Down 30% in 2022, Is Target Stock a Buy?

Target (TGT -0.70%) was once considered a stable blue chip stock for conservative investors. It's one of the largest brick-and-mortar retailers in America, it survived the rise of Amazon and the subsequent "retail apocalypse," and raised its dividend annually for more than half a century.

But this year, Target's stock has declined by more than 30% as it grappled with tough macroeconomic headwinds. Does that steep pullback represent a good buying opportunity for long-term investors -- or is it still too early to pull the trigger?

Why was Target a reliable investment?

Target's stock closed at an all-time high of $260.85 last November. At the time, investors were impressed by its robust comparable-store sales growth, stable gross margins, and expanding operating margins.

Data source: Target.

Target's e-commerce investments also paid off during the pandemic as its digital sales soared. As a result, its total comps growth accelerated, even as other retailers struggled with store closures and sluggish sales. 

Target also increased its store count from 1,844 in fiscal 2018 to 1,926 in fiscal 2021 (which ended in January 2022), as other retailers shuttered more brick-and-mortar stores to cut costs. It then leveraged that massive network of stores -- which are located within 10 miles of most customers in America -- to fulfill its online orders, same-day deliveries, and in-store pickups. That strategy enabled it to keep pace with Amazon without making massive logistics investments.

Why did Target lose its footing this year?

However, Target's growth throughout the pandemic, which was partly boosted by stimulus-induced spending, set it up for tough post-pandemic comparisons. That slowdown was already challenging, but inflationary headwinds and supply chain challenges exacerbated that pressure over the past year. 

Inflation hurt Target in three ways: It throttled consumer spending on discretionary products, boosted the company's freight costs, and pressured it to raise wages. Supply chain disruptions then prevented Target from stocking up on the right products, which coincided with its decelerating sales of bulkier products like kitchen appliances, televisions, and outdoor furniture.

These headwinds caused Target's inventories to jump 36% year over year to $15.3 billion in the second quarter of fiscal 2022. But total sales only increased 4% year over year to $50.5 billion in the first half of the year, driven by 3.3% and 2.6% comps growth in its first and second quarters, respectively. The company expects total revenue to only rise by the low- to mid-single digits for the full year, compared to its 13% growth in fiscal 2021.

It's a red flag if a retailer's inventories are rising faster than its sales. To restore that balance, Target must flush out its unwanted inventories with margin-crushing markdowns. That's why its gross margin shrank 670 basis points year over year to 23.5% in the first half of fiscal 2022 as its operating margin declined 650 basis points to 3.3%. It expects operating margin to stabilize and end the year at around 6% -- but that would still represent a 240 basis-point drop from 2021.

Based on these downbeat expectations, analysts believe Target's revenue will increase just 4% for the full year as its adjusted earnings plunge 41%. But next year, they expect the company's revenue and adjusted earnings to grow 4% and 48%, respectively, as it overcomes inventory problems.

Is Target too cheap to ignore?

Target isn't in the same sinking boat as struggling retailers like Bed Bath & Beyond or Kohl's. Its comps are still rising, it's firmly profitable, and it can easily cover its dividend. But its valuation also got a bit ahead of its growth rates last year, and the company couldn't live up to those expectations as growth cooled off this year.

But after that pullback, Target's stock now looks cheap at 13 times forward earnings, and it pays a forward dividend yield of 2.8%. Walmart -- which faces many of the same near-term inventory challenges as Target -- trades at 20 times forward earnings and pays a much lower forward yield of 1.7%.

Target is still a retail survivor, and I believe its growth will stabilize over the long term as it moves past all the near-term lumpiness from the pandemic, stimulus checks, supply chain issues, and inflation. Its stock won't blast off over the next few quarters, but its low valuation and attractive yield should make it a safe stock to own as the bear market drags on.