How Will Inventory Management and Credit Availability Intersect?
In early July FMG discussed inventory stresses and the liquidity and working capital risks inventory stresses bring. We identified the dollar impact on liquidity and asset-based lending availability created by the transition to higher inventory levels coupled with increased unit costs, stress on appraised values, and stress on line of credit structures.
Companies have replaced just in time inventory approaches with higher inventory levels to offset the supply chain problems. In addition to building inventory quantity levels, the per unit value of the inventory has been increasing as evidenced by inflation at 40 year highs. At the same time companies are experiencing higher levels of inventory and lessening of supply chain problems, the buying decisions of consumers are changing as inflation takes a toll and businesses return to more normal work schedules.
Over the last 30 days there has been an increase in the number of consumer and small business internet searches related to credit needs.
The search for “Small business loans for bad credit” was up 90%.
The search for “How to apply for a business credit card” was up 90%.
The search for “PayPal business credit card” was up 90%.
The search for “How to get a business loan with bad credit” was up 80%.
This tells us that business owners are feeling the liquidity pressures that we have been discussing the last few months, and the concerns about access to cash are increasing.
When Walmart, Target, Home Depot, Lowe’s and other big box retailers reported Q2 earnings in August of 2022 it became clear that consumer preferences were changing to basic goods – food and essentials. When compared to a year ago, consumers were slowing down purchasing of furniture and electronics.
The supply chain issues of 2021 meant that suppliers to the big box retailers and the retailers themselves, bulked up their purchase quantities and in many cases substituted products, including less desirable products, to ensure shelves were full.
Now the inventory is at risk of being excess and undesirable.
Using the quarterly reports of Walmart, Home Depot, Target and Lowe’s, Bloomberg published these graphs of inventory levels from Q1 2021 through expectations for Q1 2023.
Walmart reported that it has cancelled billions of dollars in orders and slashed prices in certain categories, for example apparel. Walmart’s head of US operations stated that it will take the company a few more months to work through the backlog of inventory and orders.
Target believes they have dealt with the inventory problems but reducing inventory levels meant the company’s earnings were below analyst estimates, and the stock price was impacted as earnings missed expectations.
The experiences of the large retailers are also occurring at smaller retailers and are impacting liquidity for businesses that are reliant on ABL structures. Inventory is aging out past eligibility, SKU turnover times are increasing past eligibility, and inventory is staying in stock longer which pushes against inventory caps.
Retailers are the tip of the impact of changing consumers demands. Distributors of products are experiencing significant liquidity stresses right now. In many cases distributors were unable to acquire needed product in 2020 and 2021, which pushed the distributors to purchase more product in late 2021 and 2022, and to make changes to the products purchased to ensure they had a variety of products to ship to their customers. We have seen small businesses with more than a one year supply of product on hand. We have seen distributors saddled with product big box stores will not be buying until the next annual selling season. We have seen businesses with warehouses full of product that is no longer desirable.
Appraisals are beginning to come in at lower NLV (net liquidation value) and OLV (orderly liquidation value) levels that those appraisals of the same assets that occurred a year or two ago.
This is translating to companies running out of cash. Applying reduced advance rates, or implementing existing turnover or aging criteria, or applying caps on line outstandings tied to inventory are all combining to create over advances for companies and their lenders. In some situations, equity may be able to bridge the gap to the next selling season, or to allow the company to work through the excess inventory.
But, in many cases inventory needs to be reduced to generate cash, even if that cash is less than originally expected. As businesses look to changing consumer demands caused by inflationary pressures, it may be time to convert inventory to cash and realign inventory levels and components of inventory with this changing consumer demand.