Target (TGT 0.18%) stock surged 17.1% on Wednesday after the company reported better-than-expected earnings. The retail giant is showing a lot of improvements, mainly in its profitability. However, its sales were down 4.3% compared to Q3 2022.
Let's discuss the good and the bad about where Target stands today, the status of its turnaround, and why Target and its 52 consecutive years of dividend increases make it a Dividend King worth buying and holding.
Prioritizing profits
Even after Wednesday's epic rally, Target stock is up less than 4% in the last three months, down 12.8% year to date, and down 50.8% over the last two years. The main driver behind Target's epic fall from grace is a lower operating margin, lower operating income, and a less profitable business.
Target's operating margin improved to 5.2% in Q3 compared to 3.9% in the third quarter. The retailer is heading in the right direction, but it is still a long way away from the 6% to 8% or so operating margin investors were used to before the COVID-19 pandemic.
Target's margins have taken a beating due to lower consumer spending on discretionary goods, inflation, supply chain challenges, and inventory mismanagement in 2021 and 2022, which the company has remedied this year.
Target's inventory was down 14% in Q3 compared to a year ago -- which is helping drive its improved profitability. And for a few quarters now, management has made it clear it is going to keep inventory tight even heading into the holiday season in anticipation of lower demand.
The turnaround is just beginning
Target's operating margin is heavily dependent on discretionary spending. It doesn't make as much money on staples like food. The issue is that staples have gone up in price, which leaves consumers with less money to spend on discretionary goods. CEO Brian Cornell said the following in his prepared remarks on the company's latest earnings call:
The industry has experienced seven consecutive quarters of declines in discretionary dollars and units. And while we're happy to see inflation rates moderating this year, if you compare industry pricing in key categories back to 2020, food at home pricing for families has increased 25% overall and in some areas, up to 30%. And if you're a parent raising a baby, you're facing increases of more than 30% on baby food and formula, too. And that's in addition to persistent increases in a variety of other categories.
Cornell's comments put into context just how much staples have gone up in price, and how the business has faced nearly two years of declines in discretionary spending. Recent macroeconomic data suggests that inflation has been cooling off. But as far as retailers like Target are concerned, consumer spending remains tight.
And Target's continued caution with its inventory management suggests it doesn't think the situation will improve in the near term.
Be patient with Target
Target's epic rebound last week was a response to the worst being over, not an indication that it will be smooth sailing from here. It will take time for the retailer's margins to fully rebound, and for its sales to return to growth.
Unfortunately, the timeline is largely out of Target's control. But what it can do is continue to effectively manage its inventory by forecasting consumer behavior trends. Target is also doing a good job tapping into the discretionary categories that consumers are going after through promotions and marketing.
Target stock isn't as cheap as it used to be. But it's still a great value and has the brand and management team capable of taking it to new heights in the coming years. The stock's 3.4% dividend yield provides a nice incentive for investors to wait for the turnaround to fully play out.
