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Is Target About to Enter a Slump?

Target (NYSE: TGT) stock got clobbered on Wednesday after releasing a less than spectacular earnings report. The sell-off, though, wasn't only due to a quarter that's already passed; it highlights fears about how ongoing issues, specifically inflation, will affect the company -- and retailers generally -- in the near future. Target stock sank 25% after the release. Are investors in for a Target slump?

The pandemic is over for Target

The pandemic definitely isn't over, but Target's fabulous growth over the past two years has come to a screeching halt. Sales increased 4% year over year in the fiscal 2022 first quarter (ended April 30), including a 3.3% increase in same-store sales. In addition that deceleration, profitability was also highly pressured. Earnings per share (EPS) almost halved from $4.17 last year to $2.16 this year. Meanwhile, Target's operating margin of 5.3% was well below expectations for 8% or higher.

A Target Shipt worker scanning a product in a store.

Image source: Target.

In all fairness, the year-over-year comparison was particularly hard for Target to match. 2021 EPS was a spectacular 643% larger than the 2020 number of $0.56, and also included a $0.53 per share gain on the sale of Dermstore. The operating margin was 9.8% last year compared with 2.4% in 2020.

That doesn't mean Target is off the hook. Investors had priced maintaining and improving performance into its stock, and they've now reevaluated that assumption. Was management caught off guard? To some degree, yes. CEO Brian Cornell cited a "combination of factors that proved to be very different than expected," including a "much higher than expected rate in transportation costs and a more dramatic change in our sales mix" than the company anticipated.

Then there was inflation. That hurt the company on two sides: rising costs from suppliers and transportation, and cuts in consumer spending on bigger-ticket items. Management knew these things were happening, as you might expect, but the extent was faster and more dramatic than it realized. It resulted in excess inventory, especially bulky items, and lower margins.

That was also due to the company staying away from cutting its own costs where it mattered. Chief Growth Officer Christina Hennington said: "In the first quarter, we invested in delivering a great guest experience to build and maintain the trust and love for the Target brand."

While an obvious solution is raising its own prices, Target is trying to avoid that to maintain its value-driven mission and generate customer loyalty. Cornell said: "While we're not happy about the near-term pressure this causes on the profit line, we strongly believe these decisions will benefit our business over time." This echoes what CEO Andy Jassy said about Amazon's slowdown, and Walmart is in a similar boat as well.

Cheap price, high dividend yield

Target stock typically trades at a fairly cheap valuation, and at this price, it looks like quite the deal at only 11 times trailing 12-month earnings. Even better, at this price, Target's dividend yields 2.2%. Target's problems won't be over tomorrow, but it has created a winning model that should carry it through in the long run. Even as it leads the market plunge, it has outperformed the broader market by almost threefold over the last five years.

Chart showing Target's price beating the S&P 500 since 2018, even after recent fall.

TGT data by YCharts

Target might be in for a bit of a slump in the near term. But it has the tools to continue beating the market, and if you have some patience, it looks like a compelling stock to buy at this price.

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John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Jennifer Saibil has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Amazon. The Motley Fool has a disclosure policy.

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