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Jun 7, 2022

Target’s bloated inventory spurs another profit outlook cut

Target's warnings indicate a problem within the company, not the global economy: CEO

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Target Corp. cut its profit outlook for the second time in three weeks as it rushes to ease an inventory surge by marking down items and canceling orders.

Soaring merchandise stockpiles and “unusually high transportation and fuel costs” prompted Target to cut its outlook for operating profit to about 2 per cent of sales this quarter. On May 18, the company had projected the gauge would be in a wide range around 5.3 per cent. 

The rapidly worsening outlook underscores Target’s struggle to adjust to rapid shifts in demand amid stubborn inflation that’s forced consumer spending into less-profitable staple goods and away from discretionary categories such as electronics and home products. That’s left retail companies with a whole lot of merchandise that shoppers don’t want.

“This may prompt some other retailers to proactively talk about their own inventory positions before we get to next quarter,” Bloomberg Intelligence analyst Jen Bartashus said in a phone interview after Target’s profit cut.

Shares of Target fell 2.8 per cent at 11:13 a.m. on Tuesday, paring an earlier drop of as much as 7.8 per cent. The slump dragged down shares of its rivals, including Walmart Inc. Target had already fallen 31 per cent so far this year, including its biggest skid since 1987 after the release of its first-quarter results, which featured a profit forecast cut and a big jump in inventories. That came at the heels of a huge run-up in the stock price during the first two years of the pandemic and years of sales growth.

In the past, bloated retail inventories have been harbingers of economic slowdowns or recessions as consumers pull back spending, but Bartashus said the read-through from Target is murkier because the company maintained its sales guidance for the year.

“There’s a little more nuance than what we may have seen historically,” she said. Bartashus expects Target’s inventory cuts will be focused on discretionary categories rather than taking effect across the board.

 

SHIFTING DEMAND

Across the US, some excess of the inventory was accumulated intentionally to hedge against another potential wave of supply-chain disruptions that made some items tough to find over the past couple of years. Now, however, retailers have to account for consumers’ sudden price sensitivity while balancing their own surging operating costs from fuel, labor and other expenses. Holding on to larger merchandise stockpiles is expensive, and if the goods fail to move, markdowns further hurt profitability while benefiting bargain-hunting shoppers.

Given the inventory overhang at a number of rivals, Minneapolis-based Target decided to take “a decisive set of actions,” according to Chief Financial Officer Michael Fiddelke.

“Excess inventory doesn’t usually age well,” Fiddelke said in an interview. “We want to make sure that we’re being aggressive to right-size our inventory now.” He said this would improve shoppers’ experience while boosting value for investors in the long term.

That means marking down more merchandise and canceling orders from vendors. The company will also offload excess inventory and adjust some prices to offset surging costs. Target is also seeking to get a handle on supply-chain disruptions by adding “incremental holding capacity near US ports,” which will give it greater flexibility. In the short term, that could help push prices lower, at least for some products.

Meanwhile, Walmart has said it would need “another couple quarters” to work through its bloated inventory. And Costco has said it expects to be able to sell its excess stuff, including belated holiday items from 2021 that will go out on shelves later this year.

So far it looks like Target’s issues are more “internal rather than external,” said John Zolidis, president of Quo Vadis Capital, in a research report. “Sadly, nearly all hard-fought goodwill earned from investors over the previous three years has possibly evaporated in just three weeks.”

Oliver Chen, an analyst at Cowen Inc., said Target’s plan to clear excess inventory was a positive signal ahead of the critical back-to-school season later this year, one of the biggest sales periods for retailers. Target said it sees operating margin rising to about 6 per cent in the second half of the year.

“Speed is the name of the game in retail, and Target is doing that now,” Chen said in an interview on Bloomberg Television. “We’re looking forward to a better back half.”