Big-box retailer Target (TGT -0.54%) is having a tough year as profits are down, inventory levels are high, and the stock is down close to 30% year to date. There aren't many reasons to invest in the retail stock right now as it faces some big challenges ahead.
Management, however, is optimistic that things are improving and the business is on the right track. Should you invest in Target today, or are you better off waiting until next year to see if the stock is a better buy then?
Inventory remains elevated but management isn't worried
Due to supply chain issues, many retailers have been struggling with high inventory levels. Inventory that is just sitting around means more costs for the business and space that's taken up by an older product rather than a newer one which may be easier to sell.
As of Oct. 29, Target's inventory balance was $17.1 billion -- 14% higher than what it reported a year ago.
TGT Inventories (Quarterly) data by YCharts.
However, on the company's third-quarter earnings call, Chief Operating Officer John Mulligan said that
inventory is in a much healthier position than earlier in the year because of the heaviness you're seeing today is due to the early arrival of fresh inventory we are planning to sell.
That is positive news, but as seen in the chart above, even in previous years when there has been a spike in inventory heading into the holidays, inventory has never been as high as it is now. This puts immense pressure on the business to move a lot of that product out quickly, and that can mean significant discounts and poor margins -- again.
In Q3, the company's net earnings of $712 million were just 2.7% of the $26.5 billion in revenue that Target reported.
TGT Profit Margin (Quarterly) data by YCharts.
Target's margins continue to struggle and Chief Financial Officer Michael Fiddelke hinted at the challenge it faces, saying that the company expects "greater markdown pressure from Q4 promotions, given the increase in price sensitivity our guests have shown recently." And so, whether inventory is new or old, it may not necessarily be a breeze to move it.
But there's at least some good news to suggest better days could be ahead for the business in 2023.
Costs could come down next year
A positive development in Target's favor is that the cost of global shipping has improved as container rates recently declined by one-third. And Target still expects rates to come down even further, with prices remaining three times what the company was paying in 2019.
The company anticipates that it will begin to benefit from that next year as it renegotiates its shipping contracts, and that can help bring some of its costs down. However, that only improves costs for inventory the company still has to ship, but it doesn't help with the inventory that's still in the company's stores today.
Is Target a buy?
Shares of Target are currently trading at 23 times the company's trailing profits, which is higher than its five-year average of 17. The risk is that in future periods, if the inventory problem doesn't improve, its earnings numbers could worsen, making Target look like an even more expensive buy.
There is no compelling reason to buy the retail stock today as doing so could be a risky move. While the company maintains the inventory it has on hand is fresh and should be easier to move, Target still has to prove that it can do that.
And that's a tall task given just how much inventory it has. Perhaps in a normal year it could be doable, but with rising costs and consumers cutting back on spending, I would wait to see the results come in rather than rely on the hopes of management.
Target will eventually come out from under these problems, but it can still be a bumpy road ahead -- one that I wouldn't want to join the company on. Investors are better off waiting to see how the company is doing in 2023 before deciding to buy shares of Target.
