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Target’s Inventory Is a Big Problem. Here’s What Investors Need to Know.

Retail giant Target (NYSE: TGT) has come under the spotlight of late due to its inventory problems. Put simply, the company has too much of it, and it needs to downsize. The situation is troubling enough that the company updated its guidance just weeks after issuing it. Here’s what investors need to know about the current situation, and what it means for the stock.

The inventory isn’t moving as quickly as it was before

One metric in retail that investors find useful is the number of days inventory is outstanding, or how long it sits on store shelves before it moves. Fast-moving inventory means revenue is strong, and the company doesn’t have stale products taking up space. However, inventory turnover slowed dramatically last quarter for Target, rising to more than 71 days — the highest it has been since before 2020:

TGT Days Inventory Outstanding (Quarterly) data by YCharts.

As you’ll note, this isn’t the first time the number has been that high as there are seasonal fluctuations. But with the economy facing a possible recession, it’s troubling, especially given the value of how much Target has on its books.

Target’s inventory value is the highest it has ever been

At more than $15 billion, Target is sitting on a huge amount of inventory. That is particularly concerning nowadays because consumers are likely going to tighten up their spending as inflation is a growing problem in the economy. The company is going to have to significantly mark down inventory to get it moving. For consumers, that’ll mean some great sales in the short term. For the business, however, it will result in worsening margins.

TGT Inventories (Quarterly) data by YCharts.

One trend that investors may have picked up on in the chart above is that high inventory is a seasonal issue for Target and that it eventually declines back down. But a key point of distinction is that inventory normally peaks just before the holiday season, not during the spring. Here’s a closer look at the company’s inventory values before the pandemic:

TGT Inventories (Quarterly) data by YCharts.

In both 2018 and 2019, inventory spiked just before the holiday season and then was depleted during it. That trend of building up inventory before the holidays exacerbates Target’s issue today because, before its peak time of year, the retailer is going to need to make room for the inventory it plans to sell during the season. Otherwise, it will end up with even more inventory on its books. 

That’s why in June, when the company saw the situation wasn’t getting any better, it updated its guidance to account for deeply discounted products. Now it projects its operating margin for the second quarter will be around 2%, down from a forecast in May that projected the rate to be closer to 5.3% — what it achieved in the first quarter (period ending April 30).

Should investors be worried?

Ultimately, this shouldn’t be a long-term problem for Target. Supply chain issues have been a concern since the early stages of the pandemic when there were shortages of just about everything. It’s a different kind of problem today and one that will weigh on Target’s near-term results. But once those issues get sorted out, the financials will become more predictable and stable for the business.

Given these challenges, it’s likely that Target’s stock faces more pressure this year as next quarter’s results likely won’t be strong, and there’s the possibility that with consumers spending less because of inflation, that the inventory problem won’t go away in just a single quarter. Down already 37% this year (which is worse than the S&P 500‘s decline of 20%), shares of Target could fall even lower. It still makes for a solid long-term investment, but investors may be better off waiting until after next quarter’s results to see just how good of a handle the company has on its inventory. And by then, the retail stock could be even cheaper.

David Jagielski has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Target. The Motley Fool has a disclosure policy.

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