Top consumer product importers are masters at successfully tacking with shifting winds and riding out squalls. Their latest storm has been a combination of excess inventories, increased costs and potential consumer spending slowdown (inflation’s fallout).
Despite continuing articles about those problems, reliable imported product deliveries are back, along with reasonable shipping costs. Then there is the significant bonus of a strong U.S. dollar. It is helping to moderate rising import costs, thereby allowing companies to optimize U.S. selling prices while maintaining profit margins. (See article below for explanation.)
Disclosure: Author holds Target and Nike common stocks.
First, a quick reminder of how the negative situation came about…
The excess, “wrong” inventories were brought about by both Asian Covid-19 production shutdowns and shipping logjams. Retailers started placing new orders earlier to protect against future shortages. Then, when production and shipping restarted, the flood of shipments clogged the west coast ports, prolonging the delays and the shortage period.
Finally, the deliveries arrived: Of the too-late, missed-the-selling-opportunity products, then the later-ordered products, thereby creating the excess inventories. By then, inflation and recession issues were creating worries about consumer spending softening.
Target and Nike adopt winning strategies
During their latest earnings report calls, Target (in mid-August) and Nike (in late-September) discussed their handling of the challenging issue, excess inventories. Each had a different approach, suited to their situations.
Target first provided an early sign of the potential damage the inventory problems could produce at its May earnings call.
CNBC (May. 17) – ” Target shares sink 25% after company says high costs, inventory woes hit profits”
Then, at its August earnings call, it explained its strategy. With a retailer’s typically lower profit margin of about 4%, management decided to liquidate the excess inventory, taking the earnings hit all at once.
Importantly for investors, such a company action can be positive. It is a common approach when companies view a troubled period coming to an end. By cleaning house, they create a sound foundation for future growth.
CNBC (Aug. 17) – ” Target’s earnings take a huge hit as retailer sells off unwanted inventory”
“Chief Financial Officer Michael Fiddelke defended Target’s aggressive inventory efforts. He said the retailer had to move swiftly, so it could clear the clutter, gear up for the holidays and navigate an economic backdrop clouded by inflation.
“’If we hadn’t dealt with our excess inventory head on, we could have avoided some short-term pain on the profit line, but that would have hampered our longer-term potential,’ he said on a call with reporters. ‘While our quarterly profit took a meaningful step down, our future path is brighter.’”
Nike, as both a product producer and retailer, has a higher profit margin of about 12%. Therefore, management decided to sell the older excess inventory at special sales “events.” They believed doing so would be profitable, albeit at a lower profit margin. It would also maintain the brand’s unique strength and set the stage for the new, coming products.
CNBC (Sept. 29) – “Nike shares fall as overstocked inventory weighs on earnings”
” As delivery times and consumer demand rose this year, retailers responded by ordering inventory earlier than usual. When in-transit shipping time began to improve quickly, Nike CFO Matthew Friend said, it led to swelling inventories.”
“Nike executives said its inventory in North America alone grew 65% compared to last year, reflecting a combination of late deliveries for the past two seasons and early holiday orders that are now scheduled to arrive earlier than planned.
“That has resulted in having a few seasons’ worth of merchandise available at the same time. Because of that, Friend said, ‘we’ve decided to take that inventory and more aggressively liquidate it so that we can put the newest and best inventory in front of the consumer in the right locations.’”
When might these strategies show up in the companies’ stock prices?
Certainly, this year has been dismal for the Target and Nike shareholders. The two graphs below show the stock price movement along with the performance compared to the S&P 500 (dividends included).
As to what will spark interest in the two stocks, their coming earnings reports could do the trick. It might take the next two earnings reports to get the full effect because the second coming earnings reports will cover the year-end 2022 and early 2023 results.
Target – On November 16, Target will report and discuss results through October. In mid-February 2023, through January.
Nike – In late December (date to be announced), Nike will report and discuss results through November. In late March 2023, through February.
From those reports there could be a return of investor confidence in management’s ability not only to successfully work through the inventory-inflation issues, but also to set up their companies for growth.
The bottom line – Target and Nike represent a lower risk contrarian investment
“Contrarian” investing can seem risky. It is often viewed as buying a seriously bad security in hopes that all will be well, thereby producing a big gain. However, there is another form of contrarian investing that has lower risk – buying a “neglected” security. It happens frequently – favored stocks get the action, and others wallow from neglect.
Target and Nike certainly fit the neglected category. Buying now means possibly watching the stocks drift, only providing dividend income (yields are currently 2.6% for Target and 1.4% for Nike). The possible risks are twofold: A market selloff and a negative company development. However, the potential returns are threefold: A market rise, a positive company development, and a return to popularity (the bonus return potential from buying a neglected stock).