There's a lot I want to talk about. We are entering what's likely the final stages in this stock market crash, which will wipe out a lot of capital. Hopefully you've been patient and adopted a long-term mindset, as it's the only way to survive this and stay in the game. Unfortunately, I know, a lot of people will not come back to investing. But, I hope you're not one of them.
Alright, let's talk Target. This stock dropped nearly 25% yesterday – it's worst drop since 1987's Black Monday crash. They're not alone, however. If you were paying attention, the same happened to Walmart. They both posted horrible earnings and guidance. This confirms any belief we've that the macroeconomic conditions are going to get bad. Though the consumer is still "strong", there's clearly been a dramatic shift in how they're spending their money with inflation.
But, let's go into it in a bit more detail...
Why did Target stock crash?
For the most part, I'll focus my discussions on Target, as I believe its stock presents the best valuation for the defensive retailers (i.e. versus Walmart and Costco). If you haven't seen my first analysis on the sector, then check it out here.
The stock mainly crashed due to a MASSIVE compression on margins. It's bad news from any angle. We're talking a 50% drop in earnings and margins. To put that into perspective, that literally doubles the stock's P/E ratio – making it TWICE as expensive, overnight. That explains the dumb, because I don't care what you say... there's no one that could have saw this coming!
What happened to Target's margins?
Okay, so WTF happened for their margins to drop so significantly? There's three reasons which Target mentions:
- Inventory write-downs and markdowns. That's because they overestimated needs in "discretionary" categories – which is basically anything non-essential (i.e. clothing, fashion, etc.). Whereas food/groceries has been strong... obviously because of higher prices. It's also worth nothing that, a lot of the inventory/input costs have been higher for Target as well, which hasn't all been passed to the consumer. This is a tricky situation, since inflation hasn't been double digits since the 1970s and nobody's really navigated this environment in recent history.
- Freight and supply chain disruptions. This is a worldwide, known issue.
- Increased compensation and headcount in their warehouses. If they start layoffs, like many tech companies have already started, then it's worse news for the economy... don't be surprised.
Are we in a recession?
We could be, and the likelihood is only increasing. Though the consumer appears to be "strong". A lot of the growth were seeing is attributed to inflation, and consumer spending has to increase whether they like it or not. It's where they spend that changes. We're already seeing those changes. Target had 3.3% growth in comparable sales, but doesn't mean a whole lot when inflation has been above 8%, imo. Foot traffic is up, which is good. More than anything, I like the fact that e-commerce at Target is still growing on top of 50% last year, and 150% in 2020.
Management has done an incredible job, imo, in making Target a leading retailer... and much of the challenges right now are unfair to blame on them. It's clearly macroeconomic issues, which aren't going to last forever. So, let's keep that in mind.
That being said, nobody wants to lose money... so is right now a good time to invest in the sector?
I thought this was a Defensive sector?
Yes, so did I... but then I realized we're not just talking about a recession here... we're also talking stagflation. This bring a whole different set of challenges that we're seeing here. The issues were all talking about, is a result of inflation... so, yes, I still believe Target is defensive and has limited downside versus the rest of the market (and other competitors at this point).
Looking at Target's breakdown by segment, 20% of revenues is made of Food/beverage, which is the MOST defensive. However, including Beauty and household essentials, which still do fairly well in recessionary environments, they're at 45%. So, pretty defensive. But, how does it compare to Walmart and Costco?
Walmart's revenues are 45% from Edible grocery alone. So, much more defensive than Target. The same applies to Costco, which is more than 50% food. So, clearly, Walmart and Costco are more defensive.
However, remember, we're not just talking recession... we're also talking stagflation... WMT and COST will have pricing power and economies of scale advantage over Target as well. But, TGT can leverage its higher margins. I've talked about this in the past.
Concluding Thoughts: Invest or Nah?
It's a shitty time to be an investor. There's very little places to hide or protect your wealth, other than cash... which is being eaten away by inflation. But, I do believe we are going to see some great deals in the stock market. They are coming... and you have to be willing to take some risk to take advantage of them. But, what really matters and mitigates much of the risk, is having a longer-term horizon.
So, can Target recover in the longer term? I absolutely believe they can. In the shorter- to medium-term, it can be pretty bad, given there isn't an immediate solution to this margin compression. They've guided for 6% operating margin for fiscal 2022, which is somewhat of an improvement, but nowhere close to where they were just last year.
But, even if we assume, they never enjoy the margins of the pandemic years again, I believe there is a 30-40% upside to their stock price from here – solely based off a longer-term 5% revenue growth, and 5% net income margins.
But, I think it's prudent to wait before entering, because we may just be in the beginning stages of market capitulation. So, why not wait for better deals ahead in the coming months? I already have a long-term position in Target, so I'm in no rush.. that might be different for you. Always do your own risk assessment.
Looking at the TGT charts, I think $130 (i.e. pre-covid highs) is a possibility.
There are other deals in other companies that are coming around, so analyze them all... that's what I'll be doing, so make sure you're following. If we're looking at defensive companies with strong moats, Starbucks is also on my watchlist. Stay tuned for that!
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