Mounting inventory at Macy's is ringing warning bells at department stores

Mounting inventory at Macy's Inc portends a tough holiday quarter for U.S. department store operators as they compete with home improvement and electronics retailers for the attention of thrifty customers.

Inventory was up 4.6 percent at the end of October - 3.1 percent on a comparable basis - after the warmest fall quarter in 25 years hit sales of winter clothing and footwear.

A strong dollar also kept many tourists away from Macy's biggest stores.

"We will need to liquidate this inventory in the fourth quarter so that we can maintain the flow of fresh new merchandise," Chief Financial Officer Karen Hoguet said on a call after Macy's reported third-quarter results.

A surprise drop in comparable sales for Macy's set alarm bells ringing in the department store industry, sending shares of Kohl's Corp and Nordstrom Inc down on Wednesday.

All three are scheduled to report results this week, although analysts said J.C. Penney and Nordstrom are likely to fare better than Macy's, Kohl's could disappoint.

A survey by Sterne Agee CRT showed that, in October, more consumers used savings from lower gasoline prices to pay down debt than bought discretionary items.

Those still spending are buying more electronics than clothing and cosmetics, a shift identified by Chief Executive Terry Lundgren as contributing to a third straight quarterly decline in Macy'sstores open at least a year.

Macy's, whose flagship Herald Square store covers an entire Manhattan block, said it would need to discount to clear fall season inventories. Analysts said Kohl's was likely to follow suit, as weather is also a big factor in its sales.

"Unless you enter the fourth quarter very clean ... it puts into jeopardy the most important quarter of the year," said Dan Hess, chief analyst at research firm Merchant Forecast.

With November also expected to be the warmest in decades, some stores are hanging Christmas decorations later than usual, a subliminal message to shoppers to hold off on gift-buying until more of the fall season stock is cleared.

"There's a danger to hanging the tinsel too early," said Hess.

But the factors that weighed on Macy's should not affect J.C. Penney and Nordstrom to the same extent, analysts said.

J.C. Penney gave a sneak preview of its performance in the August-October quarter, saying comparable sales rose 6.4 percent, which would be the biggest same-store sales jump in more than nine years.

Sterne Agee CRT analyst Charles Grom said sales were being boosted by a greater number of the popular Sephora beauty outlets within J.C. Penney stores, as well as an improved assortment of home, children's and private-label goods.

Nordstrom's broad fashion spectrum, from the priciest designer apparel to more affordable clothing, would help it to clear inventories quicker than some rivals, analysts said.

(Reporting by Sruthi Ramakrishnan in Bengaluru; Editing by Robin Paxton)