There is little in retail that Walmart Inc. and Target Corp. are not ready to handle. It was therefore shocking to see that over a 24-hour period, the two descendants of the trade posted weak first-quarter profits that seemed to blind the direction of both.
Part of the explosion in results was due to fuel, which reached record levels after Russia invaded Ukraine on February 24. This was partly due to margin pressures caused by an unfavorable sales mix, as consumers shifted purchases from higher-margin products like electronics to less profitable items like groceries. An extension of this was an overrun in inventory storage activity, which came back to bite retailers after waning concerns over the COVID-19 pandemic pushed more consumer purchases towards services and “ experiences” and away from possessions.
Retailers can’t do much about fuel prices. It’s safe to say that they should have expected the pandemic-driven buying frenzy from March 2020 to the end of 2021 to die down and they should have planned their inventory strategies accordingly. Still, demand forecasting has always been a tough problem to solve, and the market is where it is. The build-up of inventories may also have been the result of supply chain delays earlier in the year that resulted in late deliveries of spoiled cargo.
Inventory levels in March, compared to activity in March 2019 after inventories stabilized following a major advance in 2018 before the Trump administration’s China tariffs, are producing mixed results. Not surprisingly, given the current shortage of motor vehicles, the ratio of vehicle and parts inventory to sales has fallen significantly, according to federal government data analyzed by Michigan State University. Apparel inventory relative to sales also fell during these periods, as did e-commerce.
However, furniture, fixtures and appliances, building materials and garden equipment, as well as a category known as “other general merchandise”, which includes Walmart and Target, among others reported higher inventory-to-sales ratios, according to government data analyzed by State of Michigan.
For the latter sectors, change has happened quickly, according to Jason Miller, professor of logistics at MSU’s Eli Broad College of Business. In November, inventory-to-sales ratios were at pre-COVID levels, Miller said. They have since exploded upwards.
Miller said he expects a “cooling” in order volumes from retailers, even if inflation-adjusted sales remain constant, as retailers look to reduce their existing inventory. He also expects retailers to launch major discount programs to accelerate inventory burn. Fewer orders in some categories bode ill for carriers whose networks are tightly tied to access routes to retailers’ fulfillment centers, Miller said.
In a Friday note, Bascome Majors, an analyst for Susquehanna Investment Group, said the year-over-year gap between sales and inventory – a rough barometer of the impact of higher sales on the replenishment activity – turned positive in spring 2020 and accelerated under favorable conditions. territory for four consecutive quarters. Gradually, however, the gap turned negative, according to Majors. In the first quarter of this year, inventory growth exceeded sales growth by 200 basis points. The recent surge in inflation, Majors wrote, has seriously distorted inventory and sales trends.
Is the freight recession priced in?
For some, high inventory levels are an expected event and should be welcomed. In a Tuesday note, Amit Mehrotra, a transport analyst at Deutsche Bank, said the increased buffer stock is part of retailers’ desire to have merchandise available when consumers scan the shelves. Mehrotra added, however, that the data points translate into a likely slowdown in freight flows in the coming months and quarters.
He said a recession is already priced into most transportation stocks, noting that shares of most trucking companies have risen in the past 30 days, while the broader market is about lower. 7%.
In an unusual world, Walmart, Target and other retailers are likely to turn to the one area where they’ve traditionally found leverage: their shipping bill. During the quarter, Target (NYSE: TGT) faced freight and transportation costs that exceeded already lofty expectations by hundreds of millions of dollars, chief operating officer John Mulligan said on the company’s analyst call Wednesday. It was basically the same story at Walmart (NYSE: WMT).
Retailers’ efforts to rein in freight costs will result in an unprecedented third and even fourth round of full truckload contract negotiations as users become more aggressive in their bids for greater savings, industry experts say. .
Discussions could become contentious. In a LinkedIn post on Friday, Jason Ickert, president of trucking company Sonwil Logistics, said a large shipper that Ickert would not identify suggested during a conference call this week with truckload carriers. that they were “artificially supporting their rates” above the accepted market. levels. The shipper “made it clear” that carriers needed to adjust their rates during what would be an “unprecedented and unforeseen third round of bidding,” Ickert wrote.
A potential switch to intermodal
Pressures to reduce transportation spending will also trigger increased interest in intermodal, whose overall costs are cheaper relative to full contract load than at any time since 2018. Intermodal fares have been rising at a slower pace than truckload contract rates, a reversal from the 2019 freight recession when higher intermodal rates helped trucking gain market share.
The shift to intermodal, if it occurs, would benefit railroads and intermodal distributors like JB Hunt Transport Services Inc. (NASDAQ: JBHT), Hub Group Inc. (NASDAQ: HUBG) and Schneider Inc. (NASDAQ: HUBG) : NRDS). However, experts warn that intermodal capacity remains limited, as does the warehouse space needed to store goods.
“Walmart, Target and other retailers will absorb every drop of intermodal capacity that Hunt, Hub, Schneider and the rails provide in 2022 and probably 2023,” said Majors of Susquehanna Investment Group. The high level of activity, he said, is expected to occur even as retailers work through a multi-quarter destocking process.