It is not a good time to be a retailer. Now that consumers’ wallets are beginning to feel the negative effects of record easy-money policies from the last couple of years in the form of inflation, retailers of every kind are missing earnings expectations, causing share prices to plunge dramatically.
Shifting consumer spending habits are also catching retailers off guard. For example, as more people move away from the pandemic-cautious lifestyle, retailers are stuck with excess athletic clothes and lounge wear because buyers are more interested in party dresses and office clothes.
One retailer that has recently taken a big hit to its share price is Target Corp. (TGT, Financial). After a disappointing start to this year, Target decided to take an aggressive stance toward getting rid of unwanted inventory, which will cause a short-term hit to profits with the goal of decreasing costs in the long term.
The market was not impressed with this proactive strategy. Target’s shares fell more than 3% after the news release detailing the company’s plans, bringing the year-to-date plunge to 32%.
However, Target’s plan to tackle the problem sooner rather than later is an arguably promising sign. The company seems willing to do what it takes to turn things around, even if that means acknowledging mistakes. Moreover, Target has grown at a faster rate than its major competitors in recent years, yet it still trades at lower valuation multiples compared to those same competitors.
A proactive strategy
One June 7, Target announced in a press release it would focus on right-sizing its inventory in order to better meet consumer demand.
One part of this plan involves marking down unwanted merchandise, removing excess inventory and cancelling orders. It also includes adding additional storage capacity near U.S. ports in order to add flexibility to the supply chain as well as mitigate higher fuel costs. For those who have never dealt with supply trucks, there is often some empty space on them in the interests of getting products to market faster, so this move could indeed help reduce transportation costs.
The other part of the plan is to adjust plans for the future as well as operations that are already in progress. This includes expanding categories that are seeing continuing strength, such as food, beverages, household essentials and beauty, as well as planning more conservatively for discretionary categories which are seeing weakness, such as home goods.
Some investors may be disappointed by the markdowns, but the company seems to view these as being due to short-term issues, not long-term weakness. In the same press release, Target announced it would add five distribution centers over the next five years, showing expectations for long-term growth.
Competitive advantages
Aside from moving quickly to address broader market issues, Target also has another major competitive advantage, which is its reputation for providing high-quality, chic products at cheap prices.
Considering Target’s main competitors are Walmart (WMT, Financial), Costco (COST, Financial) and Amazon (AMZN, Financial), this approach puts it in a unique market position. Consumers who are in search of trendy products but cannot afford to (or do not want to) go to higher-priced retailers often find themselves at Target.
Target’s strength in the “trendy but cheap” food and fashion categories is especially notable. There are multiple instances of the company imitating and even improving on popular better-for-you packaged foods, and Target is well known for offering fashionable clothes that are decent quality at good prices.
The cheap chic images also make Target an attractive partner for other brands targeting a similar consumer category, such as Ulta (ULTA, Financial) and Disney (DIS, Financial), which in turn strengthens Target’s own brand name.
Valuation
Target’s reputation for good quality at bargain prices seems to extend to its stock price as well. As we can see in the below chart, the company’s price-earnings ratio is consistently lower than its main competitors, and the valuation gap has only increased year to date:
Considering the trends in the price-earnings ratio, one might expect Target to be posting lower growth than its peers, but that is not the case. Target has a three-year revenue per share growth rate of 15% and a three-year earnings per share without non-recurring items growth rate of 36.9%, blowing Walmart and Costco out of the water, though Amazon posted faster growth thanks to its cloud offerings.
According to the GF Value chart, Target’s stock is now in the significantly undervalued range; the stock has not traded this far below its GF Value since the March 2020 market crash.
Takeaway
In a market environment where companies are struggling to adjust to high inflation and supply chain issues, it seems commonplace for stock prices to lose 20% or more thanks to a bad earnings report. This provides opportunities for value investors who are focused on the long term since we have the opportunity to pick up shares for cheap.
Thanks to its recent struggles as well as its proactive plan to combat changing market conditions, Target’s stock appears to be unfairly punished, especially now that it is trading at more attractive valuations than lower-growth competitors.
