forty-two billion versus the Nike 147 billion, Adidas 18 billion, there's definitely growth opportunity there, especially like we talked about with international, they started getting more presence and growth there. Then connected fitness is hard to say what mirror will add, but if it can even add a little bit, that could definitely help, do some of that. If anything, just get more apparel sales into their door.

Ricky Mulvey: The return on invested capital is I think about how much coverage and how much I've thought about the Mirror acquisition, I would not have guessed it to be that high.

Sanmeet Deo: Yeah, it's impressive.

Ricky Mulvey: Let's keep moving because I think there's an interesting REIT I want to talk about, and that's Simon Property Group. They do Class A malls. That's your higher-end mall. They also own JCPenney. I think they bought it out of bankruptcy. If you read David Simon on his quarterly earnings calls, his theme is this is a message to all of my haters, in-person shopping is not dead. I think it's interesting. It's got to 6.4 percent dividend yield. It's still not at pre-pandemic levels. Then it's also got an occupancy rate of about 94, 95 percent. That's about inline slightly higher than pre-pandemic levels. I think they still have a lot of question marks. I don't know if they've seen the full whiplash of the pandemic because they have an average lease term of seven years. But it's still an interesting company to me that's defying the narrative that the mall is dead.

Sanmeet Deo: While I love rule-breaking trends and innovations and online shopping and retail has been explosive during the pandemic and will continue to thrive going forward, I do agree that physical retail is not dead. When you think of the holiday season coming up, when you think of holiday shopping and buying gifts for friends and family, you're going to go out there and go to malls and stores and check out what's out there? What's on sale? What's catching your interests of gifting to somebody? You get ideas from just going shopping and being in those places and those malls and just to get out, I think we've all been enclosed for to way too long in past couple of years. Just getting out in itself is helpful. I definitely agree, the physical retail is not dead. I will say that retailers that can combine the physical with the online and really make a hybrid business model for them will thrive because then they capture anywhere and everywhere that consumers want to shop. It's definitely an interesting proposition that dividend yield is very attractive.

Ricky Mulvey: Yeah.

Sanmeet Deo: If you want to build your portfolio to have some investments in there that will help you beat the market over long term, dividend-paying stocks will definitely help you do that and achieve those results.

Ricky Mulvey: Do any companies come to mind when you think of ones that execute a really interesting hybrid strategy deal?

Sanmeet Deo: I don't know if they do a hybrid strategy, well hybrid strategy, Target does a pretty good job of online and offline retail. They've done a lot of things, especially during the pandemic, where you can shop and get your products in any way possible. You can pick them up in the store. You go there and they'll just drive up to the store, park in a designated spot and they'll bring the items out to you or they'll just deliver to you and they've improved their logistics and their delivery. So Targets have done a good job of blending that. Another business that we were chatting about too, that has been impressive in the way they manage their inventory is Macy's.

Ricky Mulvey: Yeah.

Sanmeet Deo: They've been using data and analytics to truly manage their inventory levels through this, their inventory levels have risen seven percent year over year in the second quarter. Given what we talked about with some of the other retailers, Target, Home Depot, and all those, and even other department stores, they've done pretty with the way they manage their inventory. I'm not going to say I love Macy's as an investment right now. I would have to dig in further there's a lot other concerns I would have for Macy's, but their management of the inventory is definitely been impressive.

Chris Hill: As always, people on the program may have interest in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. I'm Chris Hill. Thanks for listening. We'll see you tomorrow.