sean o’reilly: this episode of industry focus is brought to you by rocket mortgage by quicken loans. rocket mortgage brings the mortgageprocess into the 21st century with a fast, easy and completely online process. checkout rocket mortgage today at quickenloans.com/fool. welcome to industry focus, the podcast thatdives into a different sector of the stock market every day. today is tuesday, may 17th,so we’re talking about consumer goods. i’m joined by motley fool analyst vincent shen,who’s going to take us to school on that most exciting of topics, retail inventory management.how’s it going, vince? vincent shen: i’m doing well, sean. i personallythink it’s quite exciting, actually. o’reilly: oh man, i didn’t even need coffeeto do this. i’m so excited.
shen: (laughs) realistically, and on a moreserious note, this is a really important part of the business for a lot of retailers. i’lltake you through the gamut of some of the different sectors we think of, how they manageit, and then take you to the gold standard with a company that has truly outdone manyof its competitors. o’reilly: would you say that inventory managementmight be, other than advertising, the most important thing that a retailer can do? shen: i think, for some of the companies thatwe’ll talk about, it’s a huge differentiator for them, and something that has allowed themto win really strong margins, to gain incredible scale. think of walmart, for example, whowe’ll touch on briefly. but i get into any
of that stuff, sean, don’t you have anythingto mention for today’s show? o’reilly: ok. i’m actually going to be steppingback from the consumer goods and the tech shows, to focus more exclusively on the energyshow. so vince, you’ll be having lots of cool guest stars and everything. people got a tasteof what i’m going to be doing with the energy show last week when i had daniel sparks on– not only a tesla shareholder, but a tesla owner — and we talked about their driverlessmode, and the future of tesla, its valuation, and so on. it’s exciting. we’re continuingto improve industry focus, and one of the ways we’re doing that is diversifying ourcontributors. i think it’s a good move. shen: sean, i have to say, after over a yearof doing if with you, i’m going to miss you.
o’reilly: i bet. this is what i was most sadabout, like, "oh, i won’t get to hang out with vince and dylan now." i’ll just haveto go to lunch with you guys more or something. shen: and i know you like talking about yourenergy and industrial companies, but come on, you know the fun stuff is in tech andconsumer goods. o’reilly: i know! like inventory management!shen: (laughs) o’reilly: so, for the listener who’s rollingtheir eyes right now, not only because of our bad jokes, but also because of the factthat we’re about to talk about inventory management of retailers, can you draw them in a littlebit, explain what it is, maybe jazz it up a little?
shen: sure. broad context, this is the ideathat there’s a lot involved in when you walk down the aisle at a grocery store, a clothingstore, or even a big box store like a target or a walmart. there’s a lot involved withkeeping this shelves stocked with the product you want. there’s skus, which are essentiallythe numbers they assign to identify these products. when you have, let’s say, a thousandstore locations, and each of the store locations, at a big box store, for example, has potentiallytens of thousands of skus. this becomes a huge, huge operational challenge. when you’re looking at a company and tryingto generally identify how well it’s managing its inventory, on the investing side, we generallylike to use two metrics. the first one of
those is inventory turnover. that basicallytells us how many times a company will sell through the inventory it has in a given period.this number is calculated by cost of goods sold over whatever time period you want touse. traditionally it’s on a trailing 12-month basis. you divide that by its average inventorybalance during the period. so you could take q4 inventory for 2014, and then the endingbalance in 2015, average those two numbers, and you’ll get essentially 5 or 10 or 15 times,basically how many times they turned through their inventory in that year period, if you’regoing by trailing 12 months. related to this number, you can also calculatetheir days of inventory outstanding. this number basically tells you how much inventorythey have on hand measured by how many days
it would take them to sell through the balancethey currently hold. i really like this number because it puts it into perspective, how quicklya company can sell through its inventory and how much they have. it’s all within the metric,days or weeks. o’reilly: that’s kind of the name of the gamein retail. assuming that items are being sold for a profit, the more quickly you can sellthings, the more you can use that money to buy more inventory, and it keeps on spinning. shen: i’m really glad you touched on that,because the ultimate idea is that these companies are pouring resources and money into whatevergoods they’re producing or selling or acquiring from suppliers. the faster they can convertthat inventory into revenue and cash, it’s
very beneficial to them. being able to optimize,and make its management of inventory as efficient as possible, is really important to the marginsand profitability of any company. for that days of inventory outstanding number,a lower number is generally preferred. the idea is, you can sell through it very quickly.at the same time, if it’s too low, you run into the issue of potentially leaving moneyon the table if, for example, you don’t forecast demand well–o’reilly: you’re pricing to sell, yeah. shen: and, at the same time, you don’t foreseeoutsized demand, you can’t meet that, and you leave money on the table. another thingto keep in mind with these two metrics is, on their own, they don’t tell you quite asmuch as when you compare them to their peers
or their overall industry or sector. that’swhere you really see, through that comparison, how well they’re doing. moving on to our first example, i wanted totalk about urban outfitters. recently, i did a lot of research about urban outfitters forthe supernova explorer one mission. o’reilly: one of the motley fool’s awesomenewsletter services. shen: exactly. i wanted to look at it forthe apparel sector. and we’ll get more broad into the bigger department stores like nordstromas well. urban outfitters operates three primary chains. they have their namesake, urban outfitters,anthropologie, free people. they also have some ancillary brands.
o’reilly: those two satellite brands, i guess,are the ones that are going gangbusters right now, if i recall right. shen: yeah. for some years, they were theones that were providing most of the growth. things overall for the company have sloweddown. they’re in a recovery turnaround phase. but a big focus for the company, you’ll hearmultiple times in their different management calls, earnings calls, presentations thatthey do, they talk a lot about their weeks of inventory and managing that number. i pulled a lot of my calculations from s&pcapital iq. urban outfitters has an inventory turnover for fiscal year 2016 of 6.5 times.its days of inventory is at about 56.2. if
you compare that to competitors, think abercrombie& fitch, american eagle, the gap, express, urban outfitters seems to be running a littlebit more efficiently. the average for some of those peers is about 4.9 times, or 80 days.it’s taking them longer, and they’re going through their inventory fewer times in a year. so, as i mentioned with the company urbanoutfitters specifically going through this turnaround phase, by managing their inventorybetter, basically, for them, it reduces the need for them to employ markdowns to selltheir goods. and obviously, that has a very direct impact on their margins and profitability.the company has been trying to handle its inventory better by making some strides inthe supply chain. for example, going to a
single sku system across all of its channels.all of its products now, whether you see them in store or online, they’re all identifiedby that same sku number. this is basically fostering the idea of theomni-channel strategy that you hear so many retailers employing now, the idea that youwant to give a shopper or customer the ability to buy whatever it is that you’re sellingwhenever and however they want. whether they’re in your store, at home on their computer,or in your store on the app, which is something that’s becoming very common, where a shopperwill go to urban outfitters and interact quite a bit due to these beacons that the storesemploy. they’ll ping your phone if you’re a participant, and you have the urban outfittersshopping app, and it gives you special offers.
a lot of people end up shopping online whilethey’re in store. it’s really blending all these different channels. o’reilly: i’m really curious, since we’retalking about inventory management, what inventory days and how much stores are going to havean inventory in two decades. how many things is urban outfitters and macy’s and jcpenneyand walmart, how many things are they going to have on the shelves? you hear all theseretailers talking about their omni-channel strategy, and what it’s going to entail ishaving a huge … i hate to bring them up again, because we talk about them every timewe talk about retail, but amazon. you’re going to have a huge amazon-like distribution facilitythat’ll filter out to the stores. they’re
not going to have every size and every colorof shirts. they’re just not, it’s not worth it. shen: another example more specific to theapparel sector, you look at a company like zara, which is known as this fast fashion,very successful. something they stress is that they keep inventory levels pretty slim.when they ship out a new collection, for example, to stores, they do so at a very limited basis.this not only allows them to manage inventory very well, but also add some exclusivity tothe new products that come out. so there’s a bit more elevated demand from shoppers,when they think, "i might not be able to get this next week, if the store is sold out andthat’s all they’re going to have." moving on, still within apparel, but alsosome of the bigger stores, i wanted to talk
about kohl’s, jcpenney, tjx companies, macy’s,nordstrom. larger chains actually tended to have lower turnover and more inventory onhand. they average about 3.9 times and 104 days. o’reilly: so these things are sitting on theshelves for three months? shen: yeah. basically it would take them about104 days to sell through everything they have. it’s very interesting that the bigger storesare actually a little less efficient, you could call it. but not that surprising. moving on to another sector, which is on theopposite end of the spectrum from apparel retailers, naturally, as you would expect,the fastest turnover is probably going to come from companies that sell perishable goods.let’s walk down the grocery aisle, for example.
among major chains like whole foods market,kroger, supervalu, sprouts farmers market, the average for these peers is about 16 timesin 27 days of inventory. the organic food specialists, whole foods and sprouts tendto out-perform the broad industry. but if you look more broadly at the bigger box stores,like, walmart has obviously pushed significantly into the grocery business. you get a lesson, really, in how effectivelythey manage it. they do everything to run their operations as efficiently as possible.even when they get to their distribution centers that you mentioned, goods get moved from onetruck directly onto another truck to go to the stores. it never get stored in warehouses,or it does as minimally as possible.
o’reilly: i remember i saw this report orshow about walmart. they literally use supercomputers to manage their inventory and everything.it was amazing to me. it should be like, using supercomputers to solve complex problems,and they’re doing inventory stuff. shen: it is complex. that’s another reasonwhy walmart has been so successful over the decades. its numbers are a little strongerthan a target or a best buy, for example. o’reilly: this episode of industry focus isbrought to you by rocket mortgage by quicken loans. if you’ve ever bought a home, you alreadyknow how frustrating and time consuming getting a mortgage can be. rocket mortgage bringsthe mortgage approval process into the 21st century by taking all the complicated, timeconsuming parts of applying for a mortgage
out of the equation. with rocket mortgage,you can easily share your bank statements, pay stubs, at the touch of a button, helpingyou get approved in minutes for a custom mortgage solution that’s been tailored to your ownfinancial situation. and you can do it all from your phone or tablet. so, if you’re lookingto refinance your mortgage or buy a home, check out rocket mortgage today at quickenloans.com/fool.equal housing lender, licensed in all 50 states, nmlsconsumeraccess.org number 3030. vince, you were talking about the companythat epitomizes great inventory management at the beginning of the show. i’m going togo out on a limb and say it’s amazon. shen: i’d say this is generally a companyyou would discuss on the tech show with dylan.
o’reilly: it’s not amazon? what are you talkingabout? shen: this is one where i think their retailstores have become famous worldwide. they’re almost like a tourist destination unto themselves.i think there was a fun fact on the board here at fool hq that said that more picturesare taken of the apple store in manhattan, i believe the one in midtown, than are ofthe … what was it, the empire state building? o’reilly: it was the statue of liberty. imaintain that that’s because the statue of liberty is harder to get to. but, ok, it’sapple. shen: it is. here’s the company that has thehighest sales per square foot in retail. i think it’s almost $5,000.o’reilly: it’s second only to … do you know?
shen: no, it’s first. who do you– o’reilly: per square foot, it’s second onlyto tiffany’s. shen: tiffany’s is actually number two. o’reilly: you’re kidding me! apple beat themout?! shen: yes.o’reilly: wow. sorry, tiffany’s. shen: in case you’re not aware, for some background,before tim cook took over as ceo, he had a long tenure in operations for the company.he is known for making major improvements when he joined in 1998 that really changedthe ability for apple to not only manage the huge demand it would have for some of itsiphones and other products, but to do so very
profitably. for example, he scrapped all oftheir in-house warehouses, all of their in-house manufacturing facilities and went to the contractmanufacturers that became so famous, like foxconn, for example. and something that allowsthem to do is, if you order a phone, it’ll likely be shipped directly to you from themanufacturing facilities abroad. apple never even has to–o’reilly: do anything. shen: –take possession of them at any time.that’s very efficient for them. a really funny quote is, tim cook has several times useddairy products as an analogy for inventory, the idea being, "kind of like the milk inyour fridge, the longer it sits, the more likely it is to go bad." he’s even gone sofar as to describe inventory as "fundamentally
evil." that’s probably a bit of a stretch,but he believed that inventory in hand would shed about 1-2% of its value each week innormal conditions, maybe even more so during a challenging retail environment. so, it’sreally important to be able to turn these very quickly. with all that in mind, the numbers here arereally impressive. instead of having billions of dollars of parts, components, and completedproduct sitting around, they don’t have to deal with that nearly as much with the contractmanufacturers. trailing 12 months inventory turnover, as of the most recently reported2016 second quarter, 58.6 times. o’reilly: wow!
shen: blowing out even a company that sellsperishables, like a supermarket. average inventory balance during the period was only about $2.3billion. days of inventory, they can sell through it in about six days. o’reilly: i just realized, when i bought myiphone last spring, it was probably a week old at that point! (laughs) shen: and i think the scale here is what’sreally so incredible and hard to imagine. billions and billions of dollars of product,and they’re able to maintain a really well-oiled machine.o’reilly: revenues were $50 billion … yeah. shen: with those numbers, tim cook takingover, a lot of people complain or argue that
he’s not quite the visionary in terms of designthat steve jobs was. but he was also a huge contributor in his time there, both in operationsand as ceo, in developing this model and the systems in place that allow apple to be soprofitable, to cut out the costs wherever he can, and to have these numbers … sixdays they can turn through their entire inventory. o’reilly: and this is on revenues for thefiscal year ending september 26 of last year of $233 billion. that is just … i can’teven conceive of doing things that quickly. shen: beyond some of the other sectors wetalked about, that’s one i really wanted to touch on, just because it is this gold standard,i think, within retail. o’reilly: that’s awesome. thanks for yourthoughts, vince.
shen: thank you, sean. o’reilly: thanks again for being a great partnerfor the last year. shen: i’m going to miss you. o’reilly: you bet. that’s it for us, folks.if you’re a loyal listener and have questions or comments, we would love to hear from you,just email us at firstname.lastname@example.org. again, that’s email@example.com. as always,people on the program may have interests in the stocks they talk about, and the motleyfool may have formal recommendations for or against those stocks, so don’t buy or sellanything based solely on what you hear on this program. for vincent shen, i am seano’reilly. thanks for listening and fool on!