Webster defines optimism as "the belief that you could, just once, read an article that didn't start with a dictionary definition." Just as you will be disappointed, so will Target's (TGT +3.11%) management and shareholders if they really believe the current company line. Target said it expects gross margin for the full year to come in between 29% and 30%. The company just managed a 30% margin for the first six months, and that was comparable sales down only slightly. The second half of the year could come with some surprises.
Target's optimism exposed
Here's the crux of the issue -- Target is banking on two recoveries to make its estimates work out. First, it believes that it's going to have cleared the bad press associated with last holiday's data theft. Second, it believes that Americans are going to be in a better position, and not seeking out promotions as heavily this year. Those are both stretch goals, though.
Target's first half came with a 0.3% decrease in comparable store sales when compared to the first half of 2013. It's clear that customers have yet to completely forgive the business for its data breach in 2013. In order to get those customers back, Target has to do more than introduce fancy new terminals -- it needs to promote.
Its heavy promotional activity has already pushed margins down, and with traffic still a focus, there's no reason to think that Target is suddenly going to be able to level out its margins. In its third and fourth quarters last year, the company turned in gross margins of 30% and 27.6%, respectively. Given that the company earns over a third of its revenue in the weak-margined fourth quarter, there is little chance for the business to maintain its current level without some serious pop.
Promotions still reign
That's where the second hurdle comes in. Target is hoping that shoppers will be focused on "the occasion rather than promotions," meaning that there will be less promotional pressure in the back half of the year. Everything points to the second half being as difficult as the first, though. Consumers are still under wage pressure, unemployment is still high, and the retail environment continues to show signs of heavy promotion, headed toward the end of the year.
Target is in direct competition with Wal-Mart (WMT +2.19%), and that retailer is expecting a difficult end to the year. The business recently said that its shoppers continue to feel stretched and that macroeconomic factors are going to be "headwinds" in the second half of the year. To try to offset those headwinds and to help push comparable sales up, Wal-Mart has said that it's going to be cutting prices to get customers through the doors -- but gross margin is going to suffer.
The bottom line
It's the same position that Target is in, yet Target has taken an optimistic outlook on the end of the year. The problem for the market is that Target's outlook isn't realistic. The current macroeconomic trends and the persistent promotional environment are going to push Target's margins down. That's not inherently a bad thing, though, as it may drive sales up and get people through the door during a difficult period.
What Target needs to watch out for is cutting too deep. It's already on thin ice with its forecast for end of the year margins, leaving it little wiggle room if things fall apart. That's going to hurt investors and the business. Target should take a more flexible approach to its forecasts and give itself the room it needs to operate a successful business.
