Motley Fool Hidden Gems Investing - Retail, Inventory, and Deals!

Episode Date: November 12, 2022

Shipping container prices are down 74% from early this year! But many retailers have too much stuff, and shoppers are less eager to check out the clearance racks. Motley Fool Senior Analyst Sanmeet Deo joins Ricky Mulvey to discuss: - Which retailers are tackling inventory challenges well - An overlooked metric for retailers - And a compelling opportunity for long-term investors Companies mentioned: LULU, NKE, TJX, DKS, SPG, TGT, JWN, ROST, M, AMKBY Article about Macy’s inventory management: https://www.retaildive.com/news/macys-inventory-glut-management-supply-chain-officer-dennis-mullahy-peak-season/635640/ Host: Ricky Mulvey Guest: Sanmeet Deo Engineers: Rick Engdahl, Dan Boyd Learn more about your ad choices. Visit megaphone.fm/adchoices

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to speak to an advisor free of charge. BetMGM operates pursuant to an operating agreement with iGaming Ontario. TV apparel, something. Check it out. I'm Chris Hill, and that's Motley Fool's senior analyst, Sandmeet Deo. As shoppers are gearing up for Black Friday, Ricky Mulvey caught up with Sandmeet to discuss how retailers are navigating inventory pileups and how one real estate investment trust is showing how malls aren't dead. It seems that it's cheaper to put things onto a ship, but also a lot of these retailers have a lot of stuff that they're dealing with already.

That's the big theme I'm seeing. How about you? Yeah, you know, inventory excess is kind of the theme going into the holiday season right now. You know, just recently in about late September, Nike's discussion on their earnings call about their kind of inflated inventory has kind of spooked the market a little bit. You know, U.S. retailers have been sitting on a record $732 billion of inventory as of July, which is a 21% increase from a year ago, according to the Census Bureau data. So, um, this might be a good time to start looking for some deals as consumers for the

holiday season. If you're looking for a TV, electronics, apparel, um, all kinds of things. Um, inventory has been high, you know, it's been challenging for retailers, uh, over the past couple of years with the pandemic and then kind of the rise and fall of the pandemic and managing through that crisis. And, you know, I don't envy them in trying to figure out, inventory is the name of the game for retailers and for this industry. And managing it is really the most key critical element of their businesses. And, you know, managing a crisis like a pandemic was never, probably never in their playbook.

And they had to call an audible, as you could say, in sports analogy terms. But, you know, they were during the pandemic at the time when everyone was shut down, everyone looked online to shop and they continue to shop. They got some stimulus money. They had some cash set aside from not going out and eating and doing other things. So they went shopping online. And so these retailers started to build up inventories to kind of prepare for that and build, build those, build, build that up. And then, as things started easing off the pandemic, people started going out again, started shopping in stores, and then just also doing other things. Retailers started to see, well, now we have too much inventory. So, now they're trying to manage through that and figure out what's the next step.

One thing that stood out for me is, for a lot of the pandemic, the big story were these backups at the port of Los Angeles. And it was impossible to get anything overseas. Now, a 40-foot container from Shanghai to the west coast of North America is going for about $2,100. That was in late September, and that's down from a high of $8,100 just this February. Maersk, which is the largest global shipping container firm, says that they believe ocean operations will come down in the coming months. You've got a lot of things going on. Europe energy crisis, let's name Ukraine, softer consumer, all that stuff. Anytime there's any of these economic metrics and things we're looking at, there's so much

complexity to it. While freight costs and input costs are coming down, that's a silver lining for some of these retailers. The downside is some of that unwinding could be partly because of lower consumer demand and retailers selling less and therefore shipping less. That was something that was pointed out in a report I saw by some analysts at Cowen. So, metrics are complex in any economic analysis. But just to take a step back about inventories and retailers, higher inventory, just to understand why it's so critical, higher inventory levels could mean that gross margins will take a hit.

And so, forward estimates of gross margin for some of these retailers might be too high. That could be setting themselves up for lower expected numbers as they start reporting in the earnings season that's coming up. There's a few retailers that are reporting this week that are on the higher end of the spectrum in terms of prices and stuff. You have Ralph Lauren, Capri Holdings, which is the owner of Michael Kors, and Tapestry, which is the owner of Coach. So, it'll be interesting to see how they report and see what they're saying about their consumers, even trading down from higher-priced goods to maybe some of the lower-priced goods that they offer or going elsewhere. Yeah. The narrative I heard, I think it was a few weeks ago, from the National Retail Federation to the point of the consumers,

they said that they were expecting about $950 billion in holiday spending. that was up from like 6% to 8% from last year. And granted, I take all of these forecasts with a grain of salt, but their point was that people with lower incomes were going to be significantly cutting back inflation. You know the reasons. But if you had a higher income, then your spending is going to be at best unchanged. I wonder how that holds up now that you're starting to see more layoffs at a lot of these more white-collar tech firms, because you're going to see people a little bit more. Even if you're not getting laid off, you might be a little bit more concerned. And to your point, either trading down or just cutting back spending.

And I think with all the gloom and doom and then the layoffs, hearing about layoffs, also possibly experiencing a layoff, maybe experiencing the higher prices at the pump, at everywhere you go, in the grocery store, all that kind of feeds into the consumer psyche of, all right, things are tight, I need to pull back. And then once they kind of decide they're going to pull back they're going to go for the the the cheaper leggings versus the the lululemon leggings like we were talking about around you know prior offline and so once that mentality kind of sinks in that's kind of how their the consumers might proceed with with the shopping season the mindset they have for the shopping season and so yeah when i saw those national retail federation

um forecast i was a little skeptical it seems a little high to me but you know we'll see how the season plays out and and we are also seeing a lot of christmas stuff out already even before thanksgiving we were having a chat with some some other fools about this and you know the earlier and earlier stores are starting to sell christmas stuff or like um shopping and discounting that means that they're they're really trying to get rid of some of this inventory and and um starting the season the shopping season earlier means they're probably in a little bit of a little bit fear of what's going to happen, or uncertainty at least. As I was looking through some of the retailers' earnings calls, that was one of

the big themes is just how pricing has changed. For a company like Nordstrom, they were saying that even consumers are, why do I say consumers? You, you are shopping right now. You are less receptive to things on clearance racks and you want to see more new inventory and private label isn't working as well as they thought they would. That was according to Nordstrom. I'd also argue you that that's the same thing going on for a company like Dick's Sporting Goods. Dick's wasn't too keen to talk about their private label business in their latest call. But if you look at their website, they're setting the prices of a lot of things like hoodies, in some cases, $40 going down to $10 if you just look at the website. And then they were trying to sell one

hoodie for $120. And then that was getting cut to $20. Now, when I looked before this recording, I think that was for either an XXL or a small. So, your sizing may vary on that. But it's interesting to see how these retailers are, in some cases, struggling to adapt to changing preferences quickly. And then, the other thing that they're facing is this macro headwind of a very strong dollar if they're trying to do business overseas. Yeah, just to put a data point to what you're saying is, there's an Accenture survey of retail executives that was released in October. They found nearly all of them. 99% said they'd increase their promotional activity as part of their holiday plans.

And another 35% said their companies are deeply discounting or taking measures to get rid of excess inventory. So, like we said kind of at the earlier part of the podcast, if you're looking for some deals, go out there and shop and see what's out there. And if you're looking in the market for TV, apparel, something, check it out. But if you're a company like TJ Maxx, you're probably celebrating these problems right now. Yeah. So, TJ Maxx, Ross Stores, Burlington Coat Factory, Burlington Factory, I think it's called, those are off-price retailers. And what those are, they buy a lot of the excess inventory from retailers at a cheaper price. And then they go around and sell that to their customers for a reasonable price. Things that are bargain hunters that really want to go out there and look for

brand name items at lower costs. So they kind of thrive in an environment where there's excess inventory because they can kind of get those and then start selling those. And that had been tougher for them over the course of the pandemic. And it seems like it might turn now. TJ Maxx is killing it. And I have to admit, I'm very biased against this company because I spent most of my childhood trying to get my mom out of a TJ Maxx store more quickly. But Scott and Goldenberg, their vice president, in the latest call said, our overall store inventory turns are better than pre-pandemic levels. They know how to play to that shopper. They don't put their stuff online, and you really got to go through and bargain hunt and take upwards of 90 minutes

to two and a half hours for your shopping trip. I wish them well. The other thing about the off-price retailers, while I'm very interested in seeing how they perform, the other thing is their inventories have actually gone up, according to a UBS analyst report. Off-price chains have increased their inventories in the second quarter by 48% more than they increased their sales during the third quarter. It'll be interesting to see how they're managing their inventory as well. Valuations for off-price retailers aren't extremely attractive right now. TJ Maxx, Ross Stores are trading for about a forward PE of about 23X, which is not cheap The market is trading for, I think, around $15,000 now.

By just a cursory look at it, it seems like Ross is having a little bit more trouble handling their inventory than TJ Maxx. They said that their consolidated inventory levels are up about 55% from the prior year. Granted, you got all the shipping concerns, yada, yada, but that still seems like a lot of merch to go through. Any other retailers with inventory issues you want to chat about? Yeah. Some of the big ones, Target, Walmart, and Home Depot are big ones to watch for the next earnings season. They have had big inventory growth over the year-over-year period.

Target has grown their inventory 36% versus their 3.3% sales growth. Walmart, 25% inventory growth versus 8.2% sales growth. Home Depot, 38% growth over 6.5% sales growth. That inventory growth to sales growth gap is something that I look at to see, is their inventory growing well ahead of their sales growth? Because if their sales isn't keeping pace with the growth of their inventory, there might be discounting ahead, pressuring margins, which could affect their stock prices. Consumer spending, it's two-thirds of the American economy. Probably should put some of your investments in these companies that handle that consumer spending. What are the metrics you really look at as an investor. You've got your same-store sales, you've got your gross margin,

you've got your gap between inventory growth and sales growth that you just talked about. I didn't just talk about it, you did. Any others you think that the regular old investor should pay attention to? Those are the business metrics. Obviously, the valuation metrics are something I'm keeping an eye on. While off-price retailers like TJ Maxx and Ross Storrs, I'm intrigued by how this could be an environment they might thrive in. Their valuations aren't reasonable enough to take that plunge. Ironically, Target is trading at a reasonable valuation. If the valuation is low, but you can see that there's storm clouds that you can see through, Target is a phenomenal company that might be facing

some headwinds now. But if you're a long-term, five-plus-year investor, valuations that are reasonable for a company like Target might be worth taking advantage of now for your long-term investments. Speaking of retailers, going after especially that high-end consumer that the National Retail Federation says is healthy, we'll see about it in this upcoming year. You want to talk about Lululemon? Yeah. Lululemon is a great company. Everyone knows them by their leggings and their pioneering a bit of the athleisure market. It's a solid company. It's one that I'm interested in, but also a little bit worried about going into the earnings season because they have also,

again, theme of the day is the excess inventory. They've grown their inventories by a lot. They're not typically a retail that does much discounting, if at all. They sell their products at full price. People are willing to pay those products for full price because they do like the brand, like the products that they offer. They are very high-quality products that they do offer. But given an environment like this, going into it, if they have excess inventory that they can't sell, it's going to be interesting to see what they do and how that plays out, especially for a stock that is on the higher valuation end. So, you know, if they aren't able to kind of manage that situation, then the stock could take a little bit of a hit,

given the gross margin pressures that they could face. It's a tough one. No, but for the long term, though, it's definitely an interesting company. And also, one thing that is hard to kind of ferret out from their results is, you know, is that inventory growth apparel-based? Like, are they growing their apparel in excess or they, they also have owned, they also bought mirror. So, you know, is some of that inventory, the mirror products that they haven't been able to sell because connected fitness has, has been kind of slower to sell products like that. So that's another thing that I don't know if they'll say much on the earnings call about, but

we don't, it's, it's hard to, to see what's actually happening there. Lululemon is one. So I'm a shareholder and I also, I struggle with it for me. Mirror was always a, um, like I, I was like thumbs down, but I really hope you, you can continue your growth story of selling more pants and shoes, especially internationally, because I don't want to, like when I work out, I really don't want to stare at myself the whole time. And I think that would be a big, big hurdle for, for me to use mirror. But if people like it, they like it. The thing with discounting though, that it's, it's really interesting with Lululemon because they've started to open up outlet stores. And, and to your point, like they've really prided themselves on being

this full-price luxury brand. When they do sales, it seems to be pretty rare. I was in an outlet store over in Castle Rock, Colorado. The ABC Pants, which is their premium product, they're discounting. Now, the store itself seemed to be a retail war zone. There aren't a ton of these outlets opening up as they're trying to move through this excess inventory. I think they even have a sale going on right now that's called like, whoops, we made too much stuff sale. And a lot of the pants there were like, you really have to dig through some, um, I'll just say an extraordinarily widening degree of sizes, but this is a very long winded way

of saying, I wonder how Lululemon is going to handle discounting while also maintaining the appearance of being a premium brand. Nike's done a similar thing though, which is that they have very premium products. And then they also play in the outlet, uh, discount space. I mean, they, they might have to take a little page out of the Nike playbook because, you know, Nike still, while, while you, while, when I go shopping for Nike, I love Nike products and, you know, I'll go searching at the outlet stores for reasonable price Nike stuff. And if I find it there, that's awesome. But then they also come out with new stuff that still is very exciting and

very cool. And I would still pay full price for some of those things too. So manage that will be interesting to see how they do. Then one note is, I think a lot of the growth story for Lululemon is international growth. When I bought the stock, a lot of my thesis was based on, there's not a big presence in China, and this seems to be a very good market where they can expand selling their stretchy pants for $128 a piece. They opened eight new stores in Q2. They have 40 total stores in mainland China, but I'm feeling less confident about that specific growth story, because you're playing a game called, guess what the Chinese government is going to do? And I am very, you know what? I'm pretty bad at playing that game,

Sammeet. Oh, I mean, I think everyone is. That's definitely a hard nut to crack. I think though, if outside of China, Lulu can get good growth internationally outside of that market, you know, people across the world do love American brands and there is a fascination and enjoyment from American brands and Nike has proven that very well. Um, so there's still a lot of growth opportunity there that I think they can take advantage of as, as, as long as their brand name holds up well and is strong in other, in other markets. International revenue is quadrupled between 2017 and 2021. So I, I really hope they could, I will, I will, I really hope they continue to prove me wrong. I'm going to throw some fundamentals at you and see if any

of them stand out to you for our friends at Lulu. They got a price to sales of about 5.6. That seems to be relatively low historically. Price to free cash flow through the trailing 12 months is at 183. Got a 40% return on equity, 24% return on invested capital, market cap of $42 billion. Nike, on the other hand, is about 147 billion. Adidas is 18 billion. And you've got some strong Glassdoor reviews. 87% would recommend the company to a friend. 92% of the CEO, Calvin McDonald. All right. I just threw a word salad and a number salad at you. You're the analyst. Any of those stand out to you in particular? Oh, the ROIC of 24% is great. Any kind of ROIC above 20%. And I believe if I look back historically, they've done pretty close to that consistently. So,

So, any metric like that above 20% is definitely a great metric, great management. And $42 billion versus the Nike of $147 billion, Adidas $18 billion, there's definitely growth opportunity there, especially like we talked about with international, they started gaining more presence and growth there. And then connect to fitness is hard to say what mirror will add, but if it can even add a little bit, that could definitely help do some of that. If anything, just get more apparel sales into their door. The return on invested capital, as I think about how much coverage and how much I've thought about the mirror acquisition, I would not have guessed it to be that high. Yeah. Yeah. It's impressive. Let's keep moving because I think there's an interesting REIT I want to talk about,

and that's Simon Property Group. They do class A malls. So that's your higher end mall. They also own JCPenney. I think they bought it out of bankruptcy. If you read David Seidman on his quarterly earnings calls, his theme is, this is a message to all of my haters, in-person shopping is not dead. I think it's interesting. It's got a 6.4% dividend yield. I think it's still not at pre-pandemic levels. Then it's also got an occupancy rate now of about 94%, 95%. That's about in line slightly higher than pre-pandemic levels. So I think they still have a lot of question marks. I don't know if they've seen the full whiplash of the pandemic because they have an average lease term of seven years. But it's still an interesting company to me that's defying

the narrative that the mall is dead. While I love rule-breaking trends and innovations and online shopping and retail has been explosive during the pandemic and will continue to thrive going forward. I do agree that physical retail is not dead. I mean, when you think of with the holiday season coming up, when you think of holiday shopping and buying gifts for friends and family, you're going to go out there and go to malls and stores and check out what's out there, what's on sale, what's catching your interest of gifting to somebody. You get ideas from just going shopping and being in those places, in those malls, and just to get out. I think we've all been enclosed for way too long in the past couple of years. So just getting out in itself is helpful.

So I definitely agree that physical retail is not dead. I will say that retailers that can combine the physical with the online and really make a hybrid business model for them will thrive because then they capture anywhere and everywhere that consumers want to shop. It's definitely an interesting proposition. That dividend yield is very attractive. If you want to build your portfolio to have some investments in there that will help you beat the market over the long term, dividend-paying stocks will definitely help you do that and achieve those results.

Any companies come to mind when you think of ones that execute a really interesting hybrid strategy deal? I don't know if they do a hybrid strategy, but one thing, one company that has, well, hybrid strategy, Target does a pretty good job of, of, uh, online and offline retail. They've done a lot of things, especially during the pandemic where you can shop and get your products in any way possible. You can pick them up in the store. You go there and, and they'll just drive up to the store park in a designated spot and

they'll bring the items out to you or they'll just deliver to you. And they've improved their, their logistics and their delivery. So, Target has done a good job of blending that. Another business that we were chatting about, too, that has been impressive in the way they've managed their inventory is Macy's. They've been using data and analytics to truly manage their inventory levels through this. Their inventory levels have only risen 7% year-over-year in the second quarter. Given what we talked about with some of the other retailers, Target, Home Depot, and all those,

and even other department stores, they've done pretty well with the way they've managed their inventory. I'm not going to say I love Macy's as an investment right now. I would have to dig in further. There's a lot of other concerns I would have for Macy's, but their management of their inventory has definitely been impressive. as always people on the program may have interest in the stocks they talk about and the motley fool may have formal recommendations for or against so don't buy or sell stocks based solely on what you hear i'm chris hill thanks for listening we'll see you tomorrow