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There’s One Thing Department Stores Can Do to Shore Up Sagging Margins

Aggressively managing inventory levels will help U.S. department stores increase their operating income, according to Moody’s.

On Monday, Moody’s Investors Service cut its operating income forecasts for the U.S. department store sector. With no third-quarter improvement in financial performance, the ratings firm is now predicting a 20 percent decline in 2019 as fourth-quarter prospects look bleak.

The cut was the second in just two months. Moody’s retail credit analysts previously revised down their forecasts following second-quarter earnings reports that saw declines in operating income accelerate to 15 percent from a prior 10 percent decrease.

The good news, if any, is analysts now expect the sharp declines from this year to decelerate “significantly” in 2020 to just 1 percent as the department store sector will be cycling weak 2019 comparisons.

The department stores positioned to fare better will be the ones that are able to “aggressively manage inventory,” the analysts said, citing Nordstrom and Dillard’s as examples of retailers with Q3 results indicating improvements in their ability to more quickly meet demand.

Nordstrom, for example, was able to more closely link its inventory growth with sales trends, which drove a 2.7 percent decline in inventory as sales grew 2.2 percent, according to the report “Cutting Our Forecast Again as Fourth-Quarter Prospects Look Increasingly Bleak.”

The document also cited J.C. Penney Co. Inc.’s improved efforts in realigning inventories, which declined 9 percent. That allowed the mass merchandiser to garner a “351 basis point gross margin improvement [and generally] better selling margins and reduced shrink,” the analysts said, led by lead credit officer Christina Boni.

Retailers that can move away from open to buy to open to sell will have a better shot at seeing margin improvement. Open to buy looks backwards at historical buying and includes adjustments based on expected demand. In contrast, retailers can focus on their margins and make adjustments accordingly with an open to sell approach because it allows them to track what’s selling in real time.

In contrast, Macy’s in the same third quarter “continues to have a wider gap between sales and inventories growth,” the report noted, suggesting there could be further pressure from clearance activity. Sales declines at Macy’s outpaced inventory decreases, with the former at a 3.5 percent net sales decline and the latter at essentially flat levels.

Even if department stores improve their supply chains and become more efficient, they will continue to face an uphill battle with the off-price sector when it comes to speed and freshness of product, a fact seen in the declining margins of the department store sector.

Nordstrom exemplifies the bifurcation between off- and full-price sales. While its off-price segment rose 1.2 percent, full line sales fell 4.1 percent.

Because companies have focused on expense management for the past few years, leaving little else to cut, inventory management now remains critical to retail’s success.

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