Target Inventory Forecast: What’s in store for the rest of 2022?
Despite the recent sell-off, over the past three years, shares of Target Corporation (NYSE: TGT) has proven to be a very lucrative source of returns, comfortably outperforming not only its peers in the consumer discretionary sector (by 3) but the broader markets as well (by 2.3x).
After a disastrous first quarter, where the stock had sunk and earned the infamy of nearly topping the list of post-earnings losers (large caps that fell 10% or more in a single day, after earnings), questions now arise if there is still weakness in store, or if this may be a good opportunity to own a long-term wealth aggravator at cheaper levels. In this article, I will seek to answer some of these questions.
Should the target go up?
Well, a large part of the sell-side analyst community certainly thinks the stock could rebound from current levels; this is reflected in the texture of analyst ratings and the average target price.
For clarity, consider that of the 33 analysts who cover the stock, 58% of them gave a “Buy” or “Outperform” rating, with the remaining 42% including only “Hold” ratings, with no ” Sale “. anything. Also, the average price target stands at $180, which implies an upside of around 14% from current price levels. With a standard deviation of the price target close to 19%, the implied potential upside could even reach the $214 levels. If TGT shares reached these levels, it would also mean that the current gap (at $209) had closed. The market is full of gap traders who will be looking to get in ahead of a potential gap close, but if the stock were to trade above these levels, we should see a “significant” improvement in Target’s trades, this which, in my opinion, is unrealistic, given the context of a potential recession.
What is our Company Read On Target and what is the outlook for the rest of 2022?
While a few green shoots can be spotted in the macro data and it looks like the market is starting to feel a bit better about Target Corporation, I still think it would be prudent not to get carried away. Here are some thoughts for you.
Target’s long-term ambition is to be a single-digit revenue growth company, but while there’s hope that things can only improve from Q1 onwards, note that at the end of this year, annual growth is still expected to be below the company’s long-term goal; Consensus estimates currently point to January 23rd annual sales growth of just 3.85%, and to me, that looks pretty disappointing when you consider what’s in store.
First, consider that over the past few quarters, Target has had to deal with a very strong base effect where annual sales growth was up 20% (in the recently concluded first quarter, the base effect base was 23% growth a year ago). Achieving 4% growth from this lofty base was no mean feat. Fortunately for TGT, this strong base effect will subside considerably in the coming second quarter, as last year revenue growth was closer to 9%. Given the drastic drop in the base effect, there is hope for an improvement in Q2, but consensus expectations for the quarter point to an even weaker percentage annual growth of just 3.8%.
Back-to-school/college dynamics and holiday season dynamics in Q3/Q4 should support revenue in Q3 and Q4, but in an increasingly recessive environment, you wonder if the appetite will be as resilient as in recent years. Target’s best-selling products come from the beauty and personal care realm, and you imagine these are avenues where consumers would be willing to compromise when the going gets tough. There is already evidence that consumers are reducing their spending with each visit; in the first quarter, average transaction growth at Target stores was 0.6% lower.
Next consider dynamics with margins. Even before the disappointing first quarter results, TGT’s annual gross margins of 28.3% were below average and one of the lowest in the general merchandising industry. Incidentally, the company’s GMs have been down for three consecutive years now (FY19: 28.9%, FY20: 28.4%).
In the first quarter, gross margins ended up falling 430 basis points (25.7%), with much of the pressure coming from merchandising challenges and transportation and supply chain issues. The merchandising pressure came due to TGT’s inability to understand market dynamics where they ended up building more inventory than needed. Converting that inventory into revenue has proven to be a chore, with TGT’s inventory turnover rate currently at its lowest level since the October 2018 quarter, nearly 15 quarters ago. Indeed, while they’ve typically kept their inventory for just over two months, they now keep it for 72 days!
Unraveling this inventory will prove to be something of a lingering headache, both in terms of timing and the pressure it will put on gross margin through promotions and bigger markdowns. In fact, based on data from the US Census, it appears to be a problem for all General Merchants (GMs) and the situation has only gotten worse according to the most recent data available for May (rather than to improve). Typically, the inventory-to-sales ratio at GM stores in the United States has averaged about 1.34x over the past five years, but currently it’s closer to 1.58x levels, so you can get an idea of the excess stock still prevailing in the system.
While inventory resizing pressures may persist, TGT may see some respite in transportation and supply chain costs in the coming quarter (just for some context, at the end of the first quarter, management of Target said it expects to see $1 billion in additional freight and transportation costs for the remainder of 2022). Fuel costs have come down significantly from high levels, while, crucially, congestion at west coast ports appears to have decreased significantly (the backlog of ships waiting to berth is now down by 75% since the beginning of the year). For the uninitiated, Target relies heavily on this port to source goods from China. In addition to these developments, there are also suggestions that the Biden administration may lower China-related tariffs, which could serve as another useful catalyst for TGT’s cost base going forward. Nevertheless, at the operational level, TGT expects to achieve EBIT margins of only 6% for FY22, below its long-term target of 8%+.
Income statement stories aside, Target’s balance sheet isn’t in the best shape either (despite excess inventory), and I don’t see that improving much in 2022. Just for a certain outlook, total debt of over $17 billion is at its highest level since February 2013 (implying net debt/EBITDA of 1.51x), and cash on the books has collapsed to an abnormally low figure of only $1.1 billion (you have to go back 7-8 years to see a figure lower than that).
I believe TGT will continue to be heavily leveraged for the foreseeable future as it plans to ramp up its upstream and downstream supply chain. Upstream, it plans to add five distribution centers over the next two years, and downstream, it plans to open three new sorting centers by the end of this year. TGT will also indulge in additional spending to refurbish 200 of its stores this year. Indeed, TGT expects to spend an additional $4-5 billion in CAPEX this year, which will undoubtedly put pressure on the company’s leverage position.
With such high CAPEX spending and pressures on the operating front, investors should also not expect the same level of stock buyback intensity that we saw last year (buyback spending last year’s shares were over $7.3 billion).
If there’s one aspect of TGT’s story that remains resplendent, it’s the company’s dividend profile. The company has had a stellar record of paying and growing its dividends for more than half a century now, and those who hold the stock on August 17 will benefit from a 20% increase in the quarterly dividend (0.90 to 1.08). This would put the forward yield at 2.74%, which is better than the stock’s average long-term dividend yield of 2.46%; so definitely something to think about there.
Final Thoughts – Is TGT Stock a Buy, Sell or Hold?
As you may have inferred from what is extensively covered in the previous section, I am not yet ready to be bullish on Target stock, and my neutral view is also reinforced by the valuation picture. and relative image to other discretionary stocks. On a forward P/E basis, the stock is currently trading at 18.3x, more or less in line with its 5-year average of 18.9x.
Then, if you compare TGT stock to its peers in the consumer discretionary space, represented by the SPDR Consumer Discretionary ETF (XLY), we can see that the ratio is now at fair levels, trading near the middle of its long-term, implying no real advantage in pursuing TGT (over other CD stocks) at this point. Also, even if you want to try playing for a gap trade (see technical chart in the second part of the article), I don’t think now is the best time to stage an entry because we just saw seven consecutive days where the high of the day was higher than the high or the close of the previous day (it would be better to wait for a pullback if you plan to go long).
To conclude, I rate the TGT stock as a HOLD.