The bullwhip effect is in full focus after Michael Burry recently highlighted the phenomenon in a tweet. He explained: “This supply glut at retail is the Bullwhip Effect. Google it. Worth understanding for your investing endeavors. Deflationary pulses from this- -> disinflation in CPI later this year –> Fed reverses itself on rates and QT –> Cycles.”
So, what exactly does that mean? Retailers, like Target (NYSE:TGT) and Walmart (NYSE:WMT), have teams set up to predict consumer demand. They use these predictions to align with suppliers and adjust inventory accordingly.
However, when demand forecasts do not correlate with actual sales, problems arise that disrupt inventory levels and supply chain efficiencies. If retailers have too much inventory on hand, then they may lower prices to attract more demand. Remember, storing items isn’t free; more items stored equates to more maintenance and utility costs. This means that retailers are incentivized to reduce their inventory as quickly as possible.
Burry believes that falling retail prices may lead to lower Consumer Price Index (CPI) readings. The Federal Reserve uses rate hikes to combat inflation, so if it sees that CPI is declining, then it may stop hiking interest rates and engaging in quantitative tightening (QT).
Several retailers have already warned of excessive inventory. Meanwhile, retail sales are springing up across the nation as the Fourth of July holiday takes place. As a result, these discounted sales may hurt retailers’ revenue and margins in the near term. On the other hand, consumers are likely to benefit.
With that in mind, let’s take a look at seven retail stocks at risk of the bullwhip effect.
|BBBY||Bed Bath & Beyond||$4.71|
|ANF||Abercrombie & Fitch||$17.18|
Retail Stocks at Risk: Target (TGT)
Target has been especially hit hard with overstocked inventory levels. As of April 30, the retailer had $15.1 billion in inventory, up 43% year over year (YOY). On top of that, Target also lowered its Q2 operating margin guidance to 2%.
During its Q1 earnings call, Target stated that on one hand, it was holding an excessive amount of unwanted consumer goods, such as furniture and large appliances. On the other hand, demand for clothes and travel goods is increasing as people return to the office and resume traveling. To have enough inventory space to hold wanted items, Target must sell its unwanted items in a timely manner. CEO Brian Cornell explained:
We thought it was prudent for us to be decisive, act quickly, get out in front of this, address and optimize our inventory in the second quarter — take those actions necessary to remove the excess inventory and set ourselves up to continue to be guest relevant with our assortment.
Target isn’t alone in its inventory issue, though. Many other stores are facing the same problem, which points to a rocky outlook for retailers in the next few months.
Bed Bath & Beyond (BBBY)
Shares of Bed Bath & Beyond (NASDAQ:BBBY) are down over 40% in the past month after the embattled retailer reported disastrous earnings results. While inventory problems are very much present, liquidity presents a bigger problem. Loop Capital analyst Anthony Chukumba described the company’s earnings as a “dumpster fire” and believes it may go out of business in the coming months.
During Q1, BBBY saw same-store sales decline by 27% YOY on top of a net loss of $224 million. Even worse, the company’s cash balance sits at a precarious $107 million. Bed Bath & Beyond is very aware of its troubles and has hired Berkeley Research Group to review its financials and inventory.
Furthermore, several companies ordered high-demand items earlier in the year, only to discover that consumer sentiment had shifted to other items by the time their order had arrived. It’s very likely that Bed Bath & Beyond was one of these companies. Consumers are also spending less on goods and discretionary items due to record inflation levels. In addition, company-wide layoffs are also becoming more prevalent, which factors into less demand for retailers and goods.
It’s clear that the path forward for Bed Bath & Beyond presents many obstacles. Investors would be smart to weigh other options before investing in BBBY stock.
Retail Stocks at Risk: Walmart (WMT)
Like its competitor Target, Walmart has seen a major uptick in inventory levels. The country’s largest retailer by revenue has experienced an increase in inventory levels by 33% YOY. CEO John Furner even admitted that about 20% of the company’s merchandise is merchandise that it wishes it didn’t have.
Last year, Walmart paid for its own chartered ships in an effort to circumvent widespread supply chain issues. Chartered ships gave the company more control over shipping times and costs. However, the WSJ reported that these ships may have also made Walmart “more susceptible to accidental pileups of the wrong items.”
Now, Walmart must sell these unwanted items, and it has to do it quick. The company is currently holding significant discounts on products ranging from baby strollers to televisions in an attempt to clear out its inventory. As the summer progresses, seasonal items will be back in vogue, such as back-to-school supplies and travel goods.
Meanwhile, the retailer has faced difficulties selling summer goods, such as pool chemicals and grills, due to what CFO Brett Biggs characterized as “unseasonably cool weather in the U.S.”
Walmart expects its inventory challenges to improve in the coming quarters as warmer weather attracts consumers to purchase more seasonable items.
Home Depot (HD)
Despite being the largest home improvement retailer in the U.S., Home Depot (NYSE:HD) has not been able to escape inventory troubles. Due to a slow ramp-up in warm, spring-like weather, demand for home improvement items was lower than expected. Additionally, the company has experienced inventory growth that accelerated faster than sales. Still, the introduction to warmer weather should help drive Home Depot’s sales. “As spring kicks in, we’ll see that inventory begin to reflect the seasonality,” said CFO Richard McPhail.
Inflation has lowered consumer demand for home improvement goods as well, although not as much as expected. During Q1, consumer transactions were lower by 8.2%, although sales totaled $38.91 billion, beating analyst expectations of $36.72 billion.
Meanwhile, rising mortgage rates have hurt Home Depot too. The 30-year fixed mortgage rate is currently above 5.5%, marking the highest level since 2008. Paired with record-high housing prices, home sales are expected to decline in the coming quarters. This means that Home Depot will have less demand for its products among home buyers. Executives at the company have stated that consumers looking for a new house are now further incentivized to wait for better market conditions.
Retail Stocks at Risk: Lowe’s (LOW)
Lowe’s (NYSE:LOW) and Home Depot both operate in the home improvement industry, so it isn’t surprising to hear that the company is experiencing inventory problems as well. Colder-than-expected spring weather has also factored into Lowe’s oversupply of inventory. Unlike Home Depot, however, Lowe’s was unable to meet Q1 sales expectations. It reported revenue of $23.66 billion compared to analyst expectations of $23.76 billion. Furthermore, same-store sales fell by 4% while analysts were expecting a decline of 2.5%.
Still, CEO Marvin Ellison remains confident in his company, explaining “I’m not saying the macro environment does not matter. I’m saying that for home improvement we are not seeing any material impact.”
75% of Lowe’s revenue comes from do-it-yourself (DIY) customers while Home Depot collects around half its revenue from them. This makes Lowe’s more susceptible to changes in demand. On the bright side, customers are still purchasing pricey items such as refrigerators and high-end lawn equipment.
For the full year, the company expects revenue between $97 billion and $99 billion. Same-store sales are expected to fall between a range of a decline of 1% and an increase of 1%.
Abercrombie & Fitch (ANF)
Abercrombie & Fitch (NYSE:ANF) has been battered this year, with shares down more than 50% year to date. As of April 30, the clothing company had $563 million in inventory, up 45% YOY. Abercrombie stated that it had stocked up on inventory to protect against potential supply chain disruptions. Now, it appears that the company has too much inventory as it heads into the back-to-school and holiday season. CEO Fran Horowitz added:
“We’re giving ourselves more time to get our goods here, so we’re prepared and we have our in-stock [levels] where we want them to be.”
Starting this quarter, Abercrombie will no longer provide quarterly and full-year guidance on gross profit rate or operating expenses due to “volatility in freight and other costs.” This equates to reduced transparency with investors, which isn’t exactly ideal.
The company also reduced its full-year 2022 outlook in response to “economic headwinds” like reduced demand. It now sees revenue flat to up 2% compared to prior estimates of between 2% and 4% growth. On a positive note, however, Horowitz expects a “much more normalized” back-to-school shopping season as the effects of Covid-19 wear off.
Retail Stocks: Macy’s (M)
During its Q1 earnings, Macy’s (NYSE:M) reported inventory levels up 17% YOY. The inventory levels were attributable to customers buying less active wear and home goods as inflation surged to record levels. The company also reported that supply chain efficiencies improved, which contributed to higher inventory receipts than expected. Unfortunately, the lockdowns in China, as well as labor negotiations in Los Angeles’ port, have caused the company to take a “prudent and disciplined approach with our lead times and forecasting.”
Still, sales for the quarter came in at $5.35 billion, beating estimates of $5.33 billion. Furthermore, CEO Jeff Gennette acknowledged that macroeconomic factors, like inflation, are making customers more frugal with their money. Despite these factors, “our customers continued to shop.”
During the quarter, Macy’s experienced a shift toward in-store stales and clothing for special occasions. Same-store sales grew by 12.4% YOY, falling short of estimates of 13.3% growth.
High-income earners have continued to shop at Macy’s in light of inflation pressures. As a result, sales of more expensive goods have helped offset the sales decline in lower-priced goods.
For the full year, Macy’s expects revenue between $24.46 billion to $24.7 billion, which would represent growth of 0% to 1%. Shares of M stock are down over 30% YTD.
On the date of publication, Eddie Pan did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.