Watch out for this sneaky profit killer, warns Morgan Stanley

An economic slowdown that unleashed a tsunami of unsold inventory at several companies may have proved lethal to third-quarter earnings for corporate America and, soon, to future guidance.

At least, that’s what Morgan Stanley’s strategy team warned in a new note published on Monday.

“Our US equity strategy team sees inventory as a key risk to earnings: excess supply and lagging demand are likely to weigh on margins,” the note said. “The problem with inventory is two-fold: supply chain bottlenecks are being removed while demand, especially demand for goods, is slowing down.”

“We expect overall demand to slow beyond the recovery in excess goods consumption as sentiment remains weak and inflation weighs on consumers,” the strategists continued. “Rising supply and falling demand are likely to trigger discounts that add fuel to the earnings slowdown we’re calling for. The inventory problem is upon us for publicly traded companies.”

The investment bank lists a host of companies with above-average inventory risk for the coming quarters, including Ford (F), Abercrombie & Fitch (ANF), Gap (GPS), Carvana (CVNA), Best Buy (BBY ), and Micron (MU).

Inflated inventories (often leading to the need for earnings-cutting markdowns), a strong dollar, stubborn inflation and a host of other factors have set the stage for an ugly earnings season starting this week.

A train trestle crosses the highway in Northfield, Vermont, October 5, 2015. REUTERS/Brian Snyder

Wall Street analysts expect 3% year over year growth in earnings per share for S&P 500 companies for the third quarter, sales growth of 13%, and margin contraction of 75 basis points to 11.8%. , according to data prepared by Goldman Sachs. Just a few months ago, analysts were anticipating 10% growth in earnings per share for the third quarter of S&P 500 companies.

Excluding the energy sector (which has posted triple-digit earnings growth), earnings per share are expected to fall 3% and margins are projected to contract by 132 basis points.

Goldman Sachs chief US equity strategist David Kostin echoed concerns about Morgan Stanley’s inventory heading into earnings season.

“Consumer health is a focus for investors because the combination of weaker demand and excess inventory will limit the ability of some companies to raise prices,” Kostin wrote in a new note to clients. “The ISM Manufacturing index in September fell more than expected to 50.9, the lowest level since May 2020, as manufacturers struggled with excess inventory. Target inventory is a concern for investors and Nike recently lowered its gross margin forecast for 2023 due to the need to pursue aggressive discounting Although our retail analyst sees this development as a supply chain-driven timing issue, excess inventory will weigh on margins if the macro environment deteriorates “.

brian sozzi is a general editor and anchor at Yahoo Finance. Follow Sozzi on Twitter @BrianSozzi and in LinkedIn.

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