There are a couple of important details to consider regarding last quarter’s modest sales growth.
Kudos to Target (TGT 1.07%), and congratulations to its shareholders. The retailer’s stock soared more than 10% on Wednesday in response to its second-quarter numbers, which were better than expected. It also upped its full-year profit guidance, further fanning the bullish flames.
However, there are a couple of footnotes regarding the company’s Q2 results that just might make you rethink the notion that Target is completely back on track. Indeed, you might want to wait at least until the current quarter’s numbers are in hand before making a decision about owning this stock.
Red flags on Target
For the three-month stretch ending in early August, retailer Target turned $25.45 billion worth of revenue into a per-share profit of $2.57. Sales improved 2.7% year over year, driving a 42% increase in earnings that were depressed by tough economic conditions in the comparable quarter of 2023. Last quarter’s results also topped estimates for sales of nearly $25.2 billion and a profit of $2.18 per share. Same-store sales were up 2%, snapping a four-quarter streak of declines in comparable sales.
Investors understandably celebrated the report, particularly given that the company raised its 2024 earnings-per-share outlook from a range of $8.60 to $9.60 to somewhere between $9.00 and $9.70.
But there are some additional details you should know about these numbers. Chief among them is the fact that the year-ago comparison was an unusually low bar to clear.
The chart below tells the tale. In most years, sales move higher from the first quarter’s tally in Q2. Last year, they didn’t. They moved lower. Ergo, modest top-line growth of 2.7% isn’t necessarily a reflection of strength this time around.
Data source: Target Corp. and Macrotrends. Chart by author. Figures are in millions.
At the same time, inventory levels moved measurably higher again during Q2 of this year. This could be a sign that Target is easing its way back toward the bloated inventory levels seen in early 2022 that caused profit problems later that year.
How is that a problem? Here’s the deal.
Admittedly, the amount of merchandise a retailer has in its stores and warehouses seems irrelevant on the surface. Inventory is inventory, after all — you sell it when you sell it.
Except it’s not that simple. Not all inventory is always marketable. School supplies sell better in August, for example. Swimwear is really only marketable in spring and early summer. Demand for holiday décor doesn’t swell until November. Sitting on too much of the wrong merchandise at the wrong time not only clutters stores, but can prevent a retailer from being able to buy the goods it could more easily sell in the foreseeable future. There’s also the not-so-small challenge of shrinkage, loss, and damage the longer merchandise lingers on store shelves.
Target isn’t waist-deep into the sort of inventory misery it was mired in a couple of years back, to be clear. And for the record, gross margins remain strong. It’s not being forced to discount its merchandise to turn browsers into buyers.
It’s a concerning quarter-over-quarter uptick all the same, though. Inventory levels are back within sight of 2022’s frothy levels, yet sales are flat (at best). The pre-holiday inventory buildup shouldn’t be happening quite this much until the quarter now underway. It’s possible that the retailer’s slight sales growth is only the result of an even bigger inventory buildup that provides more selection than usual. Underscoring all this worry is the fact that Target doesn’t anticipate any actual sales growth for the fiscal year we’re now halfway through.
Too much bad news to bet on Target stock right now
It’s not all bad news … at least not yet. As was noted, Target is still enjoying solid pricing power. Gross profit margin rates are on the rise, nearing levels last seen at the height of the COVID-19 pandemic in 2021 when bored consumers were ready to spend money on just about anything.
Data source: Target Corp. and Macrotrends. Chart by author. Inventory figures are in millions.
Perhaps these subsequently strong profit margins will persist.
Pricing power is largely a function of consumerism’s health, though, and that’s increasingly in question. Although it’s seemingly on a stable footing right now, data from consumer research outfit Numerator indicates that Americans’ outlook on the economy, the job market, household finance, and comfort with discretionary spending all took slight hits last month, with employment optimism falling the most.
In other words, we may be nearer a setback that stifles spending — and therefore pricing power — than it seems on the surface. If that’s the case, Target’s breadwinning apparel, décor, and other discretionary lines will be the first to suffer a setback. Walmart‘s impressive Q2 report included color explaining that consumers remain quite value-conscious. Ditto for recent reports from PepsiCo and McDonald’s.
Bottom line? At the very least, interested investors will want to wait for the retailer’s third-quarter numbers due in November to decide whether or not Target’s Q2 results mark the beginning of rekindled strength. However, we may need to wait even longer than that.