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Here's the next disaster in retail. Hint: it's not J.C. Penney dying

Second-quarter earnings season for a majority of apparel retailers is shaping up to be an unmitigated disaster.

The culprit is none other than the always-fickle U.S. consumer. Thanks to shoppers spending cautiously on clothes in recent months — despite a rallying stock market and low 3.7% unemployment rate — retailers of all kinds are sitting on mountains of excess inventory. Now that inventory must be worked off at profit-margin-busting prices in order to make way for the lucrative, full-price garb targeted to back to school shoppers in August and September.

That backdrop sets the stage for scores of earnings misses, lowered profit outlooks and downtrodden earnings calls with Wall Street when the retail sector begins to release results in mid-August.

Indeed, the nervousness among investors on how bad the retail reporting season could be a result of inventory concerns has weighed heavily on numerous stock prices the last three months.

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Some notable retail laggards, according to Yahoo Finance data:

  • PVH Corp: -33%

  • Abercrombie & Fitch: -32%

  • Nordstrom: -30%

  • J.C. Penney: -30%

  • Polo Ralph Lauren: -26%

  • American Eagle Outfitters: -18%

  • Macy’s: -10%

  • V.F. Corp: -3%

Brutal performance, especially stacked up alongside a good old-fashioned stock market melt-up.

What’s up

Retail sales at clothing stores have trended lower since January, according to research compiled by Goldman Sachs. Sales at apparel sellers have declined each month from March, Goldman’s data shows.

The department store space has been particularly hard hit by consumers staying clear of the clothing aisles and ongoing store closures — sales have declined each month of the year.

Levi Strauss & Co. (LEVI) CEO Chip Bergh sounded the alarm on the company’s earnings call several weeks ago.

“We've been talking about U.S. wholesale for a long time and the industry has been talking about it. It's a little bit of a melting iceberg. But the reality of bankruptcies that have happened over the last couple of months, and the acceleration of door closures associated with that, and other customers trying to pare back their store footprint has become more and more of an impact here of late,” Bergh told analysts.

Levi’s stock plunged more than 11% on July 10 following its announcement of a mixed quarter of growth.

Where are the shoppers?
Where are the shoppers? Source: REUTERS/Brendan McDermid

Goldman says the backdrop of slowing sales and store traffic have pushed up inventories to unsatisfactory levels, raising the risk of weaker than expected profit margins in the second half of the year.

“Retail sales have deteriorated in core apparel year to date and the category has returned to deflationary pricing trends. We believe this is in part driven by a return to negative retail traffic and elevated inventories in the multi-brand channel, issues which we expect to persist,” says Goldman Sachs analyst Alexandra Walvis.

Walvis adds: “Department stores experienced a particularly tough holiday and 1H19 period, characterized by persistent traffic declines and execution errors at several banners. This has led to elevated inventories and elevated promotional activity, exacerbated by an optimistic spring ordering season.”

With inventory levels out of whack at apparel retailers, Walvis thinks investors should be cautious on the brands that ship products into the space. Those names include PVH Corp., Polo Ralph Lauren and Levi Strauss & Co.

Bergh concedes some of Levi’s key accounts are planning business more conservatively.

“Customers are managing their inventory tighter, and the way they do that is they tighten up their open-to-buy budgets,” Bergh said.

The bottom line

Bloated inventory levels in the lead-up to back to school is the last thing retailers need. The sector continues to be hammered by Amazon, investments to speed up online shipping, bankruptcies and the need to jack up prices due to the U.S.-China trade war hampering supply chains.

Unfortunately, this is the reality as the red-hot Trump stock market has people spending on vacations and new cars instead of a fresh pack of underwear or pair of jeans.

Bring on those August retail earnings warnings.

Brian Sozzi is an editor-at-large and co-host of The First Trade at Yahoo Finance. Follow him on Twitter @BrianSozzi

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