Investors weren't thrilled with the latest operating update out of Target (TGT -0.54%). While the retailer made progress in its turnaround plan, management warned that it might be at least another year before the business can fully recover in key areas like profitability.
The stock's returns in the meantime will depend on how well Target does at expanding market share and investing in growth initiatives -- all while staying conservative in its inventory purchase plans. Let's take a closer look at where the business seems to be headed in 2023.
Signs of progress
Target's late-February announcement showed encouraging growth trends through late January. Yes, sales growth remained muted through the holiday season. Target's comparable-store sales rose by less than 1%, compared to over 8% for Walmart and 7% for Costco. Shoppers are more focused on staples right now, and less interested in many of Target's more discretionary categories like home furnishings.
Yet Target managed higher customer traffic even on top of big gains a year ago. Management estimates that the company gained market share in each of its five core sales categories, despite declining sales in some areas. "We're pleased that our business delivered [comp] sales growth, in what continues to be a very challenging environment," CEO Brian Cornell said in a press release.
Prepping for a margin rebound
Investors saw no progress in moving Target's profit margins back toward the 8% of sales that the company achieved in 2021. Instead, operating profit fell below 4% for the full 2022 year. That slump is likely the single biggest factor behind the stock's underperformance in recent months.
TGT Operating Margin (TTM) data by YCharts
There are reasons for cautious optimism here, too. Target's inventory levels are much improved today after the company slashed prices in the second half of 2022. These discounting pressures should ease throughout the new fiscal year, and management is predicting that operating margin could rebound to as high as 5% of sales in fiscal Q1.
In the context of rising customer traffic, Target's 3% inventory drop confirms that it is determined to avoid a repeat of last year's markdowns. "We're pleased that we entered the year in a very healthy inventory position," Cornell told investors.
The stock's path
Bullish investors can cite Target's customer loyalty, light inventory levels, and rising margins as major factors likely driving the stock higher in 2023. Yet management says it might be several years before operating margin returns to the 6% rate that the company had achieved before the pandemic -- let alone if it will ever again climb back toward 9% of sales.
As a result, the stock isn't likely to trounce the market over the short term, especially not when peers like Costco are growing more quickly and delivering steadier earnings.
Target demonstrated with its last report that it remains highly relevant in the retailing industry. The company has a good shot at boosting profits in 2023 and continuing to push annual sales above $110 billion, compared to $106 billion in 2021. Yet shares will stay pressured as long as there are big questions around its base level of profitability.
