One Does Not Simply Become Walmart

The US consumer is “very healthy.”

That’s according to Target CEO Brian Cornell, who spent Wednesday editorializing around what, if your benchmark is Wall Street forecasts, was a pretty rough quarter.

There’s some truth to the idea that companies don’t “miss,” analysts do. But to the extent pervasive worries around retail margins and concerns about the company’s capacity to keep abreast of rapidly shifting consumer psychology were baked into estimates following last quarter’s disappointing results and a subsequent strategy update tipping additional markdowns and related efforts to trim excess inventory, it was notable that Target’s results didn’t measure up.

Nearly everything was short of Street estimates for Q2. Sales of $25.65 billion rose less than forecast, EBITDA fell 68% YoY, operating income was nowhere near estimates, EPS of 39 cents wasn’t even close, gross margin was ~200bps light and at 1.2%, Target’s operating margin was half of expectations.

You can choose your own adjective. Analysts went with words like “ugly” and “tough.” Cornell described himself as “really pleased.”

Dark humor aside, there was some cause for optimism. Cornell wasn’t so much elated about the numbers themselves as he was the “underlying performance” of the business and progress on the (bumpy) road to rightsizing inventory, in what he generously described as a “very challenging environment.”

“Very challenging” is an understatement. The operating environment is so challenging that even Walmart got it wrong. It took months for Bentonville to turn things around, so we should probably cut Target some slack. The initial reaction to the company’s results wasn’t favorable — they were juxtaposed with Walmart’s better-than-expected report, but I’d suggest that’s not entirely apples-to-apples.

Target is a bourgeoisie Walmart. I’ve never been a retail analyst, but you don’t need to be a specialist in the sector to know that Target isn’t cut out for this kind of thing. Not the way Walmart is. We’re witnessing a once-in-a-generation inflation crisis involving disrupted supply chains, and the middle-class has seen their purchasing power eroded to a degree not seen in 40 years.

Walmart wrote the manual on supply chain management. And unless you’re inclined to shop at dollar stores, Walmart is where you go when you want the lowest price. By contrast, “Targé” (as high school juniors and seniors came to call Target during the retailer’s brief run as a pop culture phenomenon in the late 90s) was uniquely positioned to get screwed, if you’ll forgive the lapse into colloquialisms. They sell a lot of discretionary items. They also target (sorry) a different tier of home goods shopper, who might be (roughly) described as sitting one income quintile above your typical Walmart visitor. Going to Walmart is almost 100% about prices. Nobody goes to Walmart for a pleasant shopping experience. At Target, the split is less skewed.

Given that, it’s small wonder Target ended up the poster child for America’s retail inventory overhang. Target is where you go when you aren’t rich, but you aren’t poor, and you want to meander around aimlessly on the way to buying reasonably priced discretionary goods that you probably don’t need. That’s exactly what American consumers wanted to do in 2020 and 2021, and exactly the opposite of what they’re doing in 2022.

This year, even the well-to-do are eschewing pleasant discretionary meandering in favor of purpose-driven visits to Walmart, something Doug McMillon sounded proud of on Tuesday.

Target is effectively being forced to retool the business — to become Walmart. But “one does not simply become Walmart,” to employ one of the few internet memes I actually enjoy no matter how many times I see it. Threading this needle, where that means donning a Walmart costume to ride out the macro storm while retaining the traits that define Target’s corporate identity, isn’t going to be easy.

I assume this is clear, but just in case: The reason I’ve dedicated as much coverage as I have to Target over the last three months is that the company inadvertently became a bellwether — or maybe “dizzy canary” is more apt. Target’s first quarter results sounded a macro alarm. Less than a month later, that alarm blared again when the company warned on margins.

It’s through that lens that analysts assessed Target’s Q2 results with both eyes on the future, and little attention paid to the past. “Overall, there were puts and takes to the Q2 results and near-term uncertainty remains, but we saw nothing to change our positive view around the 2023 recovery story,” Wells Fargo’s Edward Kelly said Wednesday.

Target emphasized that the company is working “tirelessly” on inventory rightsizing. Cornell is effectively trying to front-load the pain. “While these inventory actions put significant pressure on our near-term profitability, we’re confident this was the right long-term decision,” he said, before describing the reaffirmation of full-year operating margin guidance as an example of “cautious planning” in consideration of “current trends.”

And therein lies the quandary. Notwithstanding the Street’s apparent inclination to give Target the benefit of the doubt, some viewed the company’s decision to eschew another guidance cut as a risk factor. Specifically, the combination of a near across-the-board miss for last quarter and steady expectations for the balance of the year makes for a somewhat awkward juxtaposition. It “leaves the door open for more disappointments,” one analyst remarked, noting that inventories are still “extremely high.”

Target said it cut inventory exposure in discretionary categories and invested in “rapidly-growing frequency categories.” Inventories rose 36% YoY, slower than Q1’s 43% jump (figure above).

“The vast majority of our inventory rightsizing costs have already been incurred,” CFO Michael Fiddelke told reporters. Target, he said, “feel[s] really good about our inventory position heading into the back half of the year.”