How Will Retailers Weather the Inventory Storm?

It’s been a rocky road for retailers globally, who are struggling to fill the demand-supply gap in the wake of prolonged production cycles.

The industry’s headwinds continue with heightened inflation, factory closures, shipping delays, and port backlogs, over and above the ongoing labor-cost-freight-transport challenges that began with the COVID-19 pandemic.

Amid fears that a recession is around the corner, it seems like the recessionary phase has already hit the retail world, especially apparel, as we enter into the second half of FY2022.

The Ever-Growing Demand-Supply Gap

To bridge the demand-supply gap, prominent retailers worldwide are battling with the current situation by designing new products and ordering the same from factories much earlier than before.

Despite these efforts, production takes more than a year to reach the shelves for sale from the time the design starts, compared to the eight months it took during the pre-pandemic days, according to industry experts.

Further, the recent lockdown in China due to the resurgence of COVID-19 has further escalated the production delays by a couple of weeks.

With the objective of reducing the longer lead times, there are numerous companies who are planning to shift their production base away from the Asian locations. However, they are finding it difficult to do the same due to the advantages of lower costs and years of experience in production in Asian countries, especially China.

Let’s take a look at how some of the retailers are faring in the current scenario.

Target Corporation (TGT)

Headquartered in Minneapolis, Target Corporation is an American big-box department store chain that offers curated general merchandise and food assortments, including perishables, dry grocery, dairy, and frozen items. Shares of the retailer have lost over 40% so far this year.

On June 7, within three weeks of reporting disappointing first-quarter results and significantly lowering its outlook, the company again cut its outlook based on the deteriorating selling environment, with excess inventory leading to additional markdowns as well as the cancellation of orders.

However, in a move to strategically deploy its capital and regain investors’ confidence, Target hiked its dividends by an impressive 20% to a quarterly dividend of $1.08 per share, versus the previous dividend of $0.90 per share.

Target Corporation CEO Brian Cornell commented, “While these decisions will result in additional costs in the second quarter, we’re confident this rapid response will pay off for our business and our shareholders over time, resulting in improved profitability in the second half of the year and beyond.”

The Wall Street community is cautiously optimistic about the stock, with a Moderate Buy consensus rating based on 17 Buys and nine Holds. The average Target price target of $182.54 implies 30.96% upside potential to current levels.

On the other hand, TipRanks’ Hedge Fund Trading Activity tool shows that confidence in TGT is currently Negative, as some of the top hedge funds that were active in the last quarter decreased their cumulative holdings by 104,200 shares.

Gap (GPS)

Last month, U.S.-based global apparel retailer Gap reported disappointing earnings results and guidance for the first quarter of FY2022.

The company reported a contraction in gross margin by 930 basis points while its inventory climbed 34%.

Further, based on an uncertain macro consumer environment, inflationary cost headwinds as well as a slowdown in China, management cut expectations for the full-year FY2022.

For GAP, revenues are now forecast to decline year-over-year in the low to mid-single-digit range. More disappointingly, adjusted earnings per share (EPS) are expected to be in the range of $0.30 per share to $0.60 per share while the consensus is pegged at more than double the upper range at $1.30 per share.

Turning to Wall Street, Gap has a Hold consensus rating. That’s based on three Buys, nine Holds, and six Sells assigned in the past three months. The average Gap price target of $11.71 implies 28.26% upside potential.

Kroger (KR)

Last week, Kroger reported outstanding Q1 results, topping both earnings and revenue estimates. By emphasizing on essentials, Kroger was able to deliver a massive beat despite the inflation-driven slump, which impacted the results of big retailers. KR also raised its FY2022 guidance well above analysts’ expectations.

Based in Ohio, Kroger is an American retailer that operates supermarkets and multi-department stores throughout the U.S.

Impressed by the quarterly beat, Guggenheim analyst John Heinbockel reiterated a Buy rating with a price target of $57 (23.32% upside potential) on Kroger.

Last week, Heinbockel stated, “The significant YTD gains reflect the business’ relative top and bottom-line strength in an increasingly challenging economic climate. Although “consumables” comps trail a number of competitors, total growth is superior due to limited exposure to more discretionary categories while the 16% increase in 1Q FIFO EBIT was far superior to most large-cap retail peers.”

Overall, KR stock comes with a Hold rating on three Buys, eight Holds, and three Sells assigned in the past three months. The average Kroger price target is $53.59, implying 15.95% upside potential.

TipRanks’ Stock Investors tool shows that investors currently have a Positive stance on Kroger, with 1.2% of investors increasing their exposure to KR stock over the past 30 days.

The Takeaway

To cope with the rapidly changing environment wherein consumers are shifting their spending from discretionary products to essentials, most retailers are trying a host of actions, including right-sizing the inventory, additional markdowns, and canceling orders.

In the midst of the macro-economic and industry-wide challenges, Kroger seems to have the edge based on management’s confidence to achieve “sustainable earnings growth and total shareholder returns of 8% to 11% over time”.

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