Depending on where you looked this week, American consumers either have their backs up against the wall, or they are holding up just fine.
Target on Wednesday cut its forecast for the holiday season following a surprisingly big drop in third-quarter profits. “Spending patterns changed dramatically” at the end of the third quarter, the company cautioned. Target shares tumbled 13 per cent.
Yet a day earlier, rival big-box retailer Walmart delivered better than expected third-quarter results and said earnings this year would not fall by as much as feared. Its shares closed 7 per cent higher on the day.
It helps that Walmart is a much more grocery-heavy retailer. The discount behemoth generated about half of its sales from food in 2021, while the figure for Target was just 20 per cent. This leaves Target — better known for its cheap chic offerings in clothing and home furnishing — more exposed to the pullback in discretionary spending as Americans focus on paying for essentials such as food and fuel.
Target’s former strengths are now a weakness. Its sales hit $106bn last year, a near 50 per cent increase from 2014. Operating margin was twice that of Walmart in each of the past three years. Maybe, but Target’s share price has dropped 40 per cent this year, while that of its rival has climbed. At 15.5 times forward earnings Target is now trading at a 33 per cent discount to Walmart.
Target has long taken a cautious approach to ramping up its grocery offerings because of the razor-thin margins involved. Instead, under Brian Cornell, who took the helm in 2014, Target invested billions of dollars to revamp its stores and ecommerce strategy and expand its high-margin private labels.
Current economic conditions do not play to Target’s strengths. But investors should keep the faith. Over a five-year period it has still outperformed Walmart — gaining 171 per cent against Walmart’s 52 per cent. Given its relative value, investors can afford to take the long view on Target.
Our popular newsletter for premium subscribers is published twice weekly. On Wednesday we analyse a hot topic from a world financial centre. On Friday we dissect the week’s big themes. Please sign up here.
