In an ideal world, people would form a mental picture of the supplies they need each week and the products would instantly appear at their door.
The real world has much more friction. Retailers forecast local demand for products, place orders with manufacturers, await the shipment of those goods, and hope that consumers eagerly buy up the inventory just as it arrives in their stores.
If retailers forecast demand accurately, the right goods arrive on time in the right stores, and consumers promptly buy them off the shelves, the retailer makes a good profit.
That model can easily break. If goods are delayed in shipping and consumer needs change by the time the goods arrive in the store, retailers must decide what to do about all the unsold inventory and scramble to order more of the goods that consumers are now demanding.
This comes to mind in considering Target’s June 7 profit warning. According to the Wall Street Journal, Target — whose stock trades 43% below its all-time high of around $268 — reduced its late-May estimate of operating margin from “about 5.3% to around 2% for the second quarter of 2022.”
While the discounts needed to clear Target’s excess inventory may not be enough to stop inflation in its tracks, I remain bullish on CEO Brian Cornell and see the stock decline as a buying opportunity.
Excess Inventory Is An Industry-Wide Problem
The reason for the profit warning was a mismatch between what is in the stores and what customers want to buy. Specifically, in April Target’s inventory soared 43% as a combination of lower demand and delayed delivery meant that consumers were not buying enough of the outdoor furniture, small appliances and electronics on Target’s shelves.
With the pandemic waning, consumers are now eager to buy food and beauty products as they leave their homes for work, social events, and travel. Target is scrambling to add more of those in-demand items and discount the outdoor furniture, small appliances and electronics to clear its inventory, noted the Journal.
Target is not alone in suffering a buildup of inventory that consumers are not eager to buy. Other retailers with much higher inventory levels included Walmart — inventory rose 33% in the last quarter and Kohl’s — inventory up 40%.
It also strikes me as likely that retailers that specialize in categories which Target is discounting are likely to suffer the same fate. Specifically, Wayfair could have more furniture in stock than consumers want to buy and Best Buy may have excess electronics inventory.
Could Retail Markdowns Lower Inflation?
In theory, discounting excess inventory could lower inflation. After all, as the Journal wrote, “The rise of inventory is likely to lead to more discounts, something retailers had avoided during the product scarcity of the pandemic. While price cuts will reduce retailers’ operating profits, they “could be a boon for shoppers facing rising prices for food, fuel as well as other goods and services.”
What remains to be seen is whether discounts to clear excess inventory will reduce the general level of prices in the economy and convince the Fed to back off its interest rate increases.
Sadly for those hoping that markdowns will reduce inflation, the goods seeing markdowns only account for about 20% of the consumer price index. As Barron’s wrote, “Goods excluding food and energy account for about 22% of the consumer price index…Less than one fifth of the CPI is seeing markdowns.”
A bigger portion of the CPI is still experiencing big price increases. For example, the service sector — such as airplane tickets — accounts for some 60% of the CPI and in April airfares rose 18% from March. Meanwhile, oil — which accounts for about 10% of CPI — has risen 70% in 2022, according to Barron’s.
This Could Be An Opportunity To Buy Target Stock
I have been favorably impressed by Target’s CEO since 2014 — Brian Cornell. As I wrote in October 2019, he excels at facing problems squarely and taking practical steps to solve them.
For example, when he took over in mid-August 2014, Target was barely growing, struggling to recover from a massive consumer data breach and distracted by a disastrous expansion into Canada.
In February 2017, he announced a terrible quarterly result and a package of store improvements and other initiatives that would require $7 billion in capital spending and $1 billion in operating expenses over three years. Target stock sank 13% to $58.
By October 2019, its shares had tripled. That’s because Cornell made improvements across Target’s business. Most notably, he built the systems needed to offer consumers what is dubbed omnichannel — the ability for consumers to buy goods in-store, online with store pickup or delivery to their homes.
That really came in handy during the pandemic which began about six months after I wrote the story.
I think Target’s profit warning is another example of Cornell grabbing the bull by the horns. I am confident he will restore Target’s growth and profitability.
With shares up in trading today, perhaps investors see Target stock as a bargain.