If you're reading this, then you likely already know retailer Target (TGT 0.38%) is counting on profit problems for the quarter currently underway. Namely, operating margin rates for the second fiscal quarter should slip to somewhere near 2%, down from an estimate of around 5.3% less than a month ago. The company's warning explains that "additional [merchandise] markdowns, removing excess inventory and canceling orders" will be among several contributing factors behind the brewing profit pinch. It's also planning on holding more merchandise at shipping ports that would otherwise be on its way to its stores.
Read between the lines. Target is sitting on too much in-store inventory, perhaps buying too aggressively in anticipation of a booming post-pandemic consumerism recovery.
What the company didn't detail, however, was the degree of its current inventory headache. One simple image puts everything in perspective.
Target bought too much of the wrong stuff
Tuesday's warning didn't include any of the specifics, but the data is there for anyone willing to look for it.
In this case, the data to track down is a comparison of Target's inventory levels as of the quarter ending in April versus the retailer's sales during that three-month stretch. Take a look. For added perspective, also plotted are several years' worth of sales/inventory comparisons leading up to the first quarter's figures.
With nothing more than a passing glance, there don't seem to be any red flags. Target's inventory is trending higher, but so is revenue. To sell it, you have to have it.
Things change rather dramatically with just a couple of tweaks of the chart, however.
One of the tweaks you'll see below is the addition of a specific inventory/revenue figure, expressed as a percentage of sales. While some variances can be expected from one quarter to the next, most retailers make a point of fine-tuning this ratio just because retailing is such a fickle, low-margin business. Not only does too much inventory mean there's no room to add newer merchandise, it also means there's not always enough cash available to procure new goods. Misaligned inventory levels relative to sales can create a lasting, challenging ripple effect.
The other tweak you'll see on the revised image below is the removal of all other quarters besides the first quarters of the past several years. It seems unnecessary on the surface, but this nuance matters because timing is critical in retailing. Stores need to be rid of all springtime merchandise by now, preparing for back-to-school shopping, and even thinking about this year's always-busy holiday shopping season. To optimize sales and profits in the back half of the year, Target needs to end the first half of 2022 on the ideal footing.
As the old adage goes, read 'em and weep.
You're seeing that right. Target ended the first quarter of the current fiscal year with inventory levels at 60% of the first quarter's sales. That's the highest Q1 inventory/sales comparison in the past five years, which includes periods before and after the pandemic shook global supply chains. Prior to 2020, the retailer would end the first quarter of the year with inventory levels at just above 51% of Q1 sales.
In simplest terms, Target is moving into the second half of fiscal 2022 at a rather extreme disadvantage.
Optimization is easier said than done
Will the retailer's intended "inventory optimization" do what needs to be done to set up third- and fourth-quarter success? Possibly. The depth of the company's challenge, however, can't be overstated.
Sure, the mathematical difference between inventory at 51% of quarterly revenue and 60% of quarterly revenue may not seem terribly significant. It's a huge misalignment within the world of retailing, though. Again, what Target does or doesn't do now can adversely affect what it can afford to buy or have room to carry over the course of the next several months, which can cause the same problems into calendar 2023. The company is rightfully taking its lumps now, but it remains to be seen if it can take enough lumps now -- given the scope of its situation -- for a better "then."
Also bear in mind that the crux of the reason this company's shares are down 26% just since mid-May is its earnings shortfall reported then. Analysts were expecting a bottom line of $3.07 per share. Target only turned in $2.19, however, citing inflation and adding that same-store sales growth cooled to 3.3% from 8.9% just a quarter earlier. There's no assurance that simply discounting a bunch of merchandise here will get all of it out the door, particularly if inflation remains high and continues to crimp overall consumer spending.
At the very least, it's a matter Target shareholders will want to keep close tabs on, particularly now with a benchmark inventory/sales comparison in mind.