In recent months, it hasn’t been unusual to see a company’s stock fall dramatically after an earnings release. Wall Street seems to be giving no margin for error — and even an average quarterly report could result in a precipitous drop in share price. Unfortunately for retail giant Target (NYSE: TGT), its Q1 2022 report contained some bad news and the stock plummeted almost 25% the next day and currently trades 35% lower than its pre-earnings price.
Leading up to this report, Target had actually been doing quite well. At the market close on May 17 — a day before the earnings release — its shares were only down 7% on the year. I say “only” because the S&P 500 was off 14% over the same time frame. So is Target really 35% worse of a business now than on May 17? Let’s take a closer look to see.
Mixed earnings report
One of the headlines coming out of Target’s Q1 2022 earnings report was that the company missed the consensus analyst estimates for earnings. Target reported earnings per share (EPS) of $2.19 when $3.07 was expected. To be fair, Target’s management stated when it reported Q4 2021 results that year-over-year profit performance for 2022 would be variable and generally improve over the year. So a miss on earnings in Q1 doesn’t necessarily portend doom for the remainder of the year, even if the market reacted harshly.
What irked the market more was the reason behind the missed earnings guidance. On the earnings call, management attributed the profitability headwinds to higher-than-expected transportation costs as well as a more dramatic change in sales mix. The result was an excess of inventory in bulky categories such as outdoor furniture, large kitchen appliances, and TVs. CEO Brian Cornell said the company has a lot of work ahead of it to restore profitability.
There’s no doubt this was a miscalculation by management, so the share price drop was to some extent warranted. However, there’s something to be said for the upfront and transparent way management handled it. Just a few weeks after this earnings report, Target announced an updated plan to optimize its inventory by offering additional markdowns, removing excess inventory, and canceling orders.
Reason for hope
This news was also accompanied by revised guidance that lowered the company’s operating margin expectations to around 2%, compared to the previous guidance of 5.3% provided during the Q1 earnings report. While that’s not good news, the company also stated it expects operating margin to improve to 6% in the back half of the year, which would be an improvement over the pre-pandemic margin for the fall season. That’s a significant factor to consider and suggests that Target’s troubles may be short term in nature.
Target has been a strong-performing business for a long time, and while past performance is not necessarily indicative of future results, there are plenty of reasons to believe that the company will be poised for success once these inventory troubles are in the past.
In the Q1 report, there was evidence that Target’s investments in its omnichannel strategy are paying off. Comparable sales grew 3.3% in Q1 on top of 23% growth in Q1 of 2021. Additionally, Target’s same-day services saw even stronger growth at 8%. Specifically, drive-up sales grew in the mid-teens on top of 120% growth last year. All this growth was fueled by frequently purchased categories like food and beverages, beauty, and household essentials.
So is it a buy?
Target was a smart investment before the recent sell-off, and the current valuation makes shares even more appealing. Target currently has a price-to-earnings (P/E) ratio of 11.6, a multiple not seen since 2019. By comparison, competitor Walmart trades for more than double that level with a P/E of 25.4. To further make the point, Target’s net income has grown 111% over the past five years, compared to Walmart’s 2%.
By taking a step back, it’s easy to see that the long-term trends in Target’s business should more than compensate for the short-term challenges. The market has overreacted to the recent news, making Target a no-brainer buy at its current valuation.