Retail has an inventory problem. A nine-month labor dispute at West Coast shipping ports left merchandise piling up on the docks, causing retailers to run out of stock and hurting their sales. Now, with their shelves filled with merchandise, retailers are finding customers don't want what they're selling.
Macy's told analysts it needs to run fire sales to get rid of the piles of merchandise. The CFO elaborated, "We will need to liquidate this inventory in the fourth quarter so that we can maintain the flow of fresh, new merchandise." Its inventories were up 4.6% at the end of the quarter.
Dick's Sporting Goods missed analyst revenue and profit estimates, while inventories shot 13% higher in the quarter due to warm weather. On the other hand, Gap, which actually left the third quarter with inventories down 4% year-over-year, had to resort to heavy discounting to get to that position. Not surprisingly, it also badly missed Wall Street forecasts.
Taking stock of a bad situation
In fact, there's a growing number of retailers that have inventory levels significantly above where they should be. According to The Wall Street Journal, one research firm has identified 10 companies that are seeing inventory growth exceed that of revenue, including Lululemon Athletica (NASDAQ:LULU), Skechers (NYSE:SKX), and Under Armour (NYSE:UAA).
The Journal quotes a Nomura Securities analyst as saying the reason for the softer sales isn't so much that consumers aren't shopping, but rather what they're shopping for. "Consumers are not spending a lot of money on apparel right now. They are buying electronics, cars and items for the home."
Which means those retailers with excess inventory could be facing a dismal Christmas with weak profits and margins.
So of the three retailers above, all saddled with some of the worst increases in inventory levels, which will fare the best?
A sketchy outlook
The market is clearly worried about Skechers. Its stock has fallen over 40% from late summer highs after delivering an earnings miss as sales grew slower than Wall Street anticipated. The company insists its inventory issues are more of a timing problem than anything.
Skechers has no plans to start selling through closeout channels any time soon as all of its inventory is spoken for and will likely even increase in the fourth quarter as the spring becomes a more important season for the shoemaker.
A doozy of a problem
Similarly, Lululemon claims its inventory is just suffering from timing problems, but management also says the situation looks much worse now as inventory levels were so low a year ago. There was actually little change sequentially. However, it now has inventory from the beginning of the year mingling with merchandise from the fall and winter, and it will need to markdown at least a third of it to clear it from shelves. There are plans for two big warehouse sales over the next two quarters, and it has opened eight additional outlet stores.
While being confident of selling two-thirds of the merchandise at full price is encouraging, the weakened retail environment may see more going to discount outlet channels than planned, further undercutting Lululemon's full-price stores.
No armor plating its balance sheet
For its part, Under Armour calls its inventory situation a product of being too successful. To a large extent, footwear was the biggest culprit in rising inventory, but that's only because the segment is witnessing growth rates exceeding 40% or more. In the third quarter, footwear sales actually grew 61%, so the sportswear maker has been aligning inventory with demand.
Even so, because it is overstocked, Under Armour says it needs to liquidate the merchandise, which it plans to do through its own factory stores as well as third-party channels. While that's likely to pressure profits in the coming quarters, it could also create headaches for Skechers, which may feel the need to reduce its own prices to match a competitor. There seems to be no simple solution out of this for anyone.
A Christmas countdown to disaster?
Although most retailers have put on a brave front when it comes to addressing their high inventory levels, the situation also represents missed opportunities for better profits. With consumers as cautious as they've ever been, investors may want to prepare their portfolios against these inventory gluts.
Rich Duprey has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Lululemon Athletica, Skechers, and Under Armour. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.