Target (TGT -0.70%) has been caught up in the broad market sell-off, falling 48% off its highs. That ends the streak of several years of momentum as it benefited from being deemed an essential retailer, allowed to stay open during the lockdown stages of the pandemic while other businesses closed their doors temporarily.
Now that Target's stock has sold off, it's too cheap to ignore. But it requires closer consideration to determine if investors should buy right now.
Target's record profitability is coming to an end
The sell-off in Target's stock accelerated on June 7, when it updated investors, telling them it had to lower profit expectations because of rapidly evolving consumer spending patterns. In its most recently completed fiscal year, Target reported record earnings per share (EPS) of $14.10. To put that outperformance into context, the highest EPS in the decade before the outbreak was $5.51 in 2019.
TGT EPS diluted (annual). Data by YCharts.
Target has benefited from supply chain shortages at competitors, allowing it to capture sales at higher profit margins. The update on June 7 essentially said those excellent times are abruptly over. The company expects its operating profit margin to be 2% in its second quarter. That was down from the initially expected 5.3%. Management has started a bold discounting campaign to get unwanted inventory off the shelves.
As of the end of its fiscal first quarter (April 30), Target had $15 billion of inventory on hand. That was a 43% increase from the same quarter in the prior year. After persistently facing supply shortages, the retailer seems to have overstocked its shelves. To make matters worse, it has a lot of the wrong kind of inventory.
Consumer habits are rapidly changing as economies reopen from pandemic restrictions. Folks spend less on in-home entertainment items like TVs, game consoles, and movies. Instead, they allocate more of their discretionary income to away-from-home experiences like travel, restaurants, and concerts.
Further hurting demand at Target is the fall in consumer discretionary income. Soaring inflation forces households to spend more on necessities like food, fuel, and rent, leaving less money for nonessentials.
Target's stock is cheap enough to buy
That said, Target has invested in developing a best-in-class omnichannel shopping experience. Its customers can now choose several fulfillment options, including the traditional buy online, with the items shipped to their homes for free. Newer to the list of options in the last couple of years is buying online and having a Target associate bring the order to your car in a Target parking lot, and buying online and having the order delivered to your home for a small fee within a few hours.
The same-day services are immensely popular with consumers, increasing 9% in the first quarter on top of 90% growth in 2021. Fortunately for shareholders, both newer options are cheaper for Target than the free shipping to customers' homes for online orders.
This transition could boost Target's potential profitability in the long term. Undoubtedly, its profits have been inflated in the short term due to the pandemic. It's now going through the pains of adjustment to a longer-term normal.
TGT P/E ratio. Data by YCharts.
The stock is now trading at a price-to-earnings ratio of 11.5, near the lowest it has sold for in the past decade. Investors can undoubtedly start buying Target's stock now. Or they can place the stock on their watch list and observe how the inventory liquidation goes over the next few quarters before starting a position.
