Target (TGT 0.18%) shareholders have some good reasons to feel better about their business heading into the holiday shopping season. The retailer managed to protect its profit margins despite a difficult selling environment in 2023. Even as shoppers reduced spending in many of its core categories like home furnishings, Target's earnings and cash flow remain strong.
The news isn't as good around customer traffic trends, which worsened in the most recent quarter. Let's take a closer look at that red flag in the context of Target's wider business.
Target is seeing fewer shoppers
Customer traffic was down 5% year over year in the Q2 selling period that ran through late July, and that slump was the main factor behind Target's surprising 5% drop in comparable-store sales. Comps were flat in the prior quarter and customer traffic was up 1%, meaning trends worsened through the early summer months.
The good news is Target isn't alone in reporting weaker demand for consumer discretionary products. Shoppers are tilting spending away from these categories and toward essentials like groceries, as Costco (COST 1.01%) and Walmart have noted in their recent earnings reports.
But Target's traffic performance still looks poor compared to several large retailing peers. Costco and Walmart both grew traffic last quarter. Home Depot's traffic trends improved to a 2% decline in Q2 from a 5% decrease in Q1. Costco returned to growth in its e-commerce segment, while Target's digital sales were down a painful 11%.
The good news for Target
It isn't all bad news heading into Target's biggest selling period of the year. Management said in a conference call with investors that traffic trends picked up just as the Q2 period was closing. "We saw a meaningful recovery in both traffic and comps in July," CEO Brian Cornell said.
And the chain isn't approaching the holidays with bloated inventory holdings, either. Inventory was down 17% last quarter, including a 25% drop in the consumer discretionary categories that see weaker demand these days.
These declines make it less likely that Target will have to engage in lots of promotions and price cuts to keep inventory moving. Investors are already seeing signs of this light inventory strategy paying off. Target's gross profit margin rose last quarter and operating profit margin held steady at 5% of sales despite the pressure from weaker demand trends.
Looking ahead
One risk to this strategy is that Target could be contributing to the weak demand trends by offering such a slim selection in categories like furniture and apparel. Low inventory might leave the retailer unprepared for rebounding demand, too, causing it to miss out on sales during the Q4 period.
The company will report its Q3 results in November, and investors will be watching that announcement closely for signs of these weaknesses. Target has issued an unusually large sales forecast range for the full year, reflecting plenty of uncertainty around demand trends into early 2024.
Investors might feel tempted to take advantage of that uncertainty to pick up shares at a big discount right now. However, it might make more sense to watch the next quarterly update for signs of stabilizing customer traffic trends before jumping into this retailer's stock.
