Question about retail inventories

[ratiman]

I'm not that familiar with retail companies but maybe somebody knows: if a company ends a quarter with low inventories (vs usual levels), does that mean that a) product was flying off the shelves or b) they marked everything down to make the numbers and next quarter will be bad. 

[GregS]

If an inventory write-down or write-off is material it should be disclosed.  Check the 10-Ks and Qs if they haven't discussed in the PR or conference call.

 

The best way to figure out what's going on is look at gross margin.  If they are discounting heavily or writing off, it will show up there as COGS will be higher relative to sales.  The best situation is inventory levels dropping while revenues and GMs are rising.  That would indicate product is flying off the shelves.

 

[Cigarbutt]

Lower inventories usually are a good sign but could signal poor inventory management (purchases) and lost sales.

In addition to what GregS describes, comparing with relevant competitors can be useful.

[GregS]

To extend to Cigarbutt's point, there is a lot of nuance to look at.  Declining inventories can mean the company left sales on the table.  It also means the inventory decline probably will need to be reversed in short order.  Rising inventories outpacing sales can be due to aggressive store expansion.  And while I mention rising GMs as a good thing, sometimes lower prices can increase sales and gross profit dollars, driving operating leverage, increasing profits and ROIC.

 

If you want an example of a company that manages inventory well, look at TJX.  Their calls give color on inventory which can sometimes fluctuate with store expansion and opportunistic buys, but the main thing is they never let things get too far out of whack.

 

For an example of using inventory changes to predict future sales/profit direction, look at DSW the last few years.  In 2015-16, inventory increases were outpacing sales increases, signaling trouble with comps and future margin pain.  In early 2017, they showed signs of getting this under control and results turned positive again (I sold mid-2018 so haven't followed since then).

[ratiman]

Thanks for the responses. You could look at gross margin, but let's say that a retailer wants to meet revenue and profit targets. He marks down the highest margin products, which actually increases the gross margin. So results look great, margins went up and and so did revenues, and inventories are low. Everything looks good. But now the retailer has either drawn sales forward and/or lost price discipline. It's hard to tell a great quarter from a firesale unless you know the mix.

 

I'll take a look at TJX, thanks for the suggestion.

[Cigarbutt]

Thanks for the responses. You could look at gross margin, but let's say that a retailer wants to meet revenue and profit targets. He marks down the highest margin products, which actually increases the gross margin. So results look great, margins went up and and so did revenues, and inventories are low. Everything looks good. But now the retailer has either drawn sales forward and/or lost price discipline. It's hard to tell a great quarter from a firesale unless you know the mix.

 

I'll take a look at TJX, thanks for the suggestion.

 

The gross margin (absolute) could go up but the gross margin (relative) will go down. The mark-down move can make sense in selected circumstances (loss-leaders etc) and Sam Walton used that strategy in association with a much larger inventory turnover but it's important to differentiate from a temporary boost in absolute margins as the mark down, if significant, needs to be reported as an increase in COGS or even a separate cost line item.

 

TJX is a great example as it sells items that, by definition, are already marked down. Historically, they have used selective inventory buying decisions with low and opportunistic additional mark downs once the products sit in their inventory. They also have higher inventory turnovers than competitors. If you're interested, TJX use mostly the retail method to value their inventory, which includes an estimated amount of further markdowns (and shrinkage). Over time, TJX has remained a master at keeping margins high, by buying low (relatively) and selling high (relatively) capturing value along the way, not resorting to mark downs in order to make the numbers look good.

[bizaro86]

I agree that what inventory means depends on the company, and that off-price retail is somewhere where it is likely less useful than average. One of my best long term holdings is ROST, a competitor to TJX. Their inventory values have bounced around dramatically while the company has been a consistent secular growth story. They buy inventory when they can get it cheap and store it in distribution centers, so it varies significantly quarter-to-quarter. I think there are also some seasonal factors, as I'm pretty sure they buy overstock items post the season (ie Christmas decor in January) and store it until next year.

[spartansaver]

If you're looking a non-food retailer on a quarterly basis the inventory will be very seasonal. Assuming that a retailer has FYE of Dec., the 3Q inventory will likely be higher than usual as the company loads up for the Christmas season. At the end of the 4Q you will likely see a higher cash balance than usual as the company sold off a significant portion of the inventory (lower inventory). 1Q will likely have a lower cash balance than the 4Q after it pays off all of its supplier payables that were used to fund the purchases of inventory.

[ratiman]

This is a good discussion of the issue of gross margins and inventories. These two have a weird Smithers/Burns vibe and the info is useful.