It hasn't been an enjoyable few years for Target (TGT 0.18%) investors. After seeing the stock soar over 80% between Jan. 1, 2020 and Dec. 31, 2021, they have now watched it fall over 50% from its all-time high. It is now hovering around a three-year low. Does that make it a buy? Or could results worsen further?
Let's dive into key points and concerns from the company's recent earnings call and detail some encouraging signs for the retailer going forward.
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Ephemeral exuberance
The main reason why Target stock set all-time highs in 2021 was because the results were too good to ignore. 2019 was a record year for Target. It booked an impressive $6.36 in diluted earnings per share (EPS) and had an operating margin of 6.4%.
When the pandemic hit in 2020, it seemed doubtful Target could top its 2019 results. But a boom in consumer spending, especially on discretionary goods which Target makes high margins off of, pole-vaulted Target to a new record high with $8.64 in diluted EPS and an even better 7% operating margin.
Then, Target blew the roof off with $14.10 in diluted EPS and a whopping 8.4% operating margin in 2021, more than double the earnings of Target's then-record 2019. It was a moment in the spotlight for Target, which seemed to have everything going for it -- a strong brand that successfully leaned into e-commerce and curbside pickup paired with a recovering economy.
TGT EPS Diluted (Annual) data by YCharts.
But Target fumbled supply-chain challenges and misread consumer trends by bulking up on inventory, two costly mistakes that produced one of the worst drop-offs in performance in retail history when Target booked just $5.98 in diluted EPS in 2022 and a 10-year low operating margin of just 3.5%.
The reason the operating margin was so low is that Target had to steeply discount items to move products off the shelf and reduce its inventory. It was a painful and frankly embarrassing period for Target that evaporated all of the exuberance that investors felt over the past few years.
Turning the corner
The good news is that Target admitted its mistakes and has since drastically reduced its inventory and improved its operating margin and its earnings. Target's operating margin for the recent quarter was 4.8%, which isn't where Target wants to be long term, but it's still a meaningful improvement from last year.
It's also guiding for full-year adjusted EPS of $7 to $8. Again, that's far lower than Target's record 2021, but ahead of Target's prior record in 2019 of $6.36. Considering all of the challenges Target is dealing with, this number seems just fine.
When asked about consumer-spending trends on its Q2 2023 earnings call, Target management made it clear that while its customer base is loyal, there has been a continued shift toward less consumer-discretionary spending. Target's COO John Mulligan said the following on the call:
As [consumers] think about discretionary spending, we've seen a rotation in their wallet from goods into services. You're seeing the uptick in travel, in leisure, what's happening in entertainment. So, those trends we expect to continue into the back half of the year, we'll watch it carefully. I think our inventory position allows us the ability to chase into demand and we'll be ready when we see demand changing as we enter the holiday season. But I think the consumer is still taking a very cautious approach to discretionary spending in the goods sector.
Christina Hennington, Target's chief growth officer, noted that customers are pivoting from discretionary items to what the company calls its frequency businesses, which are lower-margin, more regular purchase items like consumer staples.
Target has made its strategy clear. If there's a surprising pickup in consumer spending, it's going to have to play catch up with its inventory. But if there's a prolonged period of muted spending, or if the economic situation gets even worse, it will be in an excellent position because its inventory is lean.
In sum, Target has turned its business around and is cautiously optimistic, but it's also refusing to get burned by overestimating the strength of the consumer like it did in 2022.
Target stock is a buy
Investors in well-known, established, and trusted companies like Target want to see consistency. For Target, consistency means steady earnings growth that makes the company more valuable (and in turn its stock) paired with a growing dividend.
The worst seems to be over for Target. The company is in a good position to build from here and can easily pivot if consumer spending improves instead of backpedaling at the expense of its margins.
With a 3.4% forward-dividend yield and reasonable valuation, Target stock seems like a safe buy now.
