Is Target A Buy After Its Reported Profit Drop? No, It’s Not (NYSE:TGT)



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The retail earnings reports last week were breathtaking. Walmart (WMT) had its biggest crash since Black Friday 1987 following a shockingly bad earnings report. Not to be outdone, Target (NYSE:TGT) followed it up this past Wednesday with its own worst day in 35 years. The venerable mass market retailer lost more than a quarter of its value in a single trading session.

Data by YCharts

After a decade of achieving little performance for stockholders, Target stock suddenly launched skyward in 2020. There was the idea that Target had positively “inflected” thanks to post-pandemic shopping patterns. However, this idea is now in serious doubt. Like so many other stocks which rallied sharply due to changing economic patterns during the pandemic, it appears Target may also make a round-trip back to 2019 level stock prices.

Target’s drop did not come in isolation. Rather, it followed on top of the big earnings whiff from Amazon (AMZN) last month along with Walmart’s miss. Amazon’s problems, you may recall, were almost all with its slumping retail business; Amazon’s cloud services results kept up with expectations. Amazon retail, however, plunged into unprofitability in North America, adding to its loss-making status in international markets. Subsequently to that quarter, Amazon has announced plans to start subletting its warehouse space as it rapidly tries to shrink its excess retail logistics capacity.

When you’ve got three bellwether retailers in the United States all putting up unfortunate results at the same time, it is clearly not a coincidence.

You could say it’s just management messing something up if one or even two retailers badly missed the numbers but when many big retailers all report the same trends, there’s a macroeconomic problem at hand.

Retail: What’s The Problem?

The easy answer is supply chains and cost inflation and all that. You know, the same story we’ve been hearing for the past year. A lot of the immediate reactions I’ve seen about the retail earnings reports follow that simple enough line of analysis. Companies are paying workers more for labor, paying more for gasoline and other transportation costs, and have had supply chains upended by numerous disruptions. The latest lockdowns in China give another reason to lean on the supply chain issue as still being the decisive factor here.

However – and let me be clear on this – I see this thinking as outdated. Supply chains are starting to clear up in many fields. Rather, the problem isn’t so much obtaining inventory to put on shelves, but instead getting consumers to buy that product once it is in stores. Consumers have slowed their spending. More precisely, they’ve stopped spending at peak 2021 levels, and that’s especially true on items that have high profit margins.

With the price of food, gasoline and other essentials soaring, retail sales remain strong as people buy their everyday goods. But as gas prices top $5/gallon in many places and grocery bills spiral ever higher and higher, there’s less cash left over at the end of the month for discretionary purchases. In areas such as furniture, apparel, and sporting goods, demand has dropped quickly as people pull back on less necessary items.

This showed up in the earnings reports for companies like Walmart and Target. Target’s CEO Brian Cornell explained what happened in last week’s conference call:

In our other three core merchandise categories: apparel, home, and hard lines, we saw a rapid slowdown in the year-over-year sales trends beginning in March, when we began to annualize the impact of last year’s stimulus payments. While we anticipated a post-stimulus slowdown in these categories and we expect the consumers to continue refocusing their spending away from goods and into services, we didn’t anticipate the magnitude of that shift. As I mentioned earlier, this led us to carry too much inventory, particularly in bulky categories, including kitchen appliances, TVs, and outdoor furniture.

This fits with what upscale furniture player RH (RH) said back in March. Its straight-talking CEO, Gary Friedman, stated that following the invasion of Ukraine and the rapid rise in gas prices:

“Our demand got hit by 10 to 12 points. We’re not actually guiding demand. I just wanted to give you color that there has been a change. I think it’s going to be that way for everybody.

[…] Other people might be banging a brighter, happier drum than me. Do they have better numbers than we do? I don’t think so.”

Those early warning signs Friedman pointed to back in March have made themselves abundantly clear across the retail industry in May. So what’s the path forward for mass market retailers in general and Target in particular?

Is Target Worth Investing In Long-Term?

I believe Target does not have a particularly great management team or business model compared to other retailers in its peer group. Target’s previous handlings of things such as the failed Target Canada expansion and its debacle around its data security have always kept this company off limits for me.

That said, Target was able to leverage the pandemic shopping boom for a time, and push up
from its usual lackluster valuation multiples (15 PE and 7x EBITDA or so) to loftier territory. Now though, we’re seeing the twin forces of multiple compression and declining earnings for Target, which can keep the stock dropping longer than folks might expect.

In any case, the stock isn’t down that far in the grander scheme of things. Shares are still up smartly from January 2020 levels. And that’s noteworthy, as Target stock did virtually nothing for the entirety of the 2010s; this is not a company that has historically generated shareholder value at a rapid clip.

Here are its earnings per share over the past decade:

Data by YCharts

Were those 2021 earnings sustainable? I’m guessing they’re not. As you can see, Target has generally earned around $5 per share per year for the past decade. There were times when they earned less due to one-off events such as cost associated with shutting down the failed Target Canada expansion. Regardless, this business earns around $5 per share in a normal year. Over the past year, however, it brought in $14/share. If this is the new steady-state for Target, then sure, a far higher share price would be justified. If Target simply overearned dramatically thanks to an unusually favorable economic climate which has now gone away, however, those earnings will come down a lot.

Why Did Target’s Profit Fall?

The question around earnings sustainability really sums up the whole situation. Target was able to earn $14/share in 2021 for several reasons. One, inventory turned really quickly. When Target was able to get product on shelves, it sold almost immediately. Additionally, there was no need to discount prices or otherwise give up margins for market share since retailers in general didn’t have enough goods to meet demand.

Now, however, as Target stated above, they ordered too many televisions, appliances, and so on compared to demand. You clean out older inventory with price cuts and more aggressive marketing. Instead of earning super-normal profit margins, Target will see its profitability return to more normal levels or perhaps even below average figures.

The earnings fall isn’t just merchandising, either. There is sharply higher labor costs as workers demand pay raises to keep up with inflation. Spiraling fuel prices make logistics expenses soar. Overhead costs such as electricity to run the stores rises in an inflationary environment. The list goes on. Last year, Target was getting to enjoy an unusually prosperous retail climate while still having lower operating costs. Now operating costs are soaring while margins on retail dip.

Analysts, however, seem to think a return to 2021 levels of abnormal prosperity are coming. Here’s the current forward earnings deck for Target:

TGT earnings estimates

TGT earnings estimates (Seeking Alpha)

The consensus sees earnings dropping 22% for FY ’23 to $10.60 per share, which seems reasonable enough. However, analysts then see earnings jumping 27% in 2024 and another 12% in 2025 based on just 4% and 3% revenue growth, respectively.

These numbers, to be blunt, don’t make any sense to me. In an inflationary economy where Target is having issues managing its supply chain, it simply seems baffling that the company will secure double-digit earnings per growth figures off of nearly flat top-line sales figures.

If anything, I’d be expecting earnings to decline once again in 2024 following FY 2023′ decline. Let me repeat that Target typically earned about $5-$6 share in a given year prior to the pandemic. And it’s not like Target has fundamentally transformed its business since then either. Absent some major new developments, it seems odd to expect the business will earn $10+ per share going forward when it has never done this historically.

Is Target Stock A Buy, Sell, Or Hold?

If you figure $7 of earnings run-rate and a 17x P/E ratio, that’d get a stock price of $119 as a target. That’s still substantial downside from here. Thus, I view shares as a sell, even after their large decline last week.

And, let me be clear, that $119 outlook is still pretty generous in light of Target’s historical performance:

Data by YCharts

Target shares were selling at $40 in 2002, $40 once again in 2009, and $80 in 2019. This is not a fast-moving company. It doesn’t have much presence in international markets, and its e-commerce efforts have also lagged rivals. It’s not like Target has suddenly flipped a switch and become a massive growth machine in 2020. It enjoyed a year of record profits, but unless you see a path to 2021 levels of prosperity continuing indefinitely, Target’s stock price makes little sense up here.

If you do want to own the company, at least consider waiting for an earnings report where they get inventory under control and start to see margins improving. That would be a better entry point than buying after the first down quarter into what’s likely to be a prolonged slowdown for the retail sector.


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