US malls are "awash with apparel inventory"

US malls are "awash with apparel inventory"

Stung by unseasonably cold spring weather that blanketed many parts of the US just as they were rolling out their spring merchandise, retailers have not only been hampered by sluggish sales but are also battling high levels of inventory, analysts warn.

Coming hot on the heels of a dismal fourth quarter and Holiday shopping season, prolonged and unseasonably cold weather in the US lasted through March and, in some places early April.

Not only did shoppers stay away from the stores - many of which were forced to close - but the storms hit just as retailers were rolling out new lines of shorts, T-shirts, bathing suits and dresses, offering little incentive for consumers to buy spring merchandise.

It was a double-whammy weighing on sales, and not only means inventory levels now remain elevated - but that sentiment is very cautious on US retailers as they prepare to release their first quarter results.

"The mall is awash with apparel inventory," says Cowen Group analyst John Kernan, adding that "inventory is dramatically out of line with sales trends."

He adds: "We expect additional gross margin outlooks to be lowered in April and May as Q1 unfolds, unless April mall traffic is robust."

Recent research by the company suggests that new competitive threats and changing channel dynamics, including the popularity of fast fashion retailers such as Forever 21, H&M and Zara is putting pressure on traditional mall based US apparel retailers, especially those in the teen space.

David Strasser at Janney Capital Markets also warns that excess inventory may cause first-quarter margin pressure, noting that weak sales pushed fourth-quarter inventories higher at many retailers, "driving likely margin shortfalls in Q1."

He continues: "Some of this will be offset as a result of the late Easter, but inventory remains elevated in stores and on balance sheets.

"We have seen the majority of companies across our space report inventory growth well above sales growth for Q4, and although each company has expressed its own reasoning behind these levels, we believe it comes down to the simple notion that demand was weak."

He adds: "This inventory is likely getting marked down substantially driving sales at lower margins."

Strasser also points out that the prolonged winter has effectively condensed the spring selling season.

Companies where the problem of inventory growth outweighing sales growth may be especially acute include Target Corporation, Williams-Sonoma and Wal-Mart Stores.

"The promotional environment around the mall and off-mall has remained elevated," agrees Ken Perkins, president of Retail Metrics, adding that 30-40% off is common.

"Weather induced, soft early spring sales, has put additional pressure on retailers to move merchandise through deeper markdowns to drive traffic and clear out transitional spring product.

"We, and investors, are watching closely for much awaited signs of pent up demand spilling forth," he says, adding: "Should we fail to see meaningful sales gains in April...we would become more worried about the state of consumer demand."

"We continue to believe that inventories will be elevated relative to sales trends at the end of 1Q14 for many retailers," agrees Richard Jaffe, analyst at Stifel, Nicolaus & Company.

Also waiting for signs of a significant sales acceleration in late April and May from pent-up demand, his concern is that "spring inventory will be carried over into Q2" and that retailers will be unable to get back the sales that were lost in the first quarter.

"The excess inventory of Q1 becomes a Q2 problem with greater urgency as stores need to be converted for back-to-school by the end of Q2. This will likely have a greater negative impact to Q2 margins."

Forward orders
Evidence also suggests many retailers are ordering conservatively as the year progresses into what, for most, is the busiest selling season.

"We anticipate that retailers will take a very conservative position regarding inventory in H2, given the prior year's weakness and subsequent need for promotions," Jaffe adds. "We believe that this will reduce the need for price promotions and reduce the competitive pricing pressure from the level seen in 2013, possibly contributing to margin improvement.

A just-released survey of sports/outdoor retailers by UBS Investment Bank and Sporting Goods Intelligence also suggests "retailers' initial orders are embedding a very cautious outlook."

The survey, which will be carried out several more times this year, measured initial orders for cold weather apparel and footwear (such as jackets, fleece and boots) for winter 2014.

"In our view, this minimises downside revenue risk [that is, the risk of cutting orders] and offers revenue upside potential for cold weather brand stocks like VF Corp, Under Armour, and Columbia Sportswear Company if winter is normal/cold," notes UBS analyst Michael Binetti.

Given that around two-thirds of retailers ended 2013 with inventories that were too low to meet demand, it is perhaps surprising that initial orders for 2014 are so conservative.

That said, 65% of retailers are still planning orders the same as, or lower than, last year - and last year was planned very cautiously after two very warm winters in a row in 2011 and 2012.

And 88% of retailers believe they will be able to chase incremental inventory from the brands such as North Face, Under Armour and Columbia if cold weather selling trends in 2014 are better than expected.

Binetti suggests cautious initial orders in cold weather categories "are likely too conservative if normal winter conditions arise," and that retailers will have to start increasing orders quickly if autumn/winter conditions improve.

This will come as good news for VF Corp, whose brands include North Face, as will comments from retailers who took part in the survey that women's jackets and boots are a key focus if conditions are good (VFC is a leader in the women's jackets category).

Less positive for the company, though, is feedback from Cowen Group that its sourcing contacts suggest retailers are planning their jeanswear order books very conservatively for spring and summer to bring inventory more in line with sales trends.