Insights

These 2 Beaten-Down Stocks Have a $76 Billion Problem on Their Hands

Target (NYSE: TGT) and Walmart (NYSE: WMT) were each beneficiaries of the coronavirus pandemic. Non-essential businesses were forced to close, dining at restaurants was restricted, and folks were sent home for remote working. That left people with fewer places they could spend their time and money.

Target and Walmart were deemed essential businesses and allowed to stay open. As a result, they captured billions of additional spending from a restricted population. The only trouble was getting enough inventory to fulfill an insatiable customer appetite. 

Their inventories have surged

To solve the inventory shortages, Walmart and Target started increasing their orders with suppliers. However, they were competing with other large businesses like Amazon (NASDAQ: AMZN), Home Depot (NYSE: HD), and Macy’s (NYSE: M) that were also boosting their orders. This created bottlenecks with manufacturers, ships that bring the products from overseas, and logistical capacity within the U.S. 

Those supply chain disruptions forced Target and Walmart to secure inventories further into the future. That meant higher risk because the products that are high in demand today may not be two years from now. Unfortunately, that’s precisely the scenario Target and Walmart have found themselves in. The two ordered billions of extra inventory that was hot during the stay-at-home stages of the pandemic. 

Now that the economic reopening has gained momentum, folks are spending more money on away-from-home experiences like restaurants, movies, and travel. In its most recent quarter, Walmart’s inventory was up by 32% to $61 billion. Similarly, Target’s inventory was up by 43% to $15 billion.

TGT Inventories (Quarterly) data by YCharts.

Target issued a notice to investors calling the inventory situation an urgent problem and introducing immediate action to resolve it. Not only does it have too much inventory, but management also mentioned its products are of the wrong type, as consumer tastes have evolved. Target is slashing prices to eliminate the excess, which is expected to impact operating profit margin in the upcoming quarter adversely.

Walmart is not taking immediate action, but it risks the necessity of more drastic action later if customers don’t purchase that inventory soon enough. Also, Walmart’s inventory increase is not as significant as Target’s (in percentage terms), so it can afford a more measured response. 

Investors need not sell these stocks

TGT PE Ratio (Forward) data by YCharts.

That said, it’s no reason for investors to panic and sell these stocks. Target and Walmart are not especially expensive when measured by their forward price-to-earnings ratios of 18.3 and 20.7, respectively. Furthermore, these are resilient businesses that have stood the test of time. They will likely figure out an effective solution to this $76 billion problem.

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Parkev Tatevosian has positions in Macy’s. The Motley Fool has positions in and recommends Amazon, Home Depot, Target, and Walmart Inc. The Motley Fool has a disclosure policy.

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