With three consecutive quarters of disappointing earnings, it is clear that Target Corp. (TGT, Financial) is not in an ideal situation.
This can be attributed to several factors, including inflation taking its toll on businesses across the globe and reducing consumer purchasing power. Adding to this, bloated inventories and so-called “organized retail crime” have also led to marked declines in revenue. The result is that Target’s stock may not show any significant upside anytime soon, despite the company being stable and part of an industry relatively resistant to inflation.
That being said, there is one area where Target shines - shareholder returns. However, when it comes to the stock market, shareholders would need some other evidence of improvement before they can expect any reward for their investments.
Target misses analyst forecasts for the third quarter in a row
Target has been going through a rough patch since the beginning of the year. Even though the popular retailer generated higher revenue year over year due to comparable sales and traffic growth, earnings were disappointing in the third quarter.
The company reported on Nov. 16 that it generated revenue of $26.52 billion, representing a 3.38% increase over the same period last year and beating estimates by a little over $117 million. However, non-GAAP earnings per share were down 49.1% from a year ago at $1.54 and missed estimates by a whopping 64 cents.
In the third quarter, Target’s comparable sales were up by 2.7% year over year, while the operating income was down to $1 billion from $2 billion last year.
Target updated its fisca 2022 guidance following the soft sales and earnings growth. The company now expects a low single-digit decline in comparable sales, while the operating margin is expected to stay around 3%. The lower profitability also drove down Target’s return on invested capital to 14.6% for the trailing 12 months, compared to 31.3% during the same period a year ago.
Another factor that contibuted to the profit decline was stolen inventory. According to the management, theft was responsible for reducing the gross profit margin by $400 million in 2022.
A clear reminder of the fickle nature of the markets, Target has become a textbook example of how companies investing heavily in growth can backfire. For the last three quarters, the big-box store chain's earnings have been far from impressive, widening losses and leading to inconsistent arguments to calm exasperated investors. With markets already bearish and investors more conscious than ever of their investments, disappointing earnings are unlikely to satiate them now. Target's continuous struggles came at the wrong time for shareholders as they push for reliable returns. A heavy price could be paid if this trend continues into the fiscal fourth quarter and beyond.
Excess inventory is causing further headaches
Earlier in June, Target took several steps toward inventory optimization after its first-quarter results. The company announced additional markdowns, removing excess inventory and order cancelations.
In the third quarter, Target’s inventory was worth $17.12 billion compared to $14.96 billion in the previous year, representing a 14.43% year-over-year increase in the inventory balance. This could lead to further markdowns and a revenue decline. However, this could be offset by management’s decision to reduce complexities and costs. According to the company's management team, these measures could save the company $2 billion to $3 billion over the next three years.
The retail market has been heavily impacted in the last year, and Target is no exception. Despite its impressive efforts to adapt, excess inventory remains a major issue. As the markets remain in flux, Target needs to manage its excess inventory carefully, or these items will weigh them down financially and reputationally. To keep sales up and revenue steady, it needs to quickly assess what items have sold well during this time and adjust production accordingly. Doing so is not only integral to their success, but can also provide an example of excellence for other retailers who are struggling.
Shareholder returns are still somewhat steady
Even though Target has been facing declining earnings since the beginning of the year, it did not deter the company from increasing its dividend in June.
The company has been increasing its dividend for 50 years and plans to continue its streak. Target paid $497 million in dividends in the third quarter, which was 20% more than last year. However, it did not repurchase any stock during the quarter. The company still has $9.7 billion remaining capacity under its share repurchase program, which was approved in August 2021.
Dividends from Target have been a crucial source of income for many investors, even amid uninspiring earnings reports. Certainly, these quarterly results put the stock in a precarious position, triggering an outflow of capital in response. However, the retailer has done its best to address this by continually paying off dividends, effectively cushioning the blow for its shareholders. It is an admirable effort to limit liability while continuing to invest in shareholder equity- not an easy compromise to make.
From an income investor perspective, it is clear that Target is dedicated to ensuring stability and growth through measured dividends, which will surely build some of the confidence needed going forward.
Disney and Ulta Beauty partnerships are a notable bright spot
Target also expanded two significant partnerships between the third quarter of 2021 and the first quarter of 2022. The first one was with Ulta Beauty (ULTA, Financial), which was expanded to accommodate 800 additional Ulta Beauty shops at Target locations in 2022. The second was with Walt Disney (DIS, Financial), increasing the Disney Store count by 160.
The partnership with Ulta Beauty has proven to be quite significant as it almost tripled beauty segment revenue for Target in the third quarter of 2022. Further, the Disney shops might prove their worth throughout the holiday season. Every item can be found at these outlets, from costumes and toys to books and DVDs.
These strategic decisions ensure Target captures a bigger market share while delivering luxury experiences to its customers.
Takeaway
Even though it may be hard to stomach, Target has continued to miss its earnings targets. Much of this can be attributed to the inflationary pressure that is affecting businesses across the globe due to consumers losing purchasing power. Many have pointed to its bloated inventory balance and organized retail crime for further revenue losses and markdowns.
It is safe to say that even though the company belongs to a mostly resilient sector, Target is not demonstrating a resounding stock performance. Fortunately for shareholders, returns are being made on their investment; yet from an investor perspective, it appears that any rejoicing will have been momentarily withheld.
