Target just went from great to bad to ugly.  But the worst may be over

Target just went from great to bad to ugly. But the worst may be over

Inflation-weary shoppers shifted to buying staples like groceries and gas, rather than “non-essential” general goods that are central to Target’s sales and profits. It was a stark contrast to larger rival Walmart (WMT), which posted a narrow profit decline for the quarter. But many analysts believe Target is in a good position going forward that it’s not in danger of joining some of the other winners of the pandemic that are now struggling, like online retailer Wayfair(W). On Friday it announced that it had to lay off 5% of its staff because it was expanding too quickly when times were good.

Target’s earnings decline was due to the deep discounts it had to offer on many of its general merchandise, such as clothing, electronics, and housewares. The profit loss from such heavy discounting was inevitable. But company executives insist it was the right choice.

“Consider the alternative: we could have kept excess inventory and attempted to reduce it slowly, over several quarters or even years. While this would have reduced the short-term financial impact, it would have slowed our business over time,” CEO Brian Cornell told investors. “The vast majority of the financial impact of these camp actions is now behind us.” He forecasts a significant improvement in operating margin in the fall season.

Many analysts agree that Target did the right thing when it took the hit. Some say the sudden shift in consumer spending habits wasn’t the result of a management miscalculation.

“All of last year the supply chain has been very, very tight. The stores were out of stock on many items. They ordered for very reasonable demand,” said Bobby Griffin, Retail Analyst at Raymond James. “Then there was a very rapid change in consumer behavior.”

Consumer discretionary buying was shifting away from commodities to things like travel, Griffin said.

Other experts say that target management was not entirely innocent in being caught with too much incorrect inventory.

“My feeling is that this [problem at Target] 70% consumer behavior and 30% inventory-related misperceptions,” said Eric Schiffer, chief investment officer of Los Angeles-based private equity firm The Patriarch Organization.

There is some hope for all retailers that they could benefit from the large, steady fall in gas prices over the last two months.

The national median price of gasoline has fallen $1.11, or 22%, to $3.91 since hitting a record $5.02 on June 14. Since then he has fallen every day. That should save households an average of $100 a month. And wholesale gasoline futures are pointing to even lower gas prices in the coming weeks and months.

Target has always had more trouble with a sudden shift in consumer spending than Walmart. Walmart gets more than half of its sales from groceries, while Target is closer to 20%, said Owen Chen, retail analyst at Cowen. Walmart also had to offer sales for its non-essential general merchandise during the quarter.

And Walmart has increasingly competed with low prices, an advantage at a time when even middle- and upper-income shoppers are concerned about higher prices. Walmart executives reported seeing more deals from these higher-income households last quarter, a statement that pleased their investors.

But Chen said the numbers suggest they didn’t get these higher-income shoppers from Target’s traditional customers.

Target profit collapses 90% as inflation-weary buyers pull back

“I think that’s Target [store] Traffic numbers show it’s done a good job of retaining its customers,” he said. The number of customers who made purchases from Target rose 2.7% year over year in the just-just-ended quarter. And that’s an increase of more than 20% since then in the same period of 2019, before the pandemic.

Target shares have outperformed some of its peers and are down 28% so far this year, compared to a mere 5% drop at Walmart. Schiffer said he wouldn’t be surprised if Target’s stock continued its decline, as he believes it’s overvalued by as much as 30%. But he doesn’t think that positions Target badly for the future.

“I would stay the course,” he said. “The pace of growth during the pandemic has never been sustainable. They will still grow, just not as fast.”