Target (TGT -0.70%) has transformed itself over the last decade, going from a middling big-box chain to a unique omnichannel retailer with a number of competitive advantages.
The company has invested in store-based fulfillment, coaxing customers into picking up their online orders, which is a more cost-effective way of fulfilling them than shipping from warehouses. It's also excelling with its private-label owned brands, which helps distinguish the retailer and increase customer loyalty.
Consequently, the stock has been a big winner over the last decade, but more recently it's struggled as shopping habits have shifted back to services and the company has struggled to manage its inventory.
So is Target a buy today? Let's hear what a bull and a bear have to say about it.
Image source: Target.
Target is selling at an attractive valuation
Parkev Tatevosian: Admittedly, Target's business is in a precarious position after the economic reopening. The company thrived in the earlier stages of the pandemic as folks had more money and fewer places to spend it. Unsurprisingly, sales exploded by 19.8% in Target's fiscal year 2021. That was a substantial increase for a company that had not experienced revenue growth of over 3.7% in the seven years prior.
TGT Inventories (Quarterly) data by YCharts
Indeed, Target could barely keep up with the soaring consumer demand. Management tried to avoid the constant shortage of things to sell by ramping up inventory levels. Unfortunately, as Target's inventory started arriving in stores, consumer behavior rapidly changed. Economies reopened, and people wanted to eat at restaurants, travel, and visit theme parks. Target's inventory sat on shelves, and management decided to slash prices and offer promotions to work through the things people no longer wanted with the same enthusiasm.
Thankfully, Target has made excellent progress on that front. Target's operating profit margin decreased to 3.7% in its quarter that ended in January, down from 6.5% in the same quarter the year before, as the promotions went into effect.
TGT PE Ratio (Forward) data by YCharts
Besides the slight error in inventory, Target has done an excellent job managing the business over the last several years. The company rolled out fulfillment options like buy online and pick up in a Target parking lot, which proved popular with customers. And the headwinds rising from inventory troubles have Target stock selling near its cheapest valuation all year, at a forward-price-to-earnings ratio of 18.96.
The problems may not be so temporary
Jeremy Bowman: Target's management, led by CEO Brian Cornell, has made a lot of good decisions over the last decade, but last year was an exception. The retailer was plagued by excess inventory, poor merchandising decisions, and a consumer shift in spending away from the discretionary categories that tend to be the company's bread and butter, like apparel, home goods, and toys.
Looking ahead to 2023, Target expects some improvement in operating margin as it's brought inventory more under control, but the company still sees more challenges than it anticipated just a year ago, and the challenges in the broader economy with a bank crisis swirling could spoil any hopes for a comeback this year.
Despite its smart strategic moves, Target is ultimately beholden to consumer demand, and that could make 2023 difficult as it doesn't enjoy the benefits of a large grocery business the way Walmart and Costco Wholesale do.
For example, Target's comparable sales rose just 0.7% in its fourth quarter, effectively a decline in a high-inflation environment. Management said that comparable sales would be flat for the current year, and expects to see some operating margin improvement with a goal of steadily driving operating margin to above its pre-pandemic level of 6% over the next few years.
However, the company will need the economy to recover in order to achieve its goals, and investors may be overestimating the economic recovery.
While I think Target still has long-term growth potential, 2023 seems likely to be another tough year for the retailer, and the stock isn't cheap at a price-to-earnings ratio of 20 based on this year's earnings estimates. Investors may want to take another look when the economy is on the mend.
