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Aritzia shares tumble as much as 13% despite record quarterly sales

Higher inventory levels appear to be weighing on investor sentiment

An Aritzia store is seen Tuesday, July 13, 2021 in Montreal. Aritzia Inc. says it had record quarterly revenue in its third quarter as it made gains company wide including notable growth in the U.S. and online.THE CANADIAN PRESS/Ryan Remiorz
Aritzia says net sales in the third quarter reached $624.6 million, the highest of any quarter in the company's history. (THE CANADIAN PRESS/Ryan Remiorz)

Aritzia Inc. (ATZ.TO) shares fell as much as 13 per cent on Thursday, despite posting record quarterly sales, as higher inventory levels weigh on investor sentiment.

The Vancouver-based clothing retailer announced its quarterly results on Wednesday and said net sales in the third quarter ended Nov. 27 reached $624.6 million, the highest of any quarter in the company's history and an increase of 38 per cent compared to the same period last year. Strong sales in the United States – where 50 per cent of Aritzia's sales now come from – and e-commerce growth fuelled the record results. Just two years ago, the U.S. represented 33 per cent of the company's total sales.

Despite the strong sales momentum, Aritzia's stock fell on Thursday. Shares of the clothing company closed the trading day on the Toronto Stock Exchange at $46.16 a share, a decline of 10 per cent compared to Wednesday's close.

Many retailers have been grappling with elevated inventory levels as supply chain issues improve and an inflationary environment puts pressure on sales.

Aritzia says inventory levels in the third quarter amounted to $508 million, an increase of 187 per cent compared to the same time last year. However, the company notes that last year's inventory levels were "extremely low" and negatively impacted sales.

The company now expects gross margins – the amount of profit made on goods measured as a percentage – to decrease by approximately 2.5 percentage points on a year-over-year basis in the fourth quarter, due to higher warehousing costs related to inventory levels, ongoing inflationary pressures and foreign exchange headwinds.

"Given what we knew at the time, we made the strategic decision to order future season buys earlier in order to build back our inventory base due to unprecedented sales growth, mitigate supply chain risk, and ensure our ability to fuel the robust demand for our product," Aritzia's chief executive officer Jennifer Wong said on a conference call with analysts on Wednesday afternoon. With supply chain issues easing and freight timelines improving, the company received the inventory sooner than expected.

Still, Wong says the company's markdowns in its upcoming quarter will be "no greater" than pre-pandemic levels.

"We are confident with the composition of our inventory, which is heavily concentrated in client favourites and has certainly enabled the strong sales growth we have delivered," Wong said.

Analysts say the strong sales momentum should outweigh concerns about higher costs and inventory levels.

"Though near-term margin pressure and elevated inventory are front and centre, we believe the robust brand momentum outweighs cost concerns," CIBC Capital Markets analyst Mark Petrie wrote in a note to clients on Thursday.

"New and expanded stores continue to perform well and the economics are excellent. We remain bullish on both store growth and e-commerce, driven by brand awareness and an improved online platform."

In a note to clients on Thursday, BMO Capital Markets analyst Stephen MacLeod says the higher levels are not expected to drive discounting – a key concern for investors when it comes to retailers with bloated inventories – and reflect the company's strategic decision to order future seasonal product earlier.

"While inventory is elevated, revenue growth remains robust," MacLeod wrote.

"On-order inventory was much higher last year, whereas this year more product has been received or is already in-transit. This is anticipated to lead to additional warehousing costs, but markdowns are not expected to exceed pre-pandemic levels."

Several retailers have seen stocks fall under pressure over concerns about bloated inventory levels.

Shares of Lululemon fell 9 per cent on Monday after the company issued a press release saying it expects gross margins to decline by between 0.9 and 1.1 percentage points in its upcoming fiscal quarter. The decline came as Lululemon hiked its total sales forecast amid strong holiday traffic.

Alicja Siekierska is a senior reporter at Yahoo Finance Canada. Follow her on Twitter @alicjawithaj.

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