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By Jennifer Haidu, CFA
Record inventory levels at retailers expected to benefit consumer wallets at the expense of retailer margins
Balancing inventory supply and demand is simple in theory, but difficult to execute.
Inventory management is a key performance driver for retailers. Retailers must anticipate demand months in advance of potential sales, allowing adequate manufacturing and transportation time for inventory to arrive. Shifting consumer preferences and spending, coupled with seasonality, means demand is always fluid. The pandemic and subsequent reopening gave rise to dramatic shifts in consumer demand, roiling manufacturing, and the global supply chain. Retailers continue to struggle with this supply-demand dynamic, which we anticipate will persist into 2023.
Retailers experience a Goldilocks dilemma. Many retailers were caught short on inventory as supply chain challenges left shelves empty in 2020 and 2021. Determined not to miss out on sales in 2022, retailers placed orders earlier and in greater quantities than what is seasonally typical. However, retailers misestimated categories of demand and logistics issues, leading to more late arrivals. Consequently, in 2022 retailers have had the wrong inventory at the wrong time. Inventory balances ballooned in 1Q and 2Q and the spread between sales and inventory growth is more mismatched now than at any time in recent history. The balances are elevated on a unit basis and a dollar basis, reflecting cost inflation.
Record inventory levels expected to benefit consumer wallets at the expense of retailer margins. Retailers have been very clear about the desire to right-size inventories in the second half of 2022. The largest retailers are diversified and able to cancel and delay orders. But many high-yield retailers only sell their own brands, and cancelling orders is not possible, requiring promotions to clear inventory. Promotional activity began to increase during the second quarter, and we expect this to accelerate during the fall and holiday selling season. This is bad news for retailer margins, which are already being pressured by cost inflation in raw materials, labor, and transportation. Therefore, we anticipate heightened margin risk for the second half of the year. We also expect this pressure to bleed into wholesaler margins, as those companies deal with cancelled and reduced orders.
Who could be the winners and losers? The winners will be consumers who take advantage of heavy promotional activity. Off-price retailers should also benefit from reduction of excess inventory. The losers are likely to be big-box and department stores, but these may fare better than single-brand retailers and wholesalers, which will need multiple quarters to find the “just-right” balance of supply and demand.
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