Retail's silver lining: Leaner inventories

Amid retailers' modest fourth-quarter results and muted projections for 2016, here's a silver lining.

Those 40 percent off promotions that whacked much of the industry's bottom line over the holidays helped many retailers clear through excess inventory, positioning them for a more profitable spring.

A shopper browses clothing at a JC Penney store in Queens, New York.
Michael Nagle | Bloomberg | Getty Images
A shopper browses clothing at a JC Penney store in Queens, New York.

At Gap, despite a 7 percent drop in fourth-quarter comparable sales, the company managed to work through its slow-moving fall and winter products, and has already set its floor with the first round of spring merchandise. At J.C. Penney, the department store's 2.6 percent lift in inventories was matched by its fourth-quarter sales growth.

And at Macy's, where warm temperatures and an abundance of cold-weather merchandise left the retailer saddled with a 4.6 percent boost in inventory at the end of the third quarter, those levels were trimmed to a still high — but more manageable — increase of 1.6 percent.

Though numerous challenges remain for the sector, which is battling against apparel price deflation and a shift away from spending on traditional categories, some analysts are optimistic that these lean product levels and an infusion of new merchandise will spur more profitable sales in March and April.

"While it remains early in the season, we are optimistic that we'll see an improvement in sales trends," Guggenheim Securities analyst Howard Tubin told investors. "We believe that warmer temperatures relative to last year, pent-up demand for apparel and new spring product will act as catalysts to drive shoppers into stores."

Topping retailers' fourth-quarter results shouldn't be too difficult. According to Retail Metrics, earnings during the period are projected to decline 1.1 percent. That would represent the first negative quarterly earnings for retailers since first quarter 2014.

Unusually warm weather bore the brunt of the blame, as retailers resorted to steep discounts to clear through excess merchandise. For example, Macy's gross margin contracted nearly 3 percentage points.

Though February represents the smallest sales month of the first quarter, analysts said it's nonetheless retailers' first chance to put the holiday period behind them and focus on improving their full-price selling. Jefferies analyst Randal Konik noted that discounts, so far, have remained reasonably in check, even at Gap and the teen retail brands.

According to Thomson Reuters forecasts, February comparable sales are expected to turn positive and generate a meager 0.5 percent gain. Above-average temperatures during the final week of the month are expected to contribute to this boost, and analysts are optimistic this trend could continue to fuel sales.

"We expect the continuing warm weather should be good for early spring selling," Cowen analyst Oliver Chen said.

Despite these catalysts, retailers are facing plenty of headwinds during 2016. For one, companies including Kohl's and Nordstrom still have elevated merchandise, which could continue to put pressure on pricing across the industry.

For another, consumers have shown a clear reluctance to spend on traditional retail categories, instead choosing to invest in their homes or vehicles.

And in its forecast for 3.1 percent industry sales growth in 2016, the National Retail Federation said it expects the first half of the year to be weaker than the latter half, due to elevated inventories and limited momentum.