Q3 ‘Race to the Bottom’ Ahead, Analysts Warn

Morgan Stanley equity analysts believe retail’s inventory glut is likely to “remain problematic for the rest of the year.”

Consumer goods retailers were among the first to see stockpile problems.

Amazon’s first-quarter net loss of $3.8 billion significantly lagged year-ago net income of $8.1 billion. Walmart reported a softer-than-expected Q1 as a slowdown took hold and consumers shunned late-arriving merchandise. It followed by cutting billions of dollars in peak-season product. Target’s supply chain woes halved its first quarter net profits and the retailer next reworked its inventory assortment to manage overstock before slashing $1.5 billion in upcoming “discretionary” receipts to fix its inventory mess.

Bank of America Securities equity analyst Justin Post last week said sales during Amazon’s second Prime sale on Oct. 11-12 were likely lower than the main July event, which could add to growing signals of a spending slowdown.

So where does retail go from here? A “race to the bottom” in the form of deep discounts to stimulate sales, according to Morgan Stanley equity analysts Kimberly Greenberger and Alex Straton, who cover specialty apparel, footwear and department stores. This is likely to drag down margins, they added, noting they expect retail’s stock situation to continue moving in the wrong direction in Q3.

Retailers couldn’t react quickly enough with receipt cuts when signs of a slowdown first appeared March and April. Supply chain improvements at the “start of the back-to-school season could lead to an influx of inventory onto third quarter balance sheets,” they added.

Inventory should stabilize through early 2023, depending on end-of-season clearance, what happens with orders that were cut earlier this year, and supply chain backlogs clearing. Wholesalers could fare worse, however. The analysts believe retailers will use “deep discounts” to sell through holiday and winter product.

Branded wholesalers such as apparel-heavy names including Levi Strauss and Under Armour might be stuck with too much inventory through first half of fiscal year 2023 ending around Jan. 28, 2023. Sneaker-focused wholesalers such as Nike, Skechers and On Running could be a bit more insulated since inventories are more aligned with demand trends and their footwear is “less seasonal.”

And for the specialty retailers, mall-based retailers including Abercrombie & Fitch, American Eagle, Gap and Urban Outfitters are most at risk.