Target's price cuts imply earnings may be a concern - but UBS says don't worry

By Tomi Kilgore

Retailer's stock heads for lowest close in nearly 3 months ahead of earnings release

Shares of Target Corp. continued their slide Tuesday, as investors appeared to express concern that the retail giant's recent announcement about price cuts is an indication that the latest quarter's sales and margins may disappoint.

The stock (TGT) shed 1% in midday trading, putting it on track to close at the lowest price seen since March 4. That followed a 2.1% drop on Monday, in the wake of Target's announcement that it was cutting prices on 5,000 "frequently shopped" items.

The timing of the price-cut announcement - coming two days before Target reports fiscal first-quarter results - appeared to worry investors that the company needed to boost sales at the expense of profits.

In the fourth quarter, Target beat profit expectations by a wide margin, as lower markdowns gave a boost to gross margins.

But UBS analyst Michael Lasser reiterated his buy rating on Target's stock, and suggested investors shouldn't worry about the timing of Target's price cuts. Rather, Lasser said the cuts should be viewed as a long-term positive.

"Our take is that these actions are a sign of strength, not a signal of vulnerability," Lasser wrote in a note to clients. "Most likely, the company has been experiencing healthy margin gains that it can reinvest."

While 5,000 items might sound like a big number, Lasser noted that the average Target store sells about 80,000 shop-keeping units (SKUs), or different items. He figures that means the price cuts could be on at most about 6% of a store's SKUs.

Lasser estimates that depending on how much Target cuts prices, gross margins may be hurt by anywhere from 0.1 to 0.3 percentage points.

He currently forecasts Target will generate 0.15 percentage points of margin expansion in the current fiscal year, leading to a what he called a "conservative" fiscal 2024 earnings-per-share estimate of $9.45.

The current FactSet consensus is for 2024 EPS of $9.49.

There may also be some worry that a price war is brewing, as rival Walmart Inc. (WMT) said last week in its earnings report that prices in a number of categories were lower than a year ago, and that the number of grocery items that saw price rollbacks increased by 45%.

Also read: Target, Aldi cut prices on staples like chicken, diapers and pet food as shoppers rack up grocery debt.

Again, Lasser suggested, don't worry.

"[W]e think [Walmart's] and Target's actions won't be that disruptive," Lasser wrote. "Rather, they are an indication that these retailers are now back in a steady-state margin rhythm where they can make changes around the edges while still generating overall expansion."

Target's stock has gained 9% year to date, while Walmart shares have rallied 23.3%. The S&P 500 index SPX has advanced 11.3% this year.

What Wall Street expects Target to report

For the fiscal first quarter, the average estimate of 26 analysts surveyed by FactSet is for EPS of $2.06, up from $2.05 in the same period a year ago.

The FactSet consensus for net sales is $24.52 billion, or down 3.2% from the same period a year ago. Meanwhile, the consensus for same-store sales is for growth of 1.5%, which would be the first increase in five quarters.

Target has beat EPS and same-store sales expectations for the past five quarters. And the stock has rallied on the day that the past five earnings reports were released, by an average of roughly 7%.

Net sales have only beat expectations the past two quarters, but have topped estimates in seven of the past eight quarters, and in 14 of the past 16 quarters.

In Target's fourth-quarter report, the company said it expects full-year adjusted EPS in the range of $8.60 to $9.60, and expect same-store sales to fall 3% to 5%.

-Tomi Kilgore

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05-21-24 1238ET

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