Three months ago, Target (TGT 1.29%) warned shareholders that the second quarter could be a tough one. During the company's first-quarter earnings call, chief financial officer Michael Fiddelke said, "We expect a [second-quarter] operating margin rate in a wide range, centered around our first-quarter rate of 5.3%, well below where we would expect to operate under normal conditions."

The key culprit? Excess inventory that needed to be heavily marked down to get out of its stores.

And sure enough, the company largely delivered as expected. Gross margins on the goods its sold slipped from the first quarter's 24.3% to 20.4% in the second quarter, well down from the year-ago figure of 30%. Subsequently, the operating bottom line tumbled from $3.65 per share a year earlier to a scant $0.39 per share, well short of analysts' estimates of $0.79 despite same-store sales growth of 2.6%.

Sometimes a company has to bite the bullet and move on. What's largely been obscured by all the noise surrounding Target's earnings miss, however, is that it ended the three-month Q2 stretch with almost the same degree of inventory trouble that it had at the end of Q1.

Given the looming shift to autumn goods and holiday shopping shortly thereafter, the company's profit troubles could linger longer than most investors might suspect. Until the retailer clearly pushes past its inventory bloat, it might not be a worthy investment at all.

Inventory levels remain unusually high

It's more complicated than it seems. Procuring merchandise to sell is done months in advance. The specific merchandise and the amount that can be bought are often contingent on the amount of inventory already in stores and its plausible market value. Retailers might not be able to make a commitment to new goods until older goods are sold, or at least forecast to be sold. It generally involves a great deal of guesswork.

This dynamic remains a particular problem for Target, which finds itself overloaded with inventory heading into fall and winter.

The chart below illustrates the problem. Target ended July with $15.3 billion worth of inventory on the books, which is a record. Though inventory as a percentage of sales pulled back from the first quarter's 60% to 59% as of the end of the second quarter, that's still unusually high at the midpoint of the year. Prior to the pandemic, Target's second-quarter inventory levels were generally closer to 50% of second-quarter revenue.

Target's inventory levels are still oddly high after Q2.

Data source: Thomson Reuters. Chart by author. Sales and inventory data is in millions of dollars.

It's a worry for two simple and connected reasons: Target is still holding too much decreasingly marketable merchandise, which in turn is limiting the procurement of goods that will be marketable during the next few months.

Not only is the market for apparel on the verge of sweeping change (out with swimwear, in with sweatshirts), but we're also on the verge of the all-important holiday shopping season. Much of that merchandise has already been ordered, but those orders have already been capped by the relatively thin "open to buy" levels resulting from the first quarter's (and now the second quarter's) heavy in-store inventory levels.

And if the retailer can't shed enough of what it's sitting on now, what little buying flexibility it can use to get fresh goods into its stores before the end of the year will disappear within the next few weeks.

The ultimate risk is indefinitely crimped profit margins.

High inventory levels and heavy markdowns are taking a toll on Target's gross profits.

Data source: Thomson Reuters. Chart by author.

This could take a while

The situation isn't insurmountable for Target, but it's not instantaneously solvable, either. It could take several quarters to steer inventory levels back down to near 50% of sales, on average.

Once Target's buyers' options become limited because goods are moving too slowly, it makes it tougher to get enough of the right merchandise to generate much-needed cash flow to expand open-to-buy budgets. Doing so could require making pricing decisions on one product (also called a stock-keeping unit [SKU]) at a time, and then keeping close tabs on sell-through rates for that SKU at those prices. That's a tall, complicated order, but it's what must be done.

Until then -- until each quarter's inventory/sales ratios start to look more like their pre-pandemic levels -- Target stock is tough to own. You might be better served by stepping into other prospects in the meantime.