Retail sector faces ‘total inventory crisis’, analyst says


Cowen CEO John Kernan joins Yahoo Finance Live to discuss Nike earnings and stock performance, retail inventory crisis, consumer spending, chain issues supply and outlook for Nike.

Video transcript


BRIAN SOZZI: Yes, we are still watching Nike shares today after reporting first quarter results that beat expectations, but were hit by high inventories and continued China’s continued slowdown in sales. The sportswear maker saw its inventories swell 65% year-over-year in North America and net profit fall 22%. Joining us now is Cowen Managing Director John Kernan. John, good to see you here this morning. So, what’s your first stock trade?

JOHN KERNAN: Yeah, listen, the stock is down 12%, and that’s about how much we’re cutting our EPS estimates for this year and next. We are in an inventory crisis throughout the sector in North America in particular. Nike told us last night. When you look at the balance sheets of every company in the industry right now, and you look at the number of units and the dollar amount of inventory on the balance sheet, you’re in for a total inventory crisis as we enter the holidays.

Brad Smith: What does this tell you about inventory in transit specifically? And we were talking about this kind of earlier. Inventory in transit increased by about 85%, according to Nike. How does this start to be worked? How does the logistics element of this inventory begin to be rectified?

JOHN KERNAN: Yes, stocks in transit are high across the industry. It is a function of a supply chain that has been disrupted. All of these companies have been looking for low-cost sourcing in East Asia, and they’ve been looking for volume there. To some extent, when there is macro pressure, the supply chain goes backwards. Ports save. And everyone’s inventory is piling up.

We need a totally different planning – buying, planning and allocation model in this sector in the future. The working capital disruption this industry has faced needs to change. We can’t go all the way – investors don’t want to see free cash flow and working capital volatility like this.

BRIAN SOZZI: Well, John, as they say, you know what tends to go downhill often. So who is going to be impacted by this inventory crisis that you see at Nike? Is it a Foot Locker? Is it Dick’s Sporting Goods? Is it a finish line? Is it a Macy’s? Because there are finish line stores inside Macy’s. What does it look like?

JOHN KERNAN: Of course, Nike called out some of its wholesale partners last night in a positive light. Dick’s Sporting Goods was one of them. Just like JD Sports. They didn’t mention Foot Locker, but Nike has strengthened its membership platform partnerships with some of its major wholesale partners. We believe Dick’s Sporting Goods is on course for a strong third quarter. I think they are able to increase their forecast despite the fact that some of their suppliers are well over their inventory.

When you look at some of the competitors in the space, whether they’re going to start reporting profits in late October or early November, we certainly think you’ll see guidance cuts at Under Armour, Adidas, Puma, Skechers, Haines Brand, and others. There’s just too much inventory. Demand is slowing, especially in the e-commerce sector, where companies have been outbidding since COVID. And it’s a difficult situation. Earnings expectations have not bottomed out in this sector.

Brad Smith: OK, so what does it matter – because you were talking about your updates on the earnings front and your expectations now. Given the backing up of inventory and the issues that we’ve exposed and Nike itself has disclosed and perhaps what we’re expecting some other brands to continue to sail as well, the material impact on the revenue forecast real companies are coming out now, if you look at the inventory that was supposed to be for back to school now going into the holiday season, and now the holiday season inventory coming in the first moments of 2023.

JOHN KERNAN: Yeah, the only light at the end of the tunnel here is that we believe this quarter, this third calendar quarter for everyone, will represent maximum inventory growth. And that as you promote over the holidays, you get into spring, summer of next year, which seems a long way off at this point. You might actually be in a good inventory position heading into the fall of next year.

But you need time to go through this inventory. The industry is going to have to promote. I think maybe by the spring, summer of next year, as we start to see profits from some of these companies, you’ll start to see the inventory balances go down year on year. It would be good to see, but I think we’re at least six months away from that.

BRIAN SOZZI: John, why… and I’m not calling you here. I’m just curious. Why are you sticking to outperforming the price target you have?

JOHN KERNAN: Yeah, look, with Nike, their long-term goals of a high operating margin for teens, if they can get there – and certainly it will take longer than originally anticipated. This is a company with a potential earnings per share of over $7. It is trading very cheap on this long-term potential, but there is currently a lot of disruption in the market.

There are so many moving macro pieces between FX, geopolitics, consumer demand, inventory levels. We have never seen an environment like this. Nike will evolve and win in the long run if it pushes towards that high operating margin for teens. There is huge potential for profitability in the business. It will probably take a year or two longer than originally planned.

Brad Smith: In this environment for the consumer, even as Nike talked about building loyal members, should we expect more or less from that foundation of loyal members in times of declining spending at the household level?

JOHN KERNAN: Nike is very sophisticated and understands its customer acquisition cost, its customer lifetime value, probably more than any company in this industry. But look, when your inventory levels are this high, especially in apparel, it’s very degrading to gross margin. They have significantly reduced their gross margin forecast.

Nike does digital things on a scale that other companies in this industry are not able to do. Much of it depends on their membership and the very high customer lifetime value they have with some of their consumers. So Nike will digitally scale more than any company in this industry over the next five years. I think that will affect the bottom line, that high teenage operating margin. They will get there at some point. It’s just probably [AUDIO OUT] time.

Brad Smith: Yeah, well, for your point, digital business has nearly tripled to over $10 billion in revenue over the past three years. So we will continue to monitor this very closely. This represents approximately 24% of total Nike brand revenue in fiscal year 2022. Cowen Chief Executive John Kernan. John, appreciate the weather and the breakdown.



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