The silver lining in Target’s ugly neighborhood

There is no doubt that Targetit is (TGT -3.47%) the second quarter results left much to be desired.

The retail giant’s profits plunged as poor inventory planning led to aggressive markdowns in discretionary categories. Target had indicated that bottom line would take a hit as it made the decision to liquidate inventory, but the bite in earnings was worse than expected.

In June, management said it expected a 2% operating margin in the second quarter, but instead Target only announced a 1.2% operating margin, although below the 9.8% announced in the second quarter of 2021. A sharp decline in gross margin, which fell from 30.4% to 21.5% mainly due to destocking efforts, was the main reason for the decline operating margin.

As a result, adjusted earnings per share came in at just $0.39, down from $3.64 in the year-ago quarter and below analysts’ average estimate of $0.72. . Revenue growth was decent, with comparable sales up 2.6%, and overall revenue growth of 3.5% to $26 billion was consensus, but after walmart beat its own lowered forecast earlier this week, investors were disappointed Target didn’t do the same, and the stock fell 5.2% on Wednesday morning.

Still, despite the disappointing results, there are a number of reasons to remain bullish on Target.

The worst is over

Like many of its retail peers, Target overstocked its inventory in anticipation of potential supply chain delays and because it overestimated consumer demand trends in areas such as housewares and clothing. ‘electronic. In the second quarter, Target essentially maintained total dollar inventory value from the first quarter, ending the second quarter at $15.3 billion, but it realigned inventory with current demand and reduced inventory costs.

Management said on the earnings call that its inventory space was down 20% and that the vast majority of the impact of its inventory write-downs and other decisions was behind the business. . He also expects his fall inventory peak to be lower than spring’s, even though pre-holiday stock is usually the heaviest, further proof that the worst of inventory problems is over. .

Target’s forecast for the second half of the year showed that it expected a recovery in profits, as it expects an operating margin of 6%, in line with its historical average, and a revenue growth in the lower to mid-digits.

The long-term strategy remains intact

Target stock has been one of the best performers in the retail industry in recent years as the company has developed a number of differentiated competitive advantages. Even after its plunge earlier this year, the stock has still doubled in the past three years and tripled in the past five.

It has seen strong profit growth by investing in same-day fulfillment services, an area in which it is uniquely positioned to excel as it has stores that serve all populations (urban, suburban, rural) in all 50 states. Rivals like Walmart, Costcoand Amazon, on the other hand, cannot correspond to this geographic exposure. Target also offers higher margins than these competitors because its in-store fulfillment strategy makes more efficient use of its stores than shipping orders online from a fulfillment center. Finally, it has grown by opening small-format stores in underserved areas of towns and colleges and by investing in its own brands, which help build customer loyalty and generate higher margins than renowned brands.

Over the long term, the company expects to deliver high single-digit adjusted EPS growth, which, combined with a growing dividend currently yielding 2.5%, will provide investors with double-digit annual returns.

The target stock is well valued

The market punished Target for weak earnings and a reduction in guidance in its first-quarter earnings report in May, sending the stock down 25%, but inventory issues are near-term headwinds that should disappear within one or two trimesters. In a healthy economy, Target should be able to generate operating margins of at least 6%, and the stock looks cheap if you think its performance can return to full health. Last year, the company achieved adjusted EPS of $13.56, giving the stock a price-to-earnings ratio of just 13.

For a retailer who has a number of clear competitive advantages, who is a dividend aristocrat who currently pays a 2.5% yield and who has easily outperformed the market in recent years, this price looks like a bargain.