Lighter Inventory Boosts Retailers, for Now
Shares of retailers have risen on hopes that lower inventories will boost margins, but lower inventories also have their downsides
Kohl’s and other retailers have been able to get away with trimming inventory, but that strategy comes with risk. PHOTO: BLOOMBERG NEWS
For U.S. retailers, lighter inventory is in vogue. In a sector with shrinking sales, however, it is only one piece of the profitability puzzle.
As third-quarter results roll in from department stores such as Nordstrom, Macy’s andKohl’s, as well as many specialty retailers, lighter inventory has been a constant theme. For many, this has meant less discounting and better gross margins. That trend could make for a relatively strong fourth quarter, marking a swift reversal in sentiment for a sector that just last spring many investors were writing off as doomed. Shares of Nordstrom, for one, have climbed 30% since the company reported fiscal first-quarter results on May 12.
But light inventory can cut both ways, and investors may not be properly accounting for that risk.
Having lower inventory makes it more difficult for retailers to maximize sales. That, in turn, makes it tougher for them to cover the fixed costs of running stores and administrative expenses. Tight inventory can also mean selling out of a popular item. To the extent that lower inventory means less breadth of offering, it also puts more pressure on retailers to hit the right fashion notes. Failing to do so could mean having to discount anyway, causing a double hit to sales.
Granted, some retailers, among them Nordstrom and Kohl’s, have been able to find the sweet spot. They can get away with missing a few sales because their gross margin rate has improved enough that gross-margin dollars offset them, according to Richard Jaffe,an analyst with Stifel Nicolaus. Both Nordstrom and Kohl’s also have been trimming expenses, relieving some of the pressure to leverage their fixed costs.
Still, it doesn’t take much to disrupt the inventory balance. Retailers that sell out of items are often tempted to order more, thinking they can sell it and boost profits. If that incremental merchandise doesn’t resonate or if consumers continue to wait for discounts, it could kick off another round of promotions.
As for cutting costs, that isn’t a long-term strategy with e-commerce operations demanding big investments. For many retailers, the obvious expenses have already been cut. Even closing stores doesn’t solve the problem unless retailers reduce their selling general and administrative expenses in equal proportion to the closures. That should prove increasingly difficult as retailers invest in e-commerce to compete againstAmazon.com. Macy’s, which has plans to close 100 stores, said Thursday that costs were higher than expected due in part to higher investment in e-commerce.
Leaner inventories could mean a stretch of stronger results, but that alone won’t reverse retail’s long-term fortunes.
