Skip to main content

The economy may be picking up, but inventory levels could still weigh down retailers' second-quarter results.

Many retailers warned of substantial

inventory builds in the first quarter. Although many promised to work through excess inventory, some reports indicate they may be having trouble doing so.

Consumer-products manufacturers such as


(NKE) - Get Free Report



(UN) - Get Free Report

have warned of slow sales. Meanwhile, analysts have noted that many retailers are increasingly turning to promotions to push their products.

"Based on what I'm hearing in the industry from vendors, it sounds like inventory is piling up," said Richard Hastings, a retail analyst with credit agency Bernard Sands. "The logjam is more substantial than some want to admit."

Retailers as a whole have had a relatively tough year to date. Many saw poor

spring sales follow a

disappointing holiday season. A winter

blizzard in February and the

Iraq war added to problems caused by a

slow economy and rising unemployment.

Although retail sales appear to have picked up in the last two months, many retailers still seem to be working through inventory issues caused by slow sales earlier in the year. At the end of the first quarter, retail chains such as


(WMT) - Get Free Report



(KSS) - Get Free Report



(TGT) - Get Free Report


American Eagle Outfitters


warned that their inventory was higher than they wanted it to be.

The danger with having high inventory levels is that the merchandise can quickly become dated, forcing retailers to take deep discounts to clear it off their shelves and out of their warehouses. In turn, such discounts can slash retailers' profit margins.

Most retailers won't report their second-quarter earnings until next month, so it's impossible to know for sure how big an inventory problem they currently face. But if some leading vendors are an indication, inventory could pose severe problems for retailers in the second quarter.

Last week, Unilever, for instance,

cautioned investors that its full-year sales results won't meet earlier guidance. The packaged-goods giant attributed its troubles in part on retailers lightening their inventory loads.


VF Corp.

(VFC) - Get Free Report

warned earlier this month that its second-quarter earnings will come in much lower than earlier forecast. The company, which makes Wrangler jeans, North Face coats and JanSport backpacks, blamed its earnings shortfall on "aggressive moves" by retail customers to cut their inventories. (VF's story was further complicated Monday morning when it disclosed an agreement to acquire



-- a company which has seen at least two downgrades in the last three weeks on valuation concerns that kicked in when its shares cost around $13 -- for $17 a share.) Additionally, Nike

warned that orders scheduled for delivery in the U.S. this summer and fall fell 10% from the same period a year ago.

"So many different suppliers are saying the same thing," said Hastings. "This is the worst I've seen it in 15 years."

But it's not just the warnings from vendors that indicate inventory problems continue to plague retailers. Another indication comes from retailers' continued use of promotions to drive sales.

Some analysts have attributed retailers' better-than-expected sales in recent months to widespread use of markdowns. Consumers are becoming addicted to such promotions, said Craig Johnson, president of retail consulting firm Customer Growth Partners.

"Consumers are so conditioned to seeing promotional prices that no one wants to pay retail," said Johnson.

The retail sector that seems to be most affected by inventory problems is apparel, says Johnson. The problem in apparel is that there are too many chains with too many stores offering too much of the same thing, he said. That almost forces apparel chains to compete on price -- or get stuck with outdated clothes.

Hastings agrees that apparel is a particularly problematic area, but says the problem with too much inventory is spreading to other retail sectors. Retailers as a whole face a supply-and-demand curve that's out of whack right now, said Hastings, adding that he thinks it could take a year for retailers to right-size their inventory levels.

The sluggish economy and relatively high unemployment have kept a lid on demand. Meanwhile, decreasing production costs have led to overcapacity and little differentiation in consumer goods overall.

While retailers can boost sales by cutting prices, that's a short-term solution. The problem that retailers are running into is that consumers can only buy so many pairs of pants or shoes or digital cameras, Hastings said.

"We just don't consume these products like Eveready batteries, where you put in four at a time and they last you 90 days," Hastings said. "You buy four pairs of blue jeans and you're probably done for a few years.

"The costs are always going down but the demand side can't keep up with that. Even at a zero price, you're still not going come home with 22 pairs of blue jeans."

Of course, not everyone agrees that inventory will be a problem for retailers in the quarter or going forward. In a research note issued on Tuesday, UBS analyst Linda Kristiansen said that retail inventories appear to be in "decent shape" overall. Although promotional pricing seems to be picking up, that activity is in line with expected summer clearance sales by retailers, she said.

Meanwhile, Rob Wilson of Tiburon Research Group argued that inventory levels are more a problem with some particular retailers than for the retail sector as a whole. Companies such as

Restoration Hardware



Sharper Image



Ultimate Electronics


all seem to have potential inventory problems, he said. But he thinks other retailers seem to be in better shape.

"I don't think it's as much of an issue as it was a couple years ago," Wilson said. "I think people are getting smarter about over-ordering.

"I don't think anyone's banking on a huge economic recovery. But that being said, maybe they've bought more than their

sales could support."