Halfway through 2020, Levi Strauss & Co. was already planning its inventories for the holidays, with little to no insight into what consumers were going to be spending their money on, or even how much money they would have, by the end of the year.
“When the pandemic hit, we had to make a call on how we wanted to play inventory, because we were buying inventory for six months ahead of time … and not having real visibility to what the world was going to look like in six months,” Levi Chief Executive Chip Bergh told CNBC in a recent interview. “And we still have a little bit of that that we’re dealing with today.”
“We decided, we would rather have too little inventory and miss a sale, than have way too much inventory and have to be marking stuff down by 50% or 70%, which just isn’t good for brand health,” he said.
The strategy worked. Although Levi’s holiday-quarter sales dropped 12% from 2019, earnings came in ahead of analysts’ expectations, thanks to cost savings tied to lower inventory levels. Its gross margin, which measures its profitability,, was the highest it’s been during the fourth quarter in its recent history.
In the coming weeks, investors will likely see this theme play out over and over as retailers report their financial results. Some companies will have navigated the situation more successfully than others. Those that do will likely be rewarded with a stock price bump, as Michael Kors and Versace parent Capri Holdings saw Wednesday. But if the impact to sales is too severe, the news will spark a sell-off, as Urban Outfitters investors learned last month.
Investors will want to watch to be sure businesses don’t fall back into the dangerous trap of overbuying merchandise, which would lead to heavy promotions that weigh on profits.
Bare shelves, fewer discounts
It was obvious during the holidays that supplies weren’t sufficient to meet the stronger than expected demand from consumers. Shoppers showed up at stores to find shelves noticeably bare, or scoured websites and found items were totally out of stock.
Retailers including Victoria’s Secret owner L Brands and Vans owner VF Corp. are among those who said they left sales on the table because inventories were too tight. Aside from intentional decisions to limit inventories, retailers also dealt with delayed merchandise from overseas due to backlogged ports.
Capri is the latest example. It boosted its margins by selling more products during the holidays at full price and cutting inventories, which fell 18% year over year. Its sales, however, were down 17% for the three-month period ended Dec. 26. However, earnings solidly outpaced Wall Street estimates.
Capri shares have rallied more than 47% over the past year to bring its market value to $6.54 billion. Ahead of the market open Wednesday, shares traded up as much as 7%. But by mid-morning, shares were only up about 1.6%.
CEO John Idol said Wednesday the company is anticipating higher consumer demand in the second half of this year, beginning in September.
“That could be a very strong rebound as people return to a different type of normal,” Idol said, adding that the company is most encouraged about consumer demand in North America and mainland China. “It’s all going to depend on how quick the rollout happens of the [Covid] vaccines,” he said.
Gauging the timing of that rebound in demand is critical because retailers don’t want to boomerang to overflowing inventories.
“Covid was good because retailers were able to take pricing power back,” said BMO Capital Markets senior retail analyst Simeon Siegel. “The worst thing companies could do is give that back [to consumers].”
This year, Siegel expects to see a stark divergence between “those that hold the promotional line and those that cross it.” Some retailers likely will go back to old habits, he said.
“If you left sales on the table … that is the natural precursor to overbuying,” Siegel said. “Companies that had disappointing holidays might make the mistake of over-ordering inventory, again. And that will send the market back to being over-promotional.”
Urban Outfitters’ experience shows how challenging it can be to see into the future. The retailer saw how foot traffic at its stores was deteriorating ahead of the holidays and decided to keep its stock lean.
“Replenishment at the stores suffered,” said Francis Conforti, Urban’s co-president and chief operating officer, during a presentation at last month’s ICR’s virtual conference.
During the two-month period ended Dec. 31, Urban’s total company sales fell 8.4% from a year earlier.
“This may be the first time we experienced a negative impact,” due to holding back inventories, Conforti said.
The news caused more than an 11% drop in Urban’s stock, and prompted a downgrade at J.P. Morgan to underweight from neutral. Urban shares, which have a market value of $2.71 billion, have remained under pressure since then.
‘Less inventory work harder’
Some companies say they plan to forever change how much inventory then buy and when they buy it, which would mark a shift from the typical timeline of placing orders as far out as six months in advance of putting it on the shelf.
“We still have a conservative outlook and … we don’t necessarily feel the need to bring in next season’s fashions as early as we historically have,” Aeropostale CEO Marc Miller said in an interview. “I think the entire industry has woken up to this fact that — maybe we were pushing the consumer too much for that change of season, and buying in anticipation of it. And the consumer very strongly told us that they’ll buy when they’re ready to buy.”
During the past holiday season, he added, the tween and teen apparel retailer made “less inventory work harder.”
Timberland and North Face owner VF Corp.’s CEO Steve Rendle said the company is also shifting its strategy this year, to make limited supply available of new products to stir up demand.
“We’re coming through this period of time with very clean inventories, not only within our environment but our wholesale partners as well,” he said in a phone interview. “We did leave some business on the table, and … as we think about next year, an improving environment, it’s really the evolution of our model — looking at more frequent drops.”
If more companies take this approach, though, it could mean off-price retailers like TJ Maxx and Ross Stores start to find their shelves growing especially bare. These businesses benefit from brands having too much stuff, because they get to take it at the end of the season and turn it around and sell it at a discount.
“TJ Maxx’s business model is driven by the euphoria overflow,” Stacey Widlitz, president of SW Retail Advisors, said in an interview. “For now, there’s just not enough inventory really to go around.”
Widlitz, meantime, predicts apparel retailers’ inventories will remain “tight” for much of 2021, particularly because wholesale businesses, like department stores, continue to plan their orders “ultra conservatively.” “We still likely will have the lower sales, higher margin theme probably intact through next year,” she said.
Shoppers likely are not going to be rushing back to stores anytime soon, either.
Forty percent of consumers say they plan to shop for apparel in brick-and-mortar stores either the same amount or less than they do now after receive the Covid vaccine, according to a recent study by First Insight.
For Levi, the company told analysts late last month it continues to face “very low near-term visibility” in planning for the future. Management said it could return to pre-pandemic revenue levels by the end of 2021, if conditions related to the health crisis don’t worsen.
The company’s stock has gained nearly 5% over the past year, bringing its market value to nearly $8 billion. Shares hit a 52-week high of $22.64 last month, and were recently trading at around $20.
“I think we played it about right,” Bergh said. “We may have missed a sale here and there, as I said, but by and large, I’d much rather be in the position that we’re in right now than otherwise. And we feel like we’re in a good position for the first half of this year.”
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