Target (TGT -2.41%) stock fell hard this week as investors reacted to the retail giant's fiscal 2022 first-quarter earnings announcement (for the quarter ending April 30). Sales trends weren't the problem, as customer traffic rose even on top of soaring results a year ago.
The surprise challenge was around earnings, which dove in Q1 and are likely to remain depressed through at least the rest of the year. Let's take a closer look at the two main factors hurting Target's profitability today, according to its management team.
1. Buying different things
Target achieved higher in-store traffic through late April, which allowed the company to boost sales this quarter on top of last year's 17% spike. Executives also noted that the e-commerce channel is strong, and shoppers are still happily opting for quick home deliveries or in-store pickups.
However, Target saw a huge swing away from home goods categories that had seen soaring demand in earlier phases of the pandemic. Shoppers were far less interested in kitchen appliances, outdoor furniture, and TVs. "We didn't anticipate the magnitude of that shift," CEO Brian Cornell said in an earnings call with Wall Street analysts.
That move was especially costly for Target because these products are bulky, so it is more expensive to move them in and out of stores. The company used markdowns to fix the inventory imbalance, which reduced profitability.
2. Soaring transportation costs
Supply chain issues took a huge bite out of profits, too. Transportation expenses soared even compared to management's outlook just three months ago. Target now sees these costs removing a full $1 billion from earnings in 2022, thanks to rising gas prices and unusually high shipping rates.
Management said these issues will continue hurting the business in the second quarter and beyond, but conditions are likely to improve slowly in the second half of the year. Yet it will require resources to get the supply chain running at the right levels, and that spending will be another big drag on earnings in 2022.
The good news is that Target is seeing robust spending growth overall, with bright spots in areas like beauty supplies and trendy fashion. Consumers are prioritizing purchases for activities like family gatherings that had been paused during earlier phases of the pandemic.
Yet they aren't pulling back dramatically on spending or store visits. Traffic was up 4% this quarter, after all, and average spending only ticked slightly lower. "Our ... results demonstrate the underlying strength of the relationship we built with our guests," Cornell said.
That context suggests an overreaction by investors in sending Target's shares lower by over 20% following the report. But Wall Street is assuming the retailer won't see a profitability rebound in the second half of the year, and that consumer spending trends will turn negative soon.
Management doesn't expect that bearish scenario to play out, but this report demonstrates that shoppers' attitudes are changing, and are usually hard to forecast today.