Target's (TGT -0.38%) fiscal first quarter wasn't everything shareholders were hoping for. Neither was its second-quarter outlook. The retailer topped Q1's earnings estimates, but sales were flat, and the current quarter's top and bottom lines should be lackluster. The company cites increasingly cautious consumers as the cause of the headwind.
It's not all bad news, however. The company made important progress on one key front: inventory. It's no longer sitting on a mountain of the wrong merchandise, and therefore is no longer taking big markdowns to get rid of it.
Two pictures tell the tale.
Target is on the mend in one crucial way
As a refresher, retailers were counting on a swell of retail spending coming out of the COVID-19 pandemic funk in 2022. Most of them loaded up on inventory, in fact, in anticipation of that sales surge. They got it -- but the spending spree fell well short of expectations.
As a result, many of the industry's biggest names, including Walmart and Target, were headed into the latter half of last year with way too much of the wrong merchandise. Deep discounting and limited purchasing liquidity took clear tolls on bottom lines (which is a particular problem for retailers, most of which fight just to maintain paper-thin profit margins). Even following semi-successful clearing-outs of aging inventory during the final quarter of 2022, it still wasn't apparent that these companies were back to normal.
Now it seems obvious that at least Target is out of the woods.
Take a look. Last quarter's top line of $25.3 billion is right in line with the year-ago figure of just under $25.2 billion. However, inventory levels fell from nearly $15.1 billion back then to $12.6 billion as of the end of April.
This shift pulled the company's inventory/sales ratio down from 60% in the first quarter of 2022 to only 50% for the first quarter of 2023. That's in line with pre-pandemic norms headed into the second quarter of the year.
Data source: Thomson Reuters. Chart by author. Revenue and inventory figures are in millions of dollars.
That's not the most encouraging part of the story, though. Better still is the fact that Target has been able to shed this decreasingly marketable merchandise without continuing to mark it down.
That's what the graphic below shows us. Last quarter's gross profit margin rate of 28.4% is a far cry from Q2 2022's low of 20.4%. Net profit margins of practically nil then have bounced back to 5.4%. That's actually better than the chain's typical net profit margin rate prior to the pandemic:
Data source: Thomson Reuters. Chart by author.
Lots of upside left to recapture
There's still work to be done: Target needs to revive sales growth. The top line only improved by 0.5% year over year during Q1, and same-store sales growth of 0.7% wasn't much better. Same-store sales for the quarter underway will likely increase at a low-single-digit rate. Full-year revenue is expected to be flat, although the company concedes its 2023 top line could also fall by low single digits.
Of the all the potential problems for a retailer to have, however, too much of the wrong inventory can be the biggest and costliest headache. It not only takes up valuable store space, but also prevents the company from buying more goods that could be sold at higher margins. Moreover, the longer an item is on a shelf, the more likely it is to be damaged, spoiled, or stolen.
Despite the sales headwind that's now blowing, Target is looking for operating income growth of more than $1 billion this year. That should pump up per-share profits to a range of between $7.75 and $8.75, well up from last year's bottom line of $6.02 per share.
The stock edged a little higher on Wednesday following the release of its first-quarter results. It's still down 40% from 2021's high, however. The market's not fully pricing in how well the retailer's pushed past its inventory problems. And the stock's current price doesn't reflect Target's unique status as an upscale discounter.
