Target (TGT) expects Q1 headwinds to continue to impact profitability in the near term

Shares of Target Corporation (NYSE: TGT) were down 4% on Thursday, yet to fully recover from the beating it took a day earlier after delivering mixed results for the first quarter of 2022. Revenues surpassed estimates but earnings fell short of expectations. The stock has dropped 33% year-to-date.

Revenue and comps

Target’s total revenue grew 4% year-over-year to $25.2 billion in Q1, beating estimates. Comparable sales grew 3.3%, supported by a growth of 3.9% in traffic. Comparable store sales grew 3.4% while digital sales rose 3.2%, driven by same-day services which were up 8%.   

During the quarter, Target benefited from its multi-category portfolio, which allowed it to cater to the changes in customer preferences. The company saw the highest growth in categories like food & beverage, beauty, and essentials.

Food & beverage and beauty delivered low double-digit growth while essentials grew in the high single-digits. The beauty category benefited from customers spending more time outside while essentials was driven by strong demand for products like cleaning supplies and household paper. The luggage category saw growth of over 50% as people have started travelling again.

Profitability and inflation

Revenue growth for the quarter was overshadowed by inflation taking a huge bite out of profits. Adjusted EPS declined nearly 41% YoY to $2.19, missing expectations. The company said it faced unexpectedly high costs during the quarter which led to profitability coming in well below its expectations.

Operating income fell 43.3% to $1.3 billion in Q1, driven by a decline in the gross margin rate. The gross margin rate dropped to 25.7% from 30% last year, due to higher discounts, higher freight costs and supply chain disruptions.

On its quarterly conference call, Target said that freight costs in Q1 were much higher than it had anticipated. For the full year, the company now expects around $1 billion of incremental freight costs. A key reason for this pressure is the rise in fuel costs.  

Apart from this, Target faced inventory issues which also took a toll on margins. The company had excess inventory in categories such as home, electronics, and sporting goods where sales was slower than expected. These items need more space for storage which put pressure on capacity. Therefore, in order to clear these items, the retailer resorted to higher discounts which impacted margins.  

Outlook

Looking ahead, Target expects the headwinds seen during the first quarter to continue to impact profitability in the near term. Profit performance is expected to see an improvement during the latter half of the year.

However, global supply chain pressures are not expected to subside meaningfully until 2023 so the rise in costs will continue to impact profitability for the remainder of this year. Target expects revenue growth for full-year 2022 to be in the low to mid single digit range while operating income margin rate is expected to be in a range centered around 6%.

Click here to read the full transcript of Target’s Q1 2022 earnings conference call