Target Earnings: Theft, Mix Weigh on Earnings, but Distribution Improvements Should Help in Long Term

Our $171 per share valuation of no-moat Target TGT should not change much after it announced first-quarter earnings that suggest it is on pace to approximate our full-year targets. We see no reason to alter our long-term forecast materially, as we are still expecting mid-single-digit yearly revenue growth and high-single-digit operating margins forecast on average. We advise prospective investors to await a more attractive entry point.

Comparable sales rose 0.7%, somewhat higher than our 0.3% estimate, as Target’s assortment of consumables and essentials again drove sales amid consumers’ cutbacks in discretionary spending. The company’s 5.2% operating margin was slightly below the 5.3% it posted in fiscal 2022′s opening stanza, with elevated sales leading to a better performance than our 4.6% estimate. Despite the outperformance, Target’s profitability was impeded by sales mix (as consumables and essentials generally carry lower margins) and elevated shrink expenses (mostly theft, with the company citing organized retail crime in many markets). We believe both factors will become less of an issue as the year goes on as Target laps the second half of fiscal 2022. Management left full-year adjusted EPS guidance in place ($7.75 to $8.75), and our $8.68 forecast should not move significantly.

Management continues to invest in technology and process improvements to boost distribution efficiency, and we are encouraged that recent automation and sortation center investments are paying off. We believe Target can use improving efficiency and growing scale to lift operating margins into the high single digits from fiscal 2022′s 3.5%. Still, competition remains fierce and should intensify further as inflation normalizes and shoppers become more conservative in light of economic uncertainty. We believe that Target’s assortment and offering are insufficiently differentiated as to insulate it from pricing pressure driven by Walmart and Amazon’s relentless attempts to draw traffic.