What Just Happened to Target?

This morning Target announced Q1 results and the stock fell precipitously. First, the good news: overall sales beat estimates rising 4%. But the bad news was that profitability suffered due to two factors: cost pressures in fuel and freight, and lower than anticipated sales in some categories like appliances and TVs. Target had to discount some merchandise to clear it out. Management guided operating profit margins lower for the current quarter (to 5.3%). Target’s long-term profit margin goal is 8%. This is an industry-wide problem confirmed by Wal-Mart’s and Amazon’s earnings. After the incredibly strong post-Covid surge in retail spending, consumers are now shifting some discretionary dollars to travel and restaurants. This has to be frustrating for management—just as they were able to overcome snarled supply chains and build up inventory, consumer demand seems to have abated somewhat.

The stock has fared far better than its sector during this stock market correction, but today’s plunge of roughly 20% brings it more in line. This is all about building in risk that management won’t be able to turn the company around this year. I’m guessing they will, but the investment community is in a sour mood and isn’t inclined to give any company the benefit of the doubt. With a P/E ratio of about 11 it seems like a good deal of that risk has now been priced-in.

I want to highlight some of the take-aways from this announcement. First, Bloomberg News alludes to a “lightning quick return by consumers to more normal spending.” That is, the explosion of post-Covid spending fueled by stimulus dollars and pent-up demand was unsustainable and is now moderating to something more sustainable. Second, Target’s announcement screams lower inflation. For a year now all we’ve been hearing about is higher prices for everything from gasoline to hamburgers to shampoo. And now retailers are starting to “discount.” Lower inflation is a key prerequisite for fewer Federal Reserve rate hikes. And third, Target’s numbers & CEO commentary make it clear that consumers are still spending at healthy levels. I see no sign of oncoming recession.