Big-box retailer Target (TGT 0.18%) was dealing with excessively high inventory numbers earlier this year, to the point the company had to slash prices to get product moving and out of its doors. This past quarter, the company dealt with the fallout of that; its margins took a big hit, as well as the bottom line.
Unfortunately, inventory levels remain high, and the company may not be out of the woods just yet. Is Target a stock that's in trouble, or does its steep 30% decline this year make it an attractive buy on the dip?
Sales growth could be misleading
Last week, Target released its second-quarter earnings numbers. For the period ending July 30, the company's sales totaled $26 billion and rose 3.5% year over year. Comparable store sales, however, grew at a rate of only 1.3%.
While that may seem encouraging amid rising inflation, the problem is that these numbers were aided by "countless promotions and markdown programs to move the excess merchandise quickly." The risk here is that without the significant markdowns, it's possible that what little growth the company generated into the second quarter could well have evaporated. The company, however, maintains that its revenue will grow in the low-to-mid single digits this year, based on "current trends."
Margins were squeezed but are improving
In addition to modest sales numbers, the company's profits took a hit, with its operating margin a minuscule 1.2% of revenue in Q2. The gross margin of 21.5% was also noticeably thin compared to 30.4% in the year-ago quarter. Markdowns and inventory impairments weighed on cost of goods sold. As a result, the company's earnings totaled just $183 million -- down 90% from $1.8 billion in the prior-year period.
Target expects its numbers to improve in the latter half of the fiscal year, projecting that its operating margin will bounce back to around 6%, which would be in line with its five-year average.
TGT Operating Margin (Quarterly) data by YCharts.
However, this could still be a bit of a rosy outlook given that Target has lots of inventory on its books, and it may require more markdowns than the company is anticipating. Plus, inflation remains problematic for the economy, and while consumers still appear to be spending, as credit card limits rise, there could be more pressure for people to tighten their budgets as the year goes on.
TGT Inventories (Quarterly) data by YCharts.
Is Target stock a buy at its reduced price?
Target's struggles aren't over, and the company could continue to face a challenging back end of the year. Investors shouldn't forget this was the company that, within a month of projecting an operating margin of 5.3% in Q2, downgraded that forecast to just 2%.
Admittedly, these are short-term problems, and over the long haul, the inventory and supply chain issues will resolve themselves. The good news for long-term investors is that they can now buy Target at a reduced price, with the retail stock now down nearly one-third of what it was when the year started. However, at a forward price-to-earnings (P/E) multiple of 19, it's trading slightly higher than the average stock on the S&P 500, which averages a forward P/E of 18.
I wouldn't call the stock a deal right now. And given that the worst may not be behind Target just yet, investors may be better off waiting for another quarter to see how it does as its share price could continue to fall even lower.
