This week management at Target and Walmart reported the worst earnings in recent memory, sending both stocks spiraling down. Shares of Target fell by 25%, while Walmart dropped by 11%.
Despite the shock, the news may be a decent sign for the American economy, as the primary culprit is an abrupt shift in consumer demand. The COVID-19 pandemic shifted consumer spending from services to goods as consumers dealt with lockdowns and quarantines. Many have argued that the resulting demand caused an onslaught of inflation by overloading an already fragile system. In the process, it enriched established retailers.
Established retailers had the capital to accelerate a shift towards omnichannel retailing, allowing consumers to place orders online and receive the goods through pick-up or delivery. Smaller retailers weren’t so lucky. According to research by the Federal Reserve, the majority of COVID-era retailer bankruptcies were very small retailers with assets of under $95,000.
Large retailers have flourished during COVID
However, this era of outsized retailer profit may be ending. After 2+ years of concentrated buying, consumers finally shifted from goods and back into services.
Here’s Brian Cornwell, Target’s CEO, talking about the switch on this week’s earnings call:
While we anticipated a post-stimulus slowdown in these categories and we expect the consumer to continue refocusing their spending away from goods and into services, we didn’t anticipate the magnitude of that shift. As I mentioned earlier, this led us to carry too much inventory, particularly in bulky categories, including kitchen appliances, TVs and outdoor furniture.
While it is understandable, a forecasting miss is driving the inventory issue and the resulting markdowns. Forecasting is hard in typical years; translating demand forecasting signals into inventory is almost impossible during COVID. Everyone knew the bubble would pop, but it was essentially impossible to predict when. The result is that most retailers are carrying excess inventory. Target estimates that markdowns accounted for about 3% of its operating margin decline.
The table below shows Walmart and Target’s inventory days. The metric looks at the time it takes for each retailer to sell inventory. Notice that Target dropped significantly during the worst part of the pandemic, only to shoot up this year. Walmart’s legendary operations saw some boost, but stayed pretty constant, until it regressed this year. In both cases, items were flowing in and out of stores at some of the highest levels in history.
The next table shows inventory turnover. It’s a measure of how long each retailer cycles through inventory. Both firms did a great job at increasing turnover during the pandemic, only to see it drop 27% and 15% from the pandemic’s peak.
Walmart faces similar headwinds, but its massive warehousing footprint may let it layer in rollbacks at a more measured pace. Walmart has 210 different warehouses spread across America, each with over 1 million feet of space. Last quarter, it started rolling back prices on high-margin goods like apparel and held back on larger ticket items. Target isn’t going down that route.
It has 51 facilities across the company.
John Mulligan, Target’s COO, explained:
This quarter, we ended up carrying too much inventory in several categories where the slowdown in sales was more pronounced than expected, including home electronics, sporting goods, and apparel. In addition, capacity pressures were compounded by the fact that in several of these categories, including kitchen appliances, furniture, and outdoor living, items are bulkier than average and require higher-than-average amounts of storage capacity…
Rather than jamming store sales floors with excess product, which would have made them more difficult to shop, our team secured temporary storage capacity instead. And as Christina mentioned, rather than carrying items beyond their relevant season, her team made the tougher call and marked items down to clear them and keep our presentations fresh and inspiring.
The great unwind should be interesting.