Like every other retailer out there, Target (TGT -0.32%) hasn't been immune to the unfavorable macroeconomic environment. Inflationary pressures are hurting consumers' ability to spend. And inventory issues have resulted in unusually higher levels of markdowns. Shares are essentially flat over the past 12 months. And as of this writing, they are down 43% from their all-time high.
What should investors do with Target stock? Is it a buy, a sell, or a hold? Let's take a closer look at the retailer's latest earnings, as well as some other important factors, to come up with an educated course of action.
Beating analyst estimates
Target's fiscal 2023 first quarter ended on April 29. During the three-month period, the business saw its total revenue increase by just 0.6% on a year-over-year basis. Same-store sales, measuring revenue from stores open at least 13 months, were up by only 0.7%. This was the sixth straight quarter that the revenue increase decelerated.
That shouldn't be much of a surprise, given the economic situation that is forcing consumers to watch their spending. Target is seeing a focus toward higher sales of more essential items, like groceries, and less on discretionary sales, like apparel. At a time when a potential recession is on the horizon, and consumer confidence is at historically low levels, all retailers are hurting.
During the quarter, Target's operating margin contracted slightly to 5.2% compared to last year. Greater investments in pay and benefits and general inflationary cost pressures were to blame. This resulted in diluted earnings per share declining 4.8%.
An important positive sign was that Target's inventory balance, now at $12.6 billion, decreased both year over year and sequentially. As a result, the company saw an improvement in its gross margin thanks to lower promotional activity, as management continues to focus on improving the merchandising mix.
Target maintained its full-year 2023 guidance, with the expectation that same-store sales will come in between a low-single-digit drop to a low-single-digit rise, reflecting the heightened uncertainty. Management also guided diluted earnings per share (EPS) to come in at $8.25 (at the midpoint), which would be a huge jump. Nonetheless, it is still going to experience a difficult operating environment.
Looking at the bigger picture
Besides analyzing Target's most recent financials, which highlight its struggles, it's important to zoom out to understand some more pressing topics as it relates to the business from an investment perspective. For starters, I'd argue that Target doesn't really have a competitive advantage, one of the most critical factors to look for when finding stocks to invest in.
As of April 29, Target had almost 2,000 stores nationwide. And it did $109 billion in trailing -2-month overall sales. This is a sizable retailer, to be fair. But look at who Target competes with. It has to deal with behemoths like Amazon and Walmart, for example, places where most consumers probably start their shopping journeys. These two bigger rivals likely benefit from greater economies of scale than Target does.
Moreover, the company's growth outlook is not impressive. Target's fiscal 2022 revenue was up 40% compared to its pre-pandemic, fiscal 2019 figure. That's a tremendous gain, but I'd wonder how much growth there is going forward. Wall Street predicts just 3.2% annualized revenue gains over the next five fiscal years.
If a generous capital-allocation policy is what you're into, owning Target might make sense. The company has paid a consistently increasing dividend since 1967. And over the years, it has done a good job at repurchasing shares. This can only happen when a business generates lots of free cash flow.
Paying a premium valuation
Because Target's margins and earnings have been under immense pressure in recent quarters, at the same time that the stock hasn't performed well, the valuation has soared. Target's current price-to-earnings ratio of 25 is up significantly from about 12 in June of last year. And its average P/E over the past five years is 18.
What this means for investors is that they are being asked to pay a historically expensive valuation for a business that has struggled over the past year and likely will continue to deal with challenges in the near term. This doesn't seem like a worthwhile investment opportunity to me. As a result, I think it's best to avoid the stock.
