Retailer supply chains: A source of optimism

Global supply chains begin to show signs of easing

Since the onset of Covid, global supply chains have been a consistent pressure point for companies and governments alike. While stimulus-driven consumer spending and easing of covid restrictions resulted in historic retailer performance in 2021, US retailers haven’t been immune to the various internal and external pressures facing the economy. However, a handful of leading metrics have indicated a more optimistic outlook than the prevailing narrative in the market today. The global supply chain pressure index (GSCPI), a composite index comprised of transportation cost and manufacturing indicators produced by the NY Fed, has come down 33% year-to-date but remains almost 3 standard deviations above average levels. The World Container Index, a composite index tracking the average price per 40-foot container shipment, has fallen 30% since record high levels in September of 2021.

Geo-political instability, rising interest rates, and economic growth expectations have driven global investors to shift capital into US securities as a safe haven. The result is the strongest dollar in nearly 20 years, despite rampant domestic inflation. Fortunately, a strong dollar (traditionally) means more purchasing power in the hands of American consumers as well as businesses sourcing goods from abroad. A strong dollar has also historically been accompanied by a decline in oil prices; however, bans on Russia-produced oil have resulted in a disruption of the market supply-demand equilibrium.

Average shipping costs have declined 30% since September 2021

Q1 winners and losers are a mixed bag, but the outlook remains positive

First-quarter earnings season proved to be a reality check for many public retailers with seemingly no consistent themes emerging amongst the winners or losers. Grocery store chains were the only group to unanimously post year-over-year gains in net profit margins, despite gross margins declining 0.8%. Category killers such as Walmart, Target, Costco, and BJ’s saw sales growth in Q1, but revenue growth was unable to keep up with rising transportation and labor costs. On the other hand, discretionary retailers such as Best Buy were more heavily impacted by shifting consumer demand for services and essential goods.

Mass merchants and wholesalers post the largest decline in gross margins YoY

Many retailers can attribute Q1 results to poor inventory management, with first-quarter inventories of roughly 18 retailers rising 10% or more than sales. Inventories were up 26% year-over-year at Costco, 40% at both Kohl’s and Dick’s Sporting Goods, and 37% at TJX Cos. This is a result of retailers overestimating continued consumer demand, which has been curbed to an extent by inflation, and aggressive over-ordering in anticipation of persistent supply chain issues. Additionally, several retailers suffer from a surplus of the “wrong inventory”, which may be preventing potential sales of more favorable items.

Retailer revenue growth vs inventory growth

Market considerations for retailers going forward

If inflation endures, more consumers will likely continue to gravitate towards discount retailers and continue to reduce discretionary consumption. Services will likely continue to represent the primary source of discretionary spending amongst households ahead of the holiday season. Specialty retailers such as Party City will face headwinds while Best Buy may see swifter recovery as back-to-school shopping picks up. Rising interest rates will likely deter mortgage applications for some prospective homeowners. This will have an adverse impact on the growth that many home supply and furnishing stores have seen over the past year and a half. However, despite challenges, many retailers remain optimistic.