Target Inc. (TGT, Financial), a prominent retail chain in the U.S., is encountering multiple challenges, leading to a lack of investor interest.
The impact of the pandemic, which previously benefited the company, has now diminished. Comparable sales have reached a stagnant point, digital sales are experiencing a decline and even the company's once highly sought-after same-day services, like curbside pickup, are exhibiting underwhelming growth.
Although Target has made progress in reducing inventory levels, it faces threats on multiple fronts. Inventory shrinkage, partly due to theft, is projected to negatively impact the company's bottom line by over $500 million this year. Further, politically motivated boycotts associated with some of its Pride Month merchandise has impacted the company as well.
Moreover, a KeyBanc analyst has highlighted the expected resumption of student loan payments later this year can potentially reduce the buying power of Target's customer base.
On the other hand, Target's stock is now attractively priced. Despite the current lack of momentum and the potential for setbacks in the demanding business landscape, Target presents an appealing opportunity for long-term investors seeking shares of a well-established retailer at a discount.
Why is the stock falling?
Despite enduring significant challenges caused by the pandemic, high-interest rates and inflation, Target has displayed resilience by delivering two strong consecutive quarters. The company posted non-GAAP earnings per share of $2.05, surpassing estimates by 29 cents. It also outperformed revenue expectations by $40 million. Furthermore, Target has made notable progress in addressing its bloated inventory, which has decreased by 16% year over year, according to its most recent earnings report.
However, despite its recovery, Target has not gained the favor of Wall Street bulls, as it has experienced downgrades from several firms in the past month. In addition to the ongoing boycotts, another major obstacles the company has encountered is retail theft, which has had a significant impact on its profitability. Target estimates a loss of $500 million in profits in 2022 due to organized retail theft, while the entire retail industry is believed to have suffered losses of $100 billion in 2021 alone from this issue. Additionally, the retail industry is grappling with cautious consumers who, influenced by recent inflation, prioritize essential purchases over larger items like furniture and apparel.
Another obstacle facing Target is the recent debt ceiling package passed by Congress, which includes the resumption of student loans by Aug. 30. Analyst Bradley Thomas from KeyBanc Capital Markets views this policy change as a significant headwind, projecting a $46.1 billion impact from September to December and an annualized impact ranging from $128.8 billion to $148.1 billion. The resumption of federal student loans is expected to affect consumer discretionary spending within an already cautious consumer environment.
Back to Earth
At its peak, Target's stock reached over $250 per share in August of 2021, resulting in a market capitalization exceeding $120 billion. Nevertheless, the stock has been on a downward trend since then and was still deemed overvalued as of March. Assuming that Target's sales gains during the pandemic would be sustained indefinitely and that profit margins would return to pre-pandemic levels, the share price could have been justified. However, neither of these assumptions is guaranteed.
Target's stock experienced a significant slump following the release of its first-quarter results in May. The company anticipates minimal fluctuations in comparable sales this year, with projected adjusted earnings per share ranging between $7.75 and $8.75. In comparison, Target achieved adjusted earnings of $13.56 per share in 2021.
While the company's full-year guidance remains unaltered, the market is currently uncertain. In recent weeks, the stock has experienced a significant decline, with a loss of nearly 20% of its value since May 15. Currently, shares are trading around $132.
Despite various challenges, Target's stock is now priced attractively enough to warrant serious consideration. Assessing Target's value based on earnings is challenging due to the company's currently depressed profit margins and the uncertainty surrounding future margins.
Nonetheless, considering the sales figures, its valuation seems to have reverted to normal levels.
Target currently trades with a price-sales ratio of 0.57, which is lower than its historical median over the past 10 years. The minimum price-sales ratio during this period was 0.41, the median was 0.63 and the maximum reached 1.34. This indicates Target's valuation, based on sales, is currently more favorable than its historical average.
In comparison, Dollar General Corp. (DG, Financial) has a higher price-sales ratio of 0.95 and Dollar Tree (DLTR, Financial) has an even higher ratio of 1.07. This suggests Target's stock is relatively more attractively valued when compared to its peers in the retail industry based on sales.
Although Target's stock exhibited a historically higher valuation during the pandemic, the current price-sales ratio reflects a reversion to normal levels. In fact, its current sales multiple is lower than it was just prior to the onset of the pandemic in early 2020. This implies the premium previously associated with Target's stock has dissipated, presenting a potentially favorable investment opportunity for investors seeking shares of a well-established retailer at a relatively lower valuation.
Takeaway
Target has encountered numerous challenges, including protests, retail theft, reduced consumer spending and changes in government policies regarding student loans. While the company is working to overcome these obstacles, a complete recovery will take considerable time.
A potential investment in the stock should be approached cautiously because the company needs to regain strong sales growth and improve profit margins. There is a possibility the situation could worsen before any improvements are realized, and the market share gains achieved during the pandemic may not be sustainable.
Nevertheless, Target's services still offer significant competitive advantages. The expansion of same-day services has successfully attracted customers, and these channels continue to grow. During the first quarter, same-day services witnessed moderate sales growth, whereas curbside pickup demonstrated significant expansion. Although these rates are lower than those during the pandemic, Target's investments in these areas still yield positive results.
Currently, Target's stock is not favored by the market, so it may take time for a turnaround, especially considering potential further declines in a challenging business environment. However, for long-term investors seeking to acquire shares of a reputable retailer at a reasonable price, the stock now offers a promising opportunity.
