TGT and WMT giving a dose of Retail reality over the last couple days. The consumer is slowing on the margin. We get that sales were ahead, but nearly every retailer of size is reporting materially slowing trends, and nearly all of the growth in sales being seen in price/ticket as opposed to transactions. Inflation is squeezing discretionary spend, we heard it from AMZN and then from WMT…
“As it relates to Walmart U.S. general merchandise sales, we knew that we were up against stimulus dollars from last year, but the rate of inflation in food pulled more dollars away from GM than we expected as customers needed to pay for the inflation in food.”
The more important read is around gross margins and inventories. Both companies (WMT and TGT) missed EPS entirely around margin, and more concentrated on gross margins. WMT's pressure appeared to be via rising costs without adjusting pricing higher, TGT's from both costs and increasing markdowns. This was a key theme we highlighted on The UnCompable Year Retail deep dive in January (replay below). Retail has been over earnings on the gross margin line due to tight supply and elevated demand. Now at the same time demand is softening (it's not even bad yet) supply is returning.
TGT expressed it pretty clearly on its call:
"In our other 3 core merchandise categories: Apparel, Home and Hardlines, we saw a rapid slowdown in the year-over-year sales trend beginning of March, when we began to annualize the impact of last year's stimulus payments… this led us to carry too much inventory, particularly in bulky categories, including kitchen appliances, TVs and outdoor furniture. And with very little slack capacity after 2 years of unprecedented growth, we faced elevated cost to store and had begun rightsizing our inventory position."
Inventories are bloated, demand slowing, markdowns are returning. The first products to see problems have been home durables, as this was one of the earliest pandemic winners to see outsized unit consumption as we went into lockdown. We've seen the pressure on durables companies for a couple quarters now. Now that’s expanding more broadly into consumer discretionary. A later category to see margin reversion will likely be Apparel, as it saw outsized consumption in 2021, not 2020, and we are seeing the last leg of reopening demand in 1Q22. But as TGT noted, even apparel demand is slowing, and inventories are on the rise as we have been highlighting. Apparel unit imports in March were 61% ahead of 2019. Apparel has a long way to go in margin reversion and the stocks are not pricing in the risk. We walked through the specifics in our apparel Deep Dive last month (replay below).
The question now is, how much does the consumer weaken? The labor cycle is going 180. Companies couldn’t get the people they needed 6 months ago, now we see a lot of companies (particularly techy/ecom related) that need to cut costs fast to preserve cash. The consumer will likely be feeling more pressure in the coming months when companies start trimming jobs.
As for how to invest around this shift, we think the inventory dynamic is bullish for off price, our favorites being TJX and OLLI. The place we still see the most alpha short side is in apparel names & department stores, but much of retail remains shortable. Multiples can and will go to new lows.
Replay | The UnCompable Year – Get VERY Ready for 2022 Link: CLICK HERE
Replay | Apparel Deep Dive Link: Click Here
