Wal-Mart Cuts Supply Orders On Inventory Hangover And Weak Demand

September 30th, 2013 by Trefis Team
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Retail giant Wal-Mart (NYSE:WMT) is cutting some orders from its suppliers for the third and fourth quarters of fiscal 2014. According to Bloomberg, Wal-Mart’s ordering managers sent several pullback emails to a number of its suppliers on September 17. [1] This move comes as a surprise as the company usually doesn’t cut orders just two quarters in advance. A Wal-Mart spokesperson stated that the inventory pull back isn’t across the board and the retailer is still buying sufficient amount in some categories.
It appears that Wal-Mart has taken this decision in order to manage its inventory efficiently and protect its bottom line growth. Over the last two quarters, the retailer’s inventories have grown at a faster pace than the sales growth, which has resulted in an inventory hangover. The weak sales growth is attributable to the prevailing economic weakness in the U.S. which is likely to persist in the near future. The retail market in the U.S. is expected to remain uncertain throughout the year on account of cautious consumer spending and a change in spending patterns. Therefore, Wal-Mart’s top-line growth is likely to be weak during the next couple of quarters. Since the retailer already has enough inventory backlog, buying more will only impact its profits.

See our complete analysis for Wal-Mart

Weak Sales Growth Impacted Wal-Mart’s Inventory Management

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It is Wal-Mart’s corporate goal to maintain its inventory growth rate below the revenue growth rate. The retailer’s strong supply chain network allows it to replenish its inventory in a timely manner, thus avoiding surplus inventory situations. During the last year’s second quarter, Wal-Mart’s sales growth (3.8%) stayed ahead of its inventory growth (3.6%). However, in the first quarter of fiscal 2014, Wal-Mart’s sales increased by just 1% and its inventory levels grew by 4.5%. [2] Revenue growth remained weak due to low consumer spending on account of prolonged winters, payroll tax increase and delayed tax refunds. This trend continued in the second quarter as the retailer’s inventories increased by 5.5% while revenue growth stayed at 2.3%. In the second quarter, U.S. buyers continued to spend cautiously even on non-discretionary products due to prevailing economic weakness. This is evident from the fact that Wal-Mart’s groceries delivered negative comparable store sales growth in Q2 fiscal 2014. [3]

As a result of the weak sales growth, Wal-Mart was left with surplus inventory after the first half of fiscal 2014. Therefore, it is now cancelling its supply orders to meet its inventory goals.

Expected Weak Demand During The Second Half Also Facilitated The Decision

Due to a change in consumer spending patterns, the U.S. retail market is expected to remain weak during the second half of the year. Lately, U.S. buyers have started diverting some of their spending towards houses and cars to take advantage of low interest rates. Subsequently, they are holding back on other categories such as general merchandise and apparel. As a result, U.S. retail sales excluding the automotive sector increased by only 0.1% in August. [4] Since Wal-Mart accounts for about 10% of non-automotive spending in the U.S., it is clear that its sales growth in the third quarter will be weak. Therefore, the retailer is cancelling orders as it will not want another quarter where its inventory growth stays ahead of its sales growth.

The company may not have any respite even in the fourth quarter as ShopperTrak has predicted a weak holiday season this year. According to its survey, retail sales in the U.S. in November and December will see its weakest gains since 2009 due to cautious consumer spending, a change in spending patterns and a shorter season. [5] ShopperTrak founder Bill Martin stated that U.S. buyers are concerned about a number of macroeconomic and political issues such as the possible budget fight in Washington and uncertainty over Syria. Moreover, higher healthcare costs and gasoline prices as well as the payroll tax increase are weighing on consumer spending, which will be reflected in the holiday season. According to a poll conducted by Reuters, about 33% of consumers are planning to spend less on electronics, toys and jewelry, and 27% are planning to lower their spending on apparel this holiday season. [6] Overall, retail sales in November and December are expected to rise by just 2.4% while they improved by 3% last year and 4% in 2011 and 2010. Moreover, the store traffic is likely to fall by almost 1.4%. This is not a pleasing picture given that last year’s holiday season was weak despite a 2.5% increase in store traffic. [5]

Therefore, it makes sense for Wal-Mart to cut orders for the third and fourth quarters. The company needs to protect its bottom line growth since its top line growth is likely to be weak.

Our price estimate for Wal-Mart stands at $81, implying a premium of 10% to the market price.

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Notes:
  1. Wal-Mart Cutting Orders as Unsold Merchandise Piles Up, Bloomberg, Sept 26 2013 [↩]
  2. Wal-Mart’s Q1 fiscal 2014 earnings transcript, May 16 2013 [↩]
  3. Wal-Mart’s Q2 fiscal 2014 earnings transcript, Aug 15 2013 [↩]
  4. Forecast Envisions A Weak Holiday Season, The Wall Street Journal, Sept 17 2013 [↩]
  5. ShopperTrak Expects Holiday Sales Will Increase in 2013, ShopperTrak, Sept 17 2013 [↩] [↩]
  6. U.S. holiday sales expected to rise less than last year: ShopperTrak, Reuters, Sept 17 2013 [↩]