Avoid the short-term risk built into this shoe retailer

Anear a multi-decade sales record in 2021, athletic footwear and apparel retailer Foot locker (NYSE:FL) increased its inventory dramatically. The business may now have difficulty selling this inventory in a slowing economy.

The company faces one of two risks in the coming quarters – and potentially more. Here’s what it all means for investors.

The lesser of two evils

COVID-related stimulus, low interest rates and a dovish stance by the US Federal Reserve had the economy running on all cylinders in 2021. Soaring consumer demand helped Foot Locker end the year with 8 $.96 billion in sales – its highest level in more than 20 years.

Image source: Getty Images.

At the same time, countries supplying the United States with goods to feed its growing appetite have suffered multiple COVID-related shutdowns, creating supply chain bottlenecks around the world. The problems have extended to businesses of all shapes and sizes.

Fortunately for Foot Locker, its biggest supplier is Nike (NYSE: NKE), which was able to obtain the finished goods and raw materials it needed to fulfill Foot Locker’s orders. By the end of the first quarter of 2022, Foot Locker had grown its inventory by more than 37% year-over-year to $1.4 billion.

The Federal Reserve has since changed its stance and raised interest rates to curb the rapidly expanding US economy. At the same time, inflationary pressures from Russian oil and gas sanctions have helped push inflation to record highs, taking a bite out of consumers’ wallets.

Today, the company faces one of two short-term risks. First, such a stock level may suggest that Foot Locker has too many items. If the company has difficulty selling its inventory, it could face costly write-downs in future quarters.

On the other hand, Foot Locker may have the right items in stock, but given the current inflationary environment, they may have paid a higher price for the items than in the past. If so, its gross margin could suffer as high-cost inventory moves through its income statement.

Now what?

If Foot Locker has a problem with too many items, they can simply reduce new orders to scale their inventory over time. This may be the case given that Nike recently announced that its wholesale revenue fell 7% in its quarter ended May 31. Given the ever-changing fashion for athletic footwear and apparel, Foot Locker may find itself with spring items in its Q1 inventory that it cannot sell. as the season shifts to summer for the second quarter.

Adding to the potential problems embedded in its inventory, a growing chorus of economists has called for a US recession this year or in 2023, sending retail stocks crashing. For example, the SPDR SPDR S&P Retail ETF is down 33% since the start of the year. Meanwhile, Foot Locker shares have fallen 43% this year. If a recession hits the United States, Foot Locker’s inventory problems could be magnified.

Beyond retail, many sectors of the stock market are taking a beating this year. It could be a great time to buy stocks, but with so many great opportunities right now, investors may want to avoid the risk associated with Foot Locker stocks.

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BJ Cook has no position in the stocks mentioned. The Motley Fool holds positions and endorses Nike. The Motley Fool recommends Foot Locker. The Motley Fool has a disclosure policy.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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