Earnings   //   June 1, 2022

Inflation comes for big-box retailers’ earnings

After witnessing high levels of growth during the pandemic, some of the biggest retailers saw their sales slow and their profits dipping this quarter.

Walmart’s operating income was down by $1.6 billion this quarter. Its bottom line had taken a hit from staffing challenges, high fuel, storage and container costs, Walmart executives said. Target’s operating income, on the other hand, declined 43% year-over-year, which the company said was a result of shifting consumer spending away from discretionary goods to other categories like travel.

Retailers are having to navigate several challenges, including inflation, fuel and supply chain costs as well as Russia’s war on Ukraine. Target said it expects to continue feeling the impact of these issues by the second quarter before seeing some improvement later this year. In turn, big-box retailers have resorted to marking down goods to reduce unsold inventory and plan on adjusting their inventory levels to match the pace of sales.

The retail gloom comes for big-box retailers

Big-box retailers are facing drastically different conditions than they were two years ago, when Walmart and Target witnessed unprecedented levels of growth during the pandemic. Walmart’s e-commerce sales in the first quarter of 2020 grew 74% year-over-year, while Target’s digital comp sales were up 141% at that time.

“The pendulum shifted,” said Melissa Tatoris, vice president of retail at Zeta, a data-driven marketing technology company. “Now they’re over inventory and consumers are very skeptical about spending those big dollars.”

Target and Walmart aren’t the only ones losing momentum. Kohl’s operating income dropped by around 70% in the first quarter to $82 million, with comp sales down 5.2%. As a result, the company cut its full-year guidance to be flat to up 1%.  

Off-price retailers who’ve historically thrived amid macro-economic challenges have also been impacted financially by them recently. Ross’ operating margin of 10.8% was down from 14.2% last year, and Burlington’s gross margin had dropped 230 basis points.

Meanwhile, Lowe’s total sales fell 3% year-over-year in its recent quarter, a significant decrease from its 24% growth the previous year when the pandemic drove high demand for home improvement products.  

Karen Kelso, vice president of retail insights at consulting firm Kantar, said that it would have been nearly impossible for retailers to predict the current outcome. And with tough comparisons from the previous year, their growth would be hard to maintain. “The last two seasons were unsustainable,” Kelso said. “The business doesn’t run that way, at that kind of margin level. It just doesn’t. So to expect that to continue is probably wishful thinking.”

However, the supply chain issue has made it difficult for retailers to prepare for what demand could potentially look like months ahead, said Kelso. And when demand for consumer goods ultimately shifted, it left retailers sitting on more inventory. Target’s product inventories were up 43% from last year, while Walmart’s was up 32% from the previous year. Even apparel brand Abercrombie & Fitch’s inventory increased 45% year-over-year.  

Target and Walmart have begun to reduce prices on some items to right-size their inventories. Walmart, for instance, began “being aggressive with rollbacks” in apparel, whose margin can still be helpful even with reduced prices. Target also initiated a similar move to avoid carrying out-of-season items and to keep its assortment fresh. Target estimates that after the first half of the year, the company will have had time to adjust its inventory levels according to its sales, even in categories with longer lead times.

Walmart executives signaled the possibility of raising prices to recoup profits. Target said it has also raised prices on several items in different categories. “While we’re not happy about the near-term pressure this causes on the profit line, we strongly believe these decisions will benefit our business over time,” said Target CEO Brian Cornell.

Walmart and Target weren’t the only retailers that struggled to have the right inventory in place during the first quarter. Burlington executives said during the off-pricer chain’s earnings call that they had deliberately reduced inventory levels with the goal of driving fewer markdowns. But the company was instead left with too little inventory due to transportation delays.

“[Walmart and Target] are both very strong in their fundamentals and in their strategy, and they just got to weather the storm,” Kelso said. The series of events are “all kind of piled together to create a really, really challenging environment.”

Big-box shoppers feel the squeeze

Unlike big-box retailers who often cater to lower- and middle-class households, department stores don’t seem to see the same decline in profits. 

Nordstrom, for instance, saw gross profit, as a percentage of net sales, increase 190 basis points this quarter versus the previous year. Meanwhile, Macy’s operating income had more than doubled from last year. 

In April, the consumer price index, a barometer for the prices of goods and services rose 8.3% from last year, according to the Bureau of Labor Statistics’ recent report. For lower- and middle-class households, spending more on essentials like fuel and rent means fewer dollars to spend on discretionary items. That would put Walmart and Target’s customers in a bigger pinch if a larger recession hits — which only makes it more urgent for them to course-correct any issues with inventory 

“Inflation hasn’t hit those upper echelons as much as it has hit your everyday worker,” Zeta’s Tatoris said. “In this pandemic, I think there was a lot of money saved and money gleaned, to be able to spend on updating your home and things.”

Kantar’s Kelso said that retailers may continue taking a financial hit over the next few quarters as they adjust their supply of goods. She added that they may start to feel some relief during the fourth quarter as the holiday season rolls in. “That’s probably when the dust settles.”