A spotlight on inventory management in retailing
The retailing industry’s ability, or lack thereof, to successfully manage inventory is coming into focus as business-critical, according to Fidelity’s Boris Shepov.
While supply-chain disruption resulting in severe shortages of goods is not new, Fidelity’s Boris Shepov points out that the downstream impact on inventory is having a meaningful impact on retailers’ bottom line.
“The combined impact of many retailing firms increasing promotions to clear out excess inventory, along with a rapid shift in consumer spending away from some general merchandise categories, has recently resulted in several large, bellwether retailers issuing profit warnings,“ says Shepov, portfolio manager of Fidelity® Select Retailing Portfolio (FSRPX).
In managing the fund, Shepov takes a long-term view to identify companies with underappreciated structural or cyclical improvement in earnings power and cash flow, especially those attractively valued relative to their peers, own history, and the market. He also prioritizes franchises that will remain relevant across one or more of the key tenets of retail—value, convenience, selection, and service.
Early in 2022, Shepov says, many companies within the retailing industry simply did not anticipate demand to slow as much as it did.
One such example, he mentions, is big-box retailer Target (TGT)—a major fund holding on November 30—which came under pressure after ordering more inventory than it normally would amid elevated, stimulus-driven demand and supply-chain issues in 2021.
Shepov underscores that, after struggling to secure enough inventory for the 2021 holiday season, Target, like many other retailers, continued to build inventory into early 2022, as opposed to adjusting based on rapidly slowing general merchandise demand.
He notes that this led to Target’s substantial profit-margin contraction last year due to unprecedented markdowns and clearances to adjust inventory. Shepov underscores that there’s no sugarcoating the fact that these inventory planning challenges resulted in significant financial consequences.
Still, he believes that going forward there is significant earnings recovery potential based on the company’s normalized margins once inventory is realigned with sales. As Shepov sees it, Target has learned from its mistakes and will be planning more conservatively for 2023 and implementing systems to better align inventory with demand.
On the other hand, some companies have proven to be beneficiaries of this inventory glut. He cites Ollie’s Bargain Outlet Holdings (OLLI) as a retailer that has seen its closeout-product pipeline experience an uptick amid excess inventory throughout the industry. The portfolio held an outsized stake in Ollie’s at the end of November.
“Prudent inventory management will always be vital in the retailing industry, and I believe supply-chain backlogs should continue to ease in 2023 and beyond, in part because of increasing containership capacity and improving lead times, making the need to order more inventory in advance less of a concern,” concludes Shepov.
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