On Tuesday, Walmart suffered what I described as a “black swan” moment, when the company’s shares plunged following uncharacteristically disappointing quarterly results.
On Wednesday, it was Target’s turn.
Like Walmart, the company cut guidance and missed estimates on the bottom line. But, again like Walmart, it was margins that spooked investors. The company’s operating margin in Q1 was just 5.3%, which management conceded was “well below expectations.” Gross margin was 25.7%, nowhere near the 29% estimate.
For the year, operating profits will amount to just 6% of sales, a full 200bps below the prior forecast. Consider that in Q1 of 2021, the company’s operating margin was almost 10%. Gross margin a year ago was 30%.
Target cited “actions to reduce excess inventory as well as higher freight and transportation costs.” In what I’d describe as another coal mine canary for the economy, Target’s inventory rose 8.5% from Q4 and 43% YoY. In my judgement, the following quote (from the company’s press release) is very ominous from a macro perspective:
This year’s gross margin rate reflected higher markdown rates, driven largely by inventory impairments and actions taken to address lower-than-expected sales in discretionary categories, as well as costs related to freight, supply chain disruptions and increased compensation and headcount in our distribution centers.
In addition to familiar headwinds associated with inflation, logistics and labor costs, it would appear that consumers, squeezed by surging prices for necessities, are shunning discretionary purchases.
Target acknowledged that reality, while noting that demand was robust for food and household essentials. Like Walmart, the company said it’s seeing a switch from name brands to store brands.
The shares collapsed almost 25% (figure below), more than double the drop Walmart suffered on Tuesday.
Wednesday’s wipeout was on track to be the largest single-session decline since 1987.
Although this scarcely needs reiterating, the increase in food and fuel prices for US consumers is unrelenting. The food gauge in the CPI index posted a 17th consecutive monthly increase in April (figure on the left, below), data out last week showed.
At the same time, pump prices are at record levels in nominal terms (figure on the right, below) and may approach the all-time high in real terms later this summer.
In a note out earlier this week, JPMorgan’s Natasha Kaneva said gas prices in the US could reach $6.30 a gallon by August. “Unless refiners shift yields toward gasoline and cut exports immediately to rebuild stocks before the driving season picks up, US consumers should not expect much in the way of relief in prices at the pump until the end of the year,” she said.
For Target, an additional issue is the extent to which its stores are viewed as a kind of bourgeoisie Walmart. There’s something oxymoronic about buying a store brand at Target. If you want to save on a can of black beans, you buy Great Value. Period. Nobody looking for the best price on staple food items will buy them at Target if there’s a Walmart nearby unless what counts is store experience. I’ll confess I haven’t been to a Target in years, but I assume it’s still an infinitely more pleasant experience than a trip to Walmart. Or at least until you have to pay.
The read-through for the broader economy is foreboding. One of the key pillars of Morgan Stanley’s cautious outlook for US equities is excess inventory. “We’re starting to see signs that inventory is building in consumer goods,” the bank’s Mike Wilson said. “It’s happened more slowly than we initially anticipated, but that means pricing/discounting risk for impacted companies can linger for several quarters.”
Wow! The JP Morgan expectations for the price of gas are the nastiest I have ever seen. That alone can throw freezing-cold water on expectations for Q3 and Q4. Nothing positive there…
Costco and the dollar stores are up next. I wouldn’t be surprised if Costco beats and sees a nice pop post-earnings. While their clientele is similar to Target, they focus more on the food and essentials and their customer base is generally more insulated from inflation. I could also see them having less wage pressure since they already pay higher wages and have better employee retention. Might be a good entry point for Costco (or another opportunity for me to look stupid).
Maybe “Mr. Market” was right about Target, but at least in theory the market changed the value of the stock to a level that reflects an expectation that a quarter of all the profits the firm could have ever expected to earn into infinity now can’t be earned. Seriously? This is the same way the market should have reacted if, overnight a quarter of all TGT’s stores had burned to the ground for a total loss, never to be replaced. Somehow, it seems to me Mr. Market overreacted.
I will say, the decline of gross margin, while significant, implies two things. The producers have more pricing power than the sellers so PPI is the primary inflation driver here. However, as inventories seem to be rising, the PPI should start falling, Both these conditions should start to cool off inflation.
with market reactions to WMT and TGT we may be accelerating towards generalized widespread market panic…and by extension the much anticipated relief rally may be extremely short lived…
Those gas prices are already here in the Bay Area.
The gas prices are even more problematic because of the chip shortage impacting EV availability. Even if you wanted to trade in your gas guzzling pickup for an EV version, you can’t get one anyway.
isnt excessive inventory good for lowering inflation at least? silver lining mayhaps?
H-Man, it appears the consumer is going on a sabbatical and it may be a lengthy sabbatical.
The price-gouging gas station down the street from me had regular unleaded at $5.99/gal at the initial spike in oil prices at the beginning of Putin’s war. Then it went to $6.25/gal for several weeks. Mind you, there is no observable change in people’s driving habits. I still hear people in Dodge Chargers and modded Hondas revving their engines at all times of day and night to get to the next stop light as fast as possible. Today, I noticed that the price has been adjusted to $6.49/gal.
Looks like people have finally spent all their stimmy dollars and reality has returned.
Good point. But we still keep hearing that “Americans are flush with savings they can run down.”