Target (TGT -0.51%) reported fourth-quarter earnings Tuesday morning, and the results make it clear that the company is still struggling in the current macroeconomic environment.
Comparable sales rose just 0.7%, on top of 8.9% growth in the quarter a year ago, and overall revenue was up 1.3% to $31.4 billion, beating estimates of $30.7 billion. Weak performance in discretionary categories like electronics, home, and apparel was offset by stronger results in consumer staples categories like food and beverage, beauty, and household essentials.
Due to the need to clear inventory and the poor performance in higher-margin categories, gross margin slipped from 25.7% to 22.7%, and operating margin was nearly cut in half, dropping from 6.8% to 3.7%.
As a result, the company finished the quarter with $1.89 in adjusted earnings per share, down from $3.21 in the quarter a year ago, but that still cleared analyst estimates at $1.40.
Guidance for 2023 was also underwhelming as Target expects flat comparable sales growth for both the first quarter and full year, and earnings guidance for both periods was below analyst estimates.
Image source: Target.
Why it's a buy
Despite the weak guidance, the stock still gained on the report, up about 1% on Tuesday, a sign that much of that negativity was already priced into the stock.
A look beyond the weak guidance also shows that the challenges Target faces are at the macro level, and the company continues to gain market share in retail.
It just posted its 23rd straight quarter of comparable sales growth, and the company gained market share in all five of its core categories: essentials and beauty, food and beverage, apparel, home goods, and hardline items like televisions. Additionally, the retailer reported its third straight quarter of double-digit comparable sales growth.
Target's inventory levels are also normalizing, as the company said inventory was up just 3% from a year ago with a 13% decline in discretionary categories showing it's adapting to customer trends.
The company expects operating income to increase $1 billion from 2022 to 2023, showing a recovery from the weak 2022 performance.
The long-term opportunity is clear
Target's strategy and its long-term opportunity haven't changed.
The company is growing both in the physical and digital channels, adding 23 stores in 2022 and remodeling 140 locations, including adding shop-in-shop experiences with partners like Apple, Ulta Beauty, and Disney, which helps to differentiate the retailer from competitors.
The company continues to improve its digital offering as well, allowing curbside pickup customers to place Starbucks orders from select stores and adding six new sortation centers -- bringing the total to nine -- to speed speed up delivery and reduce costs.
Target also maintains its portfolio of owned brands, which range from home to apparel to food and other categories.
Management expects shopping patterns to return to pre-pandemic norms and its long-term forecast calls for operating margins to steadily improve after last year's drop, topping its pre-pandemic level of 6% and recovering to that level as early as next year.
Based on the company's 2023 EPS guidance of $7.75-$8.75, the stock trades at a price-to-earnings ratio of around 20.
That isn't cheap, but Target's earnings seem to be temporarily impaired by the inflationary and recessionary headwinds that all retailers are facing as well as the company's misreading of consumer demand last year, from which it's still recovering.
But with inventory levels now having stabilized, the company should return to steady growth once the economy improves.
Target's competitive advantages remain, including its store-based fulfillment system, a portfolio of popular owned brands, and unique partnerships with brands like Levi's, Starbucks, and Ulta, and should help the company deliver long-term growth.
In the current macroeconomic environment, investors will have to be patient, but Target still has the qualities to beat the market over the long term.
