Target's (TGT -0.70%) stock tumbled 13% on Nov. 16 in response to the retailer's third-quarter report. Revenue rose 3% year over year to $26.5 billion, clearing analysts' estimates by $120 million, but its adjusted EPS plunged 49% to $1.54 and missed the consensus forecast by $0.64.
Target has now shed more than 40% of its value over the past 12 months amid concerns regarding its slowing growth, rising inventories, and shrinking margins. But could this painful pullback actually represent a promising buying opportunity?
Image source: Getty Images.
Were Target's third-quarter numbers that bad?
Target's growth accelerated significantly during the pandemic as shoppers flocked to its stores to stock up on household products. Digital sales, which were supported by its timely e-commerce investments, also skyrocketed. Comparable store sales rose 19.3% in fiscal 2020 (which ended in Jan. 2021) and increased another 12.7% in fiscal 2021.
However, that robust growth set Target up for some tough year-over-year comparisons after the pandemic ended. That deceleration was exacerbated by soaring inflation, which curbed consumer spending on discretionary items, as well as supply chain disruptions, which prevented it from quickly refreshing its inventories. As a result, Target's comps growth decelerated, its margins declined, and its inventory levels soared over the past year.
|
Metric |
Q3 2021 |
Q4 2021 |
Q1 2022 |
Q2 2022 |
Q3 2022 |
|---|---|---|---|---|---|
|
Comps Growth (YOY) |
12.7% |
8.9% |
3.3% |
2.6% |
2.7% |
|
Gross Margin |
28% |
25.7% |
25.7% |
21.5% |
24.7% |
|
Operating Margin |
7.8% |
6.8% |
5.3% |
1.2% |
3.9% |
|
Inventories Growth (YOY) |
17.7% |
30.5% |
43.1% |
36.1% |
14.4% |
Data source: Target. YOY = Year-over-year.
When a retailer faces slowing comps growth and rising inventories, it generally needs to use margin-crushing markdowns to generate fresh sales and clear out its excess merchandise. Executing those strategies too aggressively can trap the retailer in a cycle of markdowns, rising inventories, and store closures that eventually wreck its entire business.
During the third quarter, the slight acceleration in Target's comps growth, the sequential improvements in its gross and operating margins, and its decelerating inventories growth all indicate it isn't headed off a cliff yet. However, there's still a lot of work to be done before we can consider Target a turnaround play.
In the third quarter conference call, CEO Brian Cornell said Target continues to take "decisive inventory actions based on the rapid change in consumer buying patterns," and that its margins were still being squeezed by a "higher-than-expected mix of promotional sales," product shortages related to supply chain issues, higher freight costs, and a "significant increase in theft and organized retail crime" which prompted it to make "significant investments" in theft-deterrent devices.
Dim guidance and a poor comparison to Walmart
To top it all off, Target's guidance doused all hopes of a brisk recovery. Based on its "softening sales and profit trends that emerged late in the third quarter and persisted into November," Target expects its comps to decline by the low single digits in the fourth quarter and for its operating margin to slip sequentially and year over year to about 3%.
On its own, investors might attribute Target's grim guidance to inflation, supply chain issues, and other macro headwinds. However, Walmart (WMT 1.32%) recently posted a much stronger quarterly report that suggests that many of Target's problems are specific to the company. In the third quarter of fiscal 2023 (which ended in October), Walmart's U.S. comps (excluding fuel) rose 8.2%, with an operating margin of 4.9%. It expects its comps to rise about 3% in the fourth quarter. Walmart also didn't mention theft or retail crime as headwinds during its latest conference call.
Is Target too cheap to ignore?
Target is still in better shape than other struggling retailers like Bed Bath & Beyond and Kohl's. It's also a Dividend King that has raised its payout annually for 51 straight years, and it pays a decent forward dividend yield of 2.4%. Its stock also looks cheap at 14 times forward earnings. By comparison, Walmart trades at 22 times forward earnings and pays a lower forward yield of 1.5%.
However, investors also probably won't pay a higher premium for Target until it stabilizes its comps growth and margins. Therefore, it might be smarter to simply invest in Walmart -- which will likely face fewer headwinds than Target this holiday season -- than betting on Target as a turnaround play.
