The discount being offered for Target (TGT 0.18%) shares in 2023 might be getting out of hand. The retailer's stock is down 25% so far this year compared to a 14% increase for the S&P 500. That slump comes even as retailing peers like Walmart (WMT -0.08%) and Costco Wholesale (COST 1.01%) have stocks currently beating the wider market in 2023.
There are some good reasons for investors to be disappointed about Target's short-term outlook relative to its rivals. But a lot of that pessimism was already reflected in its lower valuation. Let's look at whether the stock's drop this year now makes it a good value -- or a value trap -- going forward.
The challenges for Target
The biggest knock against Target as a company right now is the fact that sales trends look weak compared to peers and have softened in recent quarters. Customer traffic was down 4% in fiscal Q2 (ended July 29), while Walmart and Costco each managed modest gains during their comparable quarters.
Target is still reeling from the sharp demand shift away from consumer discretionary products and toward staples like groceries. Its business is focused more on things like home furnishings and consumer electronics, retail segments that are shrinking in today's economy. While Walmart and Costco managed to maintain their growth rates because of continued demand for consumer staples products, Target's growth has slowed (or actually shrank).
Management's updated outlook for the remainder of 2023 calls for comps to fall by at least 5%. It's understandable that investors avoided the stock when growth trends are decelerating, especially as we approach the holiday shopping season.
Bright spots for Target
Part of that traffic decline can be blamed on a conscious decision by Target to cut costs. For example, the retailer scaled back on its inventory holdings in its consumer discretionary segment (down 25%). Target also scaled back on its sales promotions, boosting average prices. Those moves likely pressure customer traffic, as shoppers aren't finding as many reasons to visit its stores. But they also boost profitability.
TGT Operating Margin (TTM) data by YCharts
That's the key factor behind Target's ability to outperform management's earnings forecast last quarter even though sales trends were worse than expected. Operating profit margin improved to 5% of sales from 2% a year ago. Target's pre-pandemic margin, for context, was near 6%, while its peak profitability landed at around 8% of sales during parts of 2021.
It's good news for the business that the retailer can boost margins in this tough selling environment. And with inventory down, Target will be in a position to see a sharp rebound once the current cyclical slump ends.
Lower price means lower risk
Investors will learn a lot more about Target's prospects when the company announces fiscal Q3 results in the next few weeks. The stock's performance in recent weeks suggests that Wall Street is bracing for bad news, at least when it comes to customer traffic trends. Follow that key metric for signs that Target is on the rebound, or if instead there's more weakness ahead in store for 2024.
In the meantime, the stock's lower valuation has reduced a lot of the risk for investors. You can own shares for less than 0.5 times sales compared to Walmart's P/S ratio of 0.7 and Costco's ratio of 1.
Cautious investors will still want to watch the next earnings report before jumping into the stock. Yet if you don't mind the likely volatility, you might consider buying Target now. Uncertainty around the short term is generating some attractive prices for this retailing stock today.
