Target (TGT -0.70%) investors have some big questions heading into the retailer's upcoming earnings announcement. Rival Walmart (WMT 1.32%) recently lowered its earnings outlook for a second consecutive time while noting that consumers are rapidly shifting their spending patterns in response to the waning pandemic threat and inflation.
Those changes might factor into a weak short-term earnings outlook from executives when it reports second-quarter earnings (for the quarter ending July 31) on Wednesday, Aug. 17, before the bell. But there are also a few ways that Target might surprise investors with good news that suggests a return to expanding profitability ahead. Let's look at why the retailer might soon be on a stronger growth footing.
Sales trends
We have some midquarter sales trend updates from both Target and Walmart, but not for good reasons. Both companies have warned about a rapidly shifting demand environment in recent weeks due to trends like inflation and a quick tilt away from product categories that were popular in earlier phases of the pandemic.
While overall sales appear strong, Target might feel a pinch from weaker demand in several categories, like home furnishings. Executives said in early June that customer traffic is still growing, even compared to strong results a year ago. But we'll find out on Wednesday whether the chain's expansion streak is near an end. Most investors who follow the stock are looking for sales to rise just 4%, to roughly $26 billion.
Falling margins
The company's weak earnings outlook is a big factor weighing down the stock right now. Target reported an operating margin of just 5.3% in Q1, below management's expectations and well below the double-digit rate that investors had been thrilled to see through most of 2021.
Things will get worse before they get better. Target is predicting that profitability will fall to just 2% of sales in Q2 as the company slashes prices to keep inventory moving through its stores. The Q2 period should represent the most intense cuts, which ideally will leave Target in a flexible position heading into the holiday season.
But it is possible the company had to be even more aggressive in those promotions. Investors are already looking for earnings to fall to $2.51 per share from $3.03 per share last year.
Looking ahead
Management in early June said that profitability might rebound to around a 6% rate in the second half of the year. There have been a few positive developments since then, though, including signs of stronger economic growth, high wages, and slowing inflation.
As a result, Target might have more encouraging comments to make about the next few quarters, especially now that its inventory levels are lower and better matched up to current demand trends.
Sure, the retailer likely took a big earnings hit in Q2 when it cleared out some of the products it had ordered months before on the belief that shoppers would continue favoring spending in areas that they prioritized in 2021.
But the worst could be behind the company on this score, and so investors have some good reasons to feel optimistic about Target returning to faster sales growth and rising profit margins by the time the holiday shopping season heats up.
