John Buckingham, an industry-leading, value-oriented money manager and editor of The Prudent Speculator, sees value in two leading retail stocks that have been hit hard after reporting earnings.
Target (TGT) saw its first quarterly miss since 2018; the report was a doozy, thanks to rising costs resulting in a major profit shortfall. For fiscal Q1 2023, TGT reported revenue around $24.8 billion (vs. $24.4 billion est.), while the earnings per share figure was $2.19 (vs. $3.08 est.).
Management explained that despite strong sales and consumer trends, TGT was negatively impacted by capacity constraints in the freight markets, higher transportation costs and other bottlenecks getting inventory to the right places. The net result was inconsistent inventory in stores, especially in product categories that require high-volume storage (e.g. furniture and appliances).
Target warned in March’s call that “quarterly profit performance will be choppy during the year and generally improve as the year progresses,” which might feel like a bit of an understatement after seeing Q1 results. Of course, TGT is hardly the only retailer to experience cost pressure and the company must make careful guesstimates to figure out how much of those increases can be passed to consumers without torpedoing demand.
We think that balancing act, plus uncertainty regarding inventory timing, will make the next year (or so) challenging, but while we sometimes need to have strong stomachs to endure frenetic near-term trading, our long-term thesis for Target remains very much intact.
We think the retailer is among the best in our investment universe, while its finally getting credit for being a stable business vis-à-vis its change from the Consumer Discretionary to the Consumer Staples sector later this year. We think the reclassification will be a positive change because the new peer group by which we calculate our proprietary fundamental score will be more reflective of TGT’s competition.
TGT continues to remodel stores and enhance store capabilities to support same-day fulfillment services. Management remains committed to returning cash to shareholders via share repurchases.
And on the dividend front, management plans “to recommend that our Board approve a healthy increase in the quarterly dividend, in the mid-teens to low 20% range later this year, keeping 2022 on track to be our 51st consecutive year of annual dividend increases.”
Our trims of TGT in July 2021 around $253 and in January 2021 around $197 now look well-timed and have resulted in lower-than-target weighting in our broadly diversified portfolios, so we would consider bringing positions back up to normal weight given the recent massive 29% plummet in the stock price. Our Target Price for TGT has been pared to $265.
Shares of Walmart (WMT) plunged nearly 20% after the retail behemoth released fiscal Q1 2023 financial results. The consumer bellwether earned $1.30 per share in the quarter ended April 30, a figure that was 12% below the Street target and 23% lower than that earned in the same quarter a year ago, even as revenue growth (2% year-over-year) persists beyond the stimulus-induced bump.
Cost pressures from a higher mix of food and fuel relative to general merchandise and a preference for private label food items (particularly categories like deli, lunch meat, bacon and dairy) weighed on gross margins. We suspect some of this was due to seasonal factors as cooler weather persisted longer than usual. These pressures, and a few weeks of overstaffing that boosted wages, led to a 1.25% drop in operating margin year-over-year.
Also front and center is a 32% bump to inventory on hand at the end of the quarter, some of which was attributed to inflation adjustments but also a matter of timing from supply chain elongation. Sam’s Club and International comparable sales grew 10.2% and 13.0%, respectively.
A massive drop for one of our stocks is never easy to experience, and WMT is now well into negative territory on the year. We expect the laundry list of economic obstacles to weigh on profit margins for several quarters, but an inflationary environment that seems likely to drag on ought to exaggerate consumer’s thirst for a bargain.
Walmart’s expanding omni-channel presence, value proposition and defensive characteristics continue to win it a place in our portfolio. High-quality WMT shares trade at 18 times revised NTM EPS estimates and offer a 1.9% dividend yield. Our Target Price has been cut to $168, but we think this a terrific time for those without a position to consider picking up WMT from the discount bin.
