Most stocks are up significantly from their 52-week lows as stocks surged through the first half of the year, but one well-known retail stock is getting left behind: Target (TGT 1.08%). The multi-category retailer just hit a new 52-week low, sinking to its lowest point in more than three years.
It's understandable why the stock is plumbing new depths. Consumer spending has shifted away from discretionary goods toward services such as travel and necessities such as food and gas.
Target is also experiencing record losses resulting from theft, forecasting a shortfall of $500 million this year from "shrink," and it faces other operational woes such as rightsizing inventory following its heady growth during the pandemic. All of those challenges have eaten into its profit margins.
The stock currently trades at a price-to-earnings ratio of 16. While that may not be dirt cheap, it's still a significant discount to the S&P 500, which is currently valued at a P/E of nearly 25, and Target's earnings look temporarily suppressed.
Here are a few reasons Target is worth scooping up at a discount.
Image source: Target.
The economy is beginning to look up
Unlike peers such as Walmart and Costco Wholesale that bring in most of their revenue from groceries, Target is primarily dependent on discretionary goods, making it more sensitive to the economic cycle. Consumers are less likely to buy things like a new swimsuit, kitchen gadgets, or toys when they're worried about inflation and a potential recession.
However, it looks increasingly as if those fears are fading away. The labor market continues to add jobs, and the Federal Reserve just significantly improved its forecasts for GDP growth and unemployment, essentially saying it believes a recession won't happen. Fed Chair Jerome Powell also noted that consumer spending has continued to be strong, driving economic growth.
Even if the Fed's forecast is accurate, it will take time for the macroeconomic consumer confidence to improve, but a recovery could arrive sooner than investors seem to think.
Target's competitive advantages remain
The challenges Target is facing are mostly temporary in nature. Consumer spending has shifted away from its highest-margin categories, and post-pandemic growth has been sluggish following an earlier boom. The stock isn't down because it's losing ground to a competitor or because long-term demand is moving away from it. It's struggling in the current economy and adjusting to lower demand levels.
But Target's core strengths are very much intact. It has a broader reach than any other multi-category retailer, with stores in urban, suburban, and rural areas, and in all 50 states. It also operates both small-format stores and big-box supercenters, allowing it to flex up or down depending on the community it's serving.
Its same-day fulfillment capabilities are unmatched, and the company has leaned into store-based fulfillment, which produces higher margins than using distribution centers, as Walmart and Amazon do.
Finally, its owned-brands strategy is also paying off, as the company now has at least 10 individual brands that generate $1 billion or more in sales. Exclusive brands drive higher margins than national brands, help distinguish the retailer from competitors, and create brand loyalty.
Profit margins should improve
While Target's operating margins have started to recover from their depths during 2022 when higher-than-normal inventory levels squeezed profits, there's still a lot of room for improvement. The company posted an operating margin of 4.8% in the second quarter, compared with a range of around 6%-7% during pre-pandemic times, and its gross margin was 27%, whereas it hovered around 30% in prior years.
Target continues to expect comparable sales to decline for the duration of the year, but sales will eventually recover as the economy strengthens and consumer spending shifts back from service categories such as travel and restaurants that were off-limits during the pandemic.
At its analyst day conference earlier this year, the company said it was targeting a 6% operating margin as early as next year, and it expects the operating margin to top 6% over the next three years.
Meanwhile, Target is still adding new stores, showing that it sees an opportunity for growth in both physical retail and e-commerce, and the company is a longtime dividend payer, currently offering an attractive dividend yield of 3.6%.
Target's recent results aren't going to impress anyone, but that's what makes the stock attractive. The retailer has the ability to generate significantly higher profits than it is right now. If it executes better on inventory management and theft prevention, and demand starts to recover in discretionary categories, the stock could be significantly higher in a year or two.
