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New Report: Mall-based Apparel Retail Crunched by Inventory Glut

A new report argues that a major obstacle to mall-based apparel retail will be a glut of inventory that will likely contribute to margin compression.

The report, “The Mall is Awash with Apparel Inventory,” was issued by the Cowen Group in April. According to its analysis, as inventory growth outstretches sales growth, retailers will be compelled to make even further markdowns, pinching already diminished gross margins. “From a sector perspective inventory growth relative to sales growth remains dramatically out of line, and we expect additional gross margin outlooks to be lowered in April and May as Q1 unfolds unless April mall traffic is robust,” the report noted.

Cowen’s analysis paid particular attention to youth-oriented retailers like Aeropostale (ARO), Abercrombie & Fitch (ANF) and American Eagle Outfitters (AEO), struggling under the weight of mounting inventory they couldn’t sell as originally priced. “We expect AEO, ANF, ARO to face additional top-line and gross margin pressure, and based on promotions and clearance in stores we believe all three could disappoint Street gross margin estimates in Q1 and Q2.”

The prime mover behind warehouses crowded with inventory is what the Cowen report calls “competitive threats” and an increasingly “tough environment.”  These challenges are largely presented by the emergence of fast fashion retailers who have “altered the way the consumer perceives and shops for value on a global basis.” The “Apparel Inventory” report references another study, “Fast Fashion Headwind Will Grow for Retailers-Ahead of the Curve Series,” that pinpoints inventory and supply chain management as the principal drivers behind fast fashion’s rapid success, compelling more traditional mall retailers to innovate quickly and deeply, or squander their relevance among teen shoppers, their key demographic.

At the heart of fast fashion’s ability to “cause additional disruption to specialty retail” is its supply chain efficiency. The Cowen report emphasized this advantage which more traditional retailers are straining to duplicate with mixed results. “Beyond just offering on-trend fashion and low price points, each major Fast Fashion retailer has a very rapid design process which is highly integrated with that company’s massive supply chain infrastructure. We expect H&M, Forever 21, Uniqlo and Zara to grow sq. footage at a 10%+ CAGR the next five years in N. America.”

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The sum result of the rise of fast fashion is that “teen retail faces structural headwinds” that are considerable. More than a fleeting trend, the fast fashion business model “altered the way the consumer perceives and shops for value on a global basis.” This means that teen retail chains like Abercrombie & Fitch (A&F) and Aeropostale will struggle to remain competitive in the future unless they undergo massive internal reorganization of the kind that might not be feasible in a timely way.

Innovations in supply chain management are key to fast fashion, especially regarding inventory. “Broad and shallow inventory is the key to executing Fast Fashion with upfront commitments being very small with a large open to buy. Large bets on a specific style or category create markdown risk that Fast Fashion retailers do not want. To execute this strategy it requires massive supply chain infrastructure and the ability to commit to fabrics and manufacturing capacity seasons in advance.”

All of this might take a bite out of mall foot traffic, as fast fashion retailers look to shift more business to e-commerce. “In our view the competitive environment has been exacerbated by the growth in total doors in the U.S. Specialty Retail sector particularly among apparel retailers. As cheaper Fast Fashion concepts proliferate, the need to operate brick and mortar locations may decline, particularly as the consumer increasingly shifts spending online. There have been few concepts decreasing the amount of doors operated despite mall traffic that is compounding lower and the significant shift in spend online.”