Market Overreacts to Target's Q1 Results
It wasn't a pretty quarter. We plan to cut our fair value estimate by about 10%.
Our $188 fair value estimate for no-moat Target (TGT) should fall around 10% after the company's first-quarter gross margin slumped 4 percentage points to 25.7% due to a rapidly changing demand environment and inflationary pressures. However, our reaction is a far cry from the shares’ 25% plunge after the release. Our more measured take stems from our more conservative view of the firm. While we have long viewed Target’s execution and omnichannel transformation favorably, we believed the shares were priced to perfection despite a retail environment that is rapidly changing on account of pandemic-, cost-, and e-commerce-related factors. We still suggest potential investors seek a more attractive entry point. We expect mid-single-digit yearly revenue growth rates and high-single-digit operating margins on average long-term.
Comparable sales rose 3%, including 4% traffic growth, which suggests consumers continue to respond to Target’s value proposition. The bigger story was the hit to profits. Management attributed much of the slide to a faster-than-expected consumer shift away from certain categories (particularly big-ticket items like appliances and electronics) and toward food, beverage, beauty, travel-related, and essential items. The result was overstocks in some areas, leading to markdowns and storage costs. We agree it was prudent for Target to take these steps rather than try to draw inventories down gradually, considering the importance of protecting the customer experience and store efficiency. Management has reduced its 2022 operating margin outlook to roughly 6% from more than 8%. Our existing forecast of 8.5% should fall toward the new mark. Although American consumers remain healthy despite inflation, we believe supply and demand volatility as well as high freight costs—which also weighed on Target’s profitability—will remain through 2022. Still, we see no reason to alter our long-term view of Target’s prospects on account of these largely transitory factors.
Zain Akbari does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.