Stocks of the Specific Company Experience Major Drop: Is Purchasing at Lower Prices Wise or Best to Retreat?
In August's second-quarter report, Target (TGT, -0.66%) gave investors some optimism, suggesting a potential turnaround.
However, post-pandemic, the retail giant faced obstacles such as inflation, low consumer discretionary spending, and increased theft. Unfortunately, Target's shares dropped after revealing that the recuperation trend wasn't sustainable and the company was still grappling with financial issues on both sides of its income statement.
Comparable sales only increased 0.3% during the quarter, with store traffic up 2.4%, but average transactions decreased. The company saw a shift in sales to digital channels, resulting in a 10.8% increase in digital comparative sales, while in-store comparative sales decreased by 1.9%.
Overall revenue increased by 1.1% to $25.7 billion, but fell short of the projected $25.9 billion. Gross margin dropped from 27.4% to 27.2% due to higher inventory levels and increased fulfillment and supply chain costs. Management stockpiled and repositioned inventory before the October port strike, which alleged to be a temporary drawback.
Higher wages and benefits led to an increase in selling, general, and administrative expenses from 20.9% to 21.4%, causing a decrease in operating margin from 5.2% to 4.6%, and resulting in a decline in earnings per share (EPS) from $2.10 to $1.85, far from estimations of $2.30.
Target also provided disheartening forecasts for the crucial holiday quarter, anticipating flat comparable sales growth and an EPS of $1.85 to $2.45, significantly below the predicted $2.64. The retailer revised its full-year EPS guidance from $9.00-$9.70 to $8.30-$8.90.
What's causing Target's issues
Management presented the same old reasons for their financial woes. They claimed, "We faced some unique obstacles and pressures that affected our financial performance." On the conference call, they stated that consumers were still choosing to delay purchases and wait for deals. However, Target's struggles coincided with Walmart's dominance.
Walmart displayed comparable-sales growth of 5% in its third quarter for U.S. stores, primarily driven by its food sector. It managed to decrease inventory in the third quarter and boosted gross margin, thereby improving overall profitability. Walmart reported mid-single-digit price reduction in its general merchandise sector, indicating price decreases across its product range. It also mentioned market-share gains across all income segments, a sign that it was taking market share from Target, among other retailers.
Target did have some positive aspects, such as 6% comparable-sales growth in beauty, and double-digit growth in Drive Up and same-day delivery services. However, inventory challenges, sluggish consumer behavior, and competitive disadvantages persisted, negatively impacting the business.
Can Target recover?
Despite Target's significant stock drop following the news, with a 21% decrease as of early Wednesday afternoon, there are potential reasons for a faster recovery than anticipated. Target has a lot of built-in operational leverage in its business model, and even a minor improvement in gross margin can lead to a significant surge in operating profits.
First, better inventory management could potentially lead to an expansion of gross margin to 29%, an improvement of 180 basis points. Such gains would directly contribute to the operating margin, which was just 4.6%. If the operating margin was instead 6.4% - 180 basis points higher and within Target's historical guidance for an operating margin of at least 6% - operating income would skyrocket by 39%, making a significant difference. Improving this isn't as difficult as it seems, especially considering that management expects categories that have been under pressure, such as home, to eventually recover.
Second, Target's shares are currently cheaper compared to those of peers like Walmart. Target now trades at a P/E ratio of 14 based on this year's EPS estimates. While the company must make some fundamental improvements before investors can benefit from the discounted valuation, the opportunity is still present.
After the third-quarter update, however, a stock price recovery looks even more distant.
Despite the financial challenges facing Target, there's potential for a faster recovery due to its operational leverage. Improving inventory management could expand the gross margin to 29%, significantly boosting operating profits. Furthermore, Target's shares are currently undervalued, offering a potential opportunity for investors once the company makes fundamental improvements.
Investors might want to consider diversifying their finance portfolio by looking into ways to invest in Target, considering its potential for recovery and the discounted valuation of its shares.
