Retailer Target (TGT 1.03%) is making progress in working through its post-pandemic hangover. The company aggressively used discounts last year to clear out inventory, knocking down its profits in the process. Earnings per share (EPS) plunged nearly 60% in 2022, even as sales edged higher.
While overall inventory was down just 3% year over year at the end of 2022, inventory in discretionary categories was down 13%. With an unpredictable economy, sky-high inflation, and rising interest rates putting pressure on consumers, Target is positioning itself to ride out the storm by focusing on food, beverage, beauty, and household essentials.
The retailer expects the picture to improve in 2023, although the days of heady sales growth are over for now. Target expects comparable sales to be roughly flat this year, plus or minus a few percentage points. With much of the inventory-related pain behind it, the company guided for a significant improvement to the bottom line. Per-share profit is expected to come in between $7.75 and $8.75, compared to $5.98 in 2022.
Not exactly a bargain
In the longer run, Target sees a path to taking its profitability beyond pre-pandemic levels. The timing is hard to predict, given the state of the economy and consumer spending. But Target sees its operating margin reaching 6% as early as fiscal 2024 and exceeding that level over the next three years.
Let's say Target succeeds. Based on its current annual revenue of about $108 billion, an operating margin of 7% would yield operating income of roughly $7.5 billion. Remove interest payments and apply the company's current tax rate, and you're left with a net income of approximately $5.7 billion. That works out to an EPS of about $12.30.
Right now, Target stock trades for $170 per share. Based on the company's earnings guidance for 2023, the stock certainly doesn't look cheap. The price-to-earnings ratio sits right around 20, which seems high for a retailer that's going to struggle to grow sales for the time being.
The situation gets a little more interesting if you think about the best-case scenario. If Target does hit its profitability goal and comes close to generating the EPS target based on a 7% operating margin, the price-to-earnings ratio will fall to about 14.
That doesn't seem so bad, but the world has changed since stocks were booming in 2020 and much of 2021. Investors looking for safe bets have far better options today than they had even a year ago. When you can buy a six-month U.S. treasury bill and get 5% interest, buying shares of a growth-challenged retailer in a tough economy at 20 times forward earnings and 14 times multiyear, best-case-scenario earnings isn't all that appealing.
A mixed digital story
None of this is to say that Target can't be a great long-term investment, but your definition of long-term probably needs to be more than a few years. The company has made incredible progress in transforming itself into an omnichannel retailer. Around 10% of its revenue now comes from same-day services, including pick-up and delivery. In some ways, Target is winning on convenience against its online-only competitors.
While demand for same-day services is still strong, with sales up 4.3% year over year in the fourth quarter, overall digital sales slumped 3.6%. Some of the digital growth Target enjoyed during the pandemic is now unwinding, and it's impossible to know where things will settle.
While shares of Target have tumbled from their pandemic-era high, the stock doesn't look like a particularly good deal. The retailer is facing a lot of challenges, and there's no guarantee it will reach its profitability goals anytime soon. I'll be on the sidelines for now as Target muddles its way through a very difficult retail environment.
