Target is having a much harder time than Walmart

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While Walmart Inc. announced better times for the economy as a whole, the collapse in profits for Target Corp. recalls that the struggling big box stores are not yet clear.

On Wednesday, Target laid bare the damage caused by its shrinking mountain of inventory, with a nearly 90% drop in second-quarter profits. This contrasts sharply with Walmart’s forecast on Tuesday that profits would not fall as much as expected when it issued a profit warning last month. Target stocks were down as much as 5% in early trading.

Why the difference between the two companies?

One explanation is that Walmart generated about half of its sales from groceries in 2021, while the figure for Target was just 20%. This means that Target is much more exposed to Americans giving up discretionary purchases, such as clothing, home furnishings and electronics, because they have to spend more on food, fuel and other things they need. That hasn’t helped the company stock up on those categories, anticipating that the frenetic pace of pandemic buying would continue.

Target excess inventory with aggressive discounts in areas such as kitchen appliances, patio furniture and bicycles to avoid store clutter and free up warehouse space. It was the right strategy, but it weighed heavily on profits. While same-store sales rose 2.6% in the three months to July 30, just below the Bloomberg consensus on analyst expectations, net income was just $183 million, versus $1.8 billion the previous year. Operating margin fell to 1.2% from 9.8%.

Amid this dismal report, Target maintained its outlook for full-year revenue growth in the low to mid-single digit range and an operating margin of around 6% in the second half.

There are reasons to be optimistic. With US inflation easing, some of the pressure on discretionary spending should ease. Similar to Walmart, Target said the start of the back-to-school season, often an indicator of fall and winter activities, had been encouraging. More generally, retail sales in the United States rose nearly 9% year-on-year in July, although this was flattered by inflation and market discounts.

The chain also appears to have its unsold inventory under control, which should put it in a better position for the crucial winter holiday period.

Although inventory, at $15 billion, was little changed since the end of the first quarter, Target reduced inventory in discretionary categories by about $1 billion. The company said the vast majority of customs clearance costs were behind this. It also cut its fall orders by about $1.5 billion.

Despite recent struggles, Target is still one of America’s best-run retailers. It has placed its nearly 2,000 stores at the heart of its strategy, making them attractive places to shop and using them as hubs for online deliveries. It also has a strong range of private label brands, which should benefit from lower consumer prices, and it is particularly known for its chic and inexpensive fashion.

Still, sticking to its forecast for the full year leaves little room for manoeuvre. Target is threatened by a further decline in discretionary spending if recent more positive buying trends prove to be fleeting. The shift from selling nice items to essentials could also weigh on margins, as food and beverages are less profitable than clothing and home furnishings.

The shares are down about 30% over the past year. Sounds harsh, but to rebuild its credibility with investors, Target needs to demonstrate that it’s moved beyond the stock market snafus that plagued it in the second quarter. And after two earnings warnings in two months, it will have to respect its maintained guidance.

Unless he can, it’s hard to see that the “Tarjay magic” will return anytime soon.

This column does not necessarily reflect the opinion of the Editorial Board or of Bloomberg LP and its owners.

Andrea Felsted is a Bloomberg Opinion columnist covering consumer goods and the retail industry. Previously, she was a reporter for the Financial Times.

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