Retailers have a serious inventory problem. Here are the stocks most at risk, according to UBS

Published Wed, Sep 21 20221:33 PM EDTUpdated Wed, Sep 21 20224:36 PM EDT

UBS said the inventory problem at retailers is worse than investors are expecting and identified some stocks that will be hardest hit. "[We] analyzed industry inventory levels now that Softlines earnings season is essentially over," analyst Jay Sole wrote in a note Wednesday, referring to retailers that specialize in soft goods, such as clothing, footwear or bedding. "We draw two conclusions from this work: 1) The Softlines industry inventory situation got worse q/q. The Softlines industry sales/inventory spread was -11% at the end of Q2, 1,000 bps worse than the spread after Q1. 2) The Street's 3Q and 4Q gross margin estimates look too high." "Our view is these two factors will weigh on sentiment for at least the next two months and are additional reasons to lean bearish on Softlines stocks," Sole wrote. The findings are an ugly surprise for some investors who expected retailers would resolve inventory issues after the first quarter this year, according to UBS. Sole expects that gross margin estimates for the third quarter "could be hundreds of bps too high" and said the fourth quarter outlook appears little better. "Since the industry's sales/inventory spread has deteriorated, we believe the industry's gross margin trend should deteriorate too in Q3. However, the sell-side is forecasting the industry's y/y change in gross margin to get 10 bps better in Q3 vs. Q2," Sole wrote. UBS found some stocks that are most likely to disappoint third-quarter gross margin expectations, saying these companies have poor sales/adjusted inventory spreads on both a 1- and 3-year basis, yet carry high sell-side 3Q22 gross margin outlooks, the note said. Here are the names: Burlington's reserve inventory amounted to more than half, or 52%, of total inventory at the end of the second quarter of fiscal 2022, versus more than the 31% at the end of the second quarter of fiscal year 2021, according to the note. The stock is down 54% this year. Kohl's inventory jumped at the end of the second quarter, up 48% from the end of the second quarter in 2021, because of lower sales. The department store company increased inventory to deal with growing supply chain issues, as well as to support the opening of 400 Sephora shops in its stores this year. The stock is down nearly 43% this year. Steve Madden continues to have "higher than historical levels" of inventory to deal with supply chain issues, building an average of 40 days more supply than the footwear company did before the pandemic. The stock is 37% lower this year. UBS also named Ross Stores and Carter's as high-risk stocks.