The S&P is down 17.7% in its first 95 days of trading in 2022. This marks the second-worst start ever for the index (1932 we were down 33%).
Technology and high growth names have been the primary drag on markets. We now see bears work their way into other elements of the market.
Retail is in focus this week as some of the biggest names in the industry post-earnings. The results are sounding alarms around the consumer. This is important as consumer spend has been a key element of economic strength.
Target (TGT) grabbed the market’s attention as the retail giant witnessed its largest single-session decline since the 1987 stock market crash.
Investors were aware of the difficult environment retailers face. It is one thing to understand these problems, it is a whole other ball of wax to see the numbers many feared. The Target results were an eye-opener, especially since the Minnesota-based company has been such a strong performer throughout the pandemic.
Revenues grew 4% from the prior-year period to come in at $24.8 billion, slightly better than expectations. Comparable sales grew 3.3% in the quarter, outpacing expectations of +0.2%. Traffic increased +3.9% y/y but tickets (the amount spent in a trip) declined -0.6%.
The top-line beat is impressive as the company is up against difficult comps given the stimulus checks handed out in the first quarter of 2021. The consumer continues to spend. The curious take from sales is that traffic increased yet the amount people are spending on each visit declined.
In an inflationary environment, one would expect those numbers to be flipped. We will discuss that in a moment. First, let us get to the heart of investor concern- the all-important bottom line.
Net profit fell by more than half compared to the prior-year period. It missed analysts’ EPS consensus by 31%! TGT has only missed bottom-line expectations three times in the past five years.
Target’s operating margin tumbled to 5.3%, a 450-basis point decline from last year’s first quarter. It was well below the company’s long-term target of 8%. Gross Margins fell 435 basis points to 25.7%, well below its typical 28-29% range.
The operating margin will not improve in Q2. TGT forecast operating margin to be “in a wide range centered around” the first-quarter figure of 5.3%. The open-ended outlook highlights the difficult environment retailers navigate.
Target cut its full-year operating margin outlook to 6% from 8%. Transportation is expected to contribute a $1 billion incremental hit alone.
The company did not provide sales guidance for the second quarter. It did project 2022 revenues to grow in the low-to-mid-single-digits.
Target was caught off-guard by the speed of inflation, particularly on the transportation side. Wages impacted the number as a $15 minimum wage starts to pull SG&A expenses higher.
The company’s ability to improve margins will be the single most important metric for investors to watch over the next couple of quarters.
Inventory increased 43% on a year-over-year basis (compared to 33% at WMT, 37% at TJX, and 33% at HD). The biggest problem with the inventory build is that it occurred in categories where consumers are no longer shopping. Big-ticket items like furniture and appliance as well as apparel fell out of favor. TGT needed to mark down products in this space, leading to the margin compression. This is expected to continue for the next couple of quarters.
Target said demand was strong for food. This highlights the inflation issues facing the economy. Wal-Mart (WMT) discussed food increasing double-digits in Q1. WMT forecast that this would continue into Q2. This necessity takes up a larger portion of the consumer’s wallet. That leaves fewer dollars to purchase some of those big-ticket items- unless they are severely discounted.
One other area that performed well was selective going-out areas such as beauty products which were up 45% y/y. Luggage was up 50% as people start to travel again.
The timing of the consumer shift could not be worse. Retail stores are forced to order items well in advance due to the length it takes for manufacturers to ship end products. The level of difficulty is increased as consumer demand evolves in a faster more unpredictable manner due to the impact of the pandemic.
On Tuesday, Home Depot (HD) posted a solid number while WMT missed. This started the argument that HD has homeowners shopping while WMT has lower-income buyers in search of food.
TGT depends less on the low-margin grocery business and attracts wealthier customers. Another key differentiator between WMT and TGT is the former sells gasoline which was an area impacting margins. The bite from inflation looks to be hitting a wider swath of consumers.
The four biggest big-box retailers- TGT, WMT, Costco (COST), and B.J.’s (BJ)- have lost over $100 billion in combined market value this week. Wal-Mart sounded the alarm on Tuesday but there were some assumptions that it may have been company-specific with management shooting itself in the foot. TGT destroyed the argument that this was a “Wal-Mart thing”.
The good thing is that the consumer remains in solid shape as evident by top-line performance. The problem is that investors are worried that the consumer’s wallet will start to run out of cash before the inflationary issues subside. This will continue to create an environment of winners and losers in the space as consumers are forced to choose between items.
As for Target, does this decline represent a good buying opportunity?
The valuation is certainly more compelling. The retail giant is trading at forward earnings of 10x. The stock is down -30% for the year. It pays a nice little dividend at 2.23%.
The chart has been broken as key support around the $200-psyche is no longer in play. The level traders will want to watch is around $143 which marks the 50-monthly moving average, a key trend line on the technical.
We usually like to approach a disruptive earnings gap lower with a T+3 mentality, meaning waiting three days for the initial furor and price reaction to wash out before wading into the name. The idea is that fund managers are not in a rush to buy and sellers will continue to unload losses.
Shares of TGT should drift lower and test that $143 area in coming sessions. This will set up as a good level to either play a short swing or to begin accumulating a position for those with a longer-term focus.