43% below peak, Target Corp’s earnings warning is a buying opportunity

In an ideal world, people would form a mental picture of the supplies they need each week, and the products would appear instantly on their doorstep.

The real world has a lot more friction. Retailers forecast local demand for products, place orders with manufacturers, wait for those goods to ship, and hope that consumers will eagerly buy inventory when it arrives in their stores.

If retailers forecast demand accurately, the right products arrive in the right stores on time, and consumers buy them from the shelves quickly, the retailer makes a good profit.

This model can easily break. If goods are delayed in shipping and consumer needs change by the time the goods arrive in store, retailers must decide what to do with all the unsold inventory and rush to order more goods that consumers demand. now.

This comes to mind when considering Target’s June 7 earnings warning. According to the wall street journalTarget – whose stock is trading 43% below its all-time high of around $268 – cut its end-May operating margin estimate “from around 5.3% to around 2% for the second quarter. 2022″.

While the discounts needed to eliminate Target’s excess inventory may not be enough to stop inflation in its tracks, I remain bullish on CEO Brian Cornell and view the stock decline as a buying opportunity.

Excess inventory is an industry-wide problem

The reason for the profit warning was a mismatch between what is in stores and what customers want to buy. Specifically, in April, Target inventory soared 43% as a combination of lower demand and delayed shipments meant consumers weren’t buying enough outdoor furniture, small appliances and accessories. electronics on the shelves of Target.

With the pandemic waning, consumers are now eager to shop for food and beauty products when they leave home for work, social events and travel. Target is working to add more of these in-demand items and reduce outdoor furniture, small appliances and electronics to empty its inventory, the Journal noted.

Target isn’t alone in suffering from a buildup of inventory that consumers aren’t keen on buying. Other retailers with much higher inventory levels include Walmart – inventory rose 33% last quarter and Kohl’s – inventory rose 40%.

It also seems likely to me that retailers specializing in the categories that Target offers at discount prices will likely suffer the same fate. Specifically, Wayfair may have more furniture in stock than consumers want to buy and Best Buy may have excess electronics inventory.

Could retail markdowns reduce inflation?

In theory, discounting excess inventory could reduce inflation. After all, as the Journal wrote, “The increased inventory will likely lead to more discounts, which retailers had been avoiding during the pandemic product shortage. While the price cuts will reduce retailers’ operating profits, they “could be a boon for shoppers faced with rising prices for food, fuel and other goods and services.”

It remains to be seen whether the rebates to eliminate excess inventory will reduce the general price level in the economy and convince the Fed to forgo its interest rate hikes.

Unfortunately for those hoping that markdowns will reduce inflation, markdown goods only make up about 20% of the consumer price index. As Barrons wrote: “Goods excluding food and energy make up about 22% of the consumer price index… Less than a fifth of the CPI is experiencing markdowns.

A larger part of the CPI is still seeing strong price increases. For example, the services sector – such as airline tickets – accounts for around 60% of the CPI and in April airfares were up 18% from March. Meanwhile, oil — which accounts for about 10% of the CPI — is up 70% in 2022, according to Barron’s.

This could be an opportunity to buy target stocks

I’ve been favorably impressed with Target’s CEO since 2014 – Brian Cornell. As I wrote in October 2019, he excels at facing problems head-on and taking practical steps to resolve them.

For example, when he took over in mid-August 2014, Target was barely growing, struggling to recover from a massive consumer data breach and distracted by a disastrous expansion into Canada.

In February 2017, it announced a terrible quarterly result and a package of store improvements and other initiatives that would require $7 billion in capital expenditures and $1 billion in operating expenditures over three years. The target stock fell 13% to $58.

By October 2019, its shares had tripled. That’s because Cornell has made improvements across Target’s business. Most notably, he built the systems necessary to provide consumers with what is known as omnichannel – the ability for consumers to purchase goods in-store, online with in-store pickup or home delivery.

It really came in handy during the pandemic which started about six months after I wrote the story.

I think Target’s profit warning is another example of Cornell grabbing the bull by the horns. I am confident that he will restore Target’s growth and profitability.

With stocks rising in trade today, investors may see Target stock as a bargain.

Comments are closed.