Target's Q1 22 Earnings Call
Summary of Target's Q1 22 Earnings Call
Target disappointed on its most recent earnings call. They missed guidance on earnings per share by 28.5% due to much higher product costs than they anticipated. Management on earnings calls usually tries to remain upbeat and have a positive outlook. They talked a lot about how well they were treating their customers and how they had positive revenue and traffic growth.
In the end though, Q1 performance wasn’t good. Supply chain disruptions, inflation, high product and labor costs, an awful EPS miss and a large dip in gross margin dominated the call. The stock dropped almost 25% during the day.
Exhibit A: Earnings Miss
Here is my summary of the call below:
Supply chain issues, high freight and transportation costs, and high inflation really hurt their gross margins. Management doesn’t expect these supply chain pressures to be resolved until 2023 at the earliest, and higher costs will affect profitability for the remainder of the year.
Here is what the CFO said on the call:
“We don’t expect the external environment will be anything close to normal in the back half of the year. In particular, we don’t expect to see any meaningful reduction in global supply chain pressures until 2023 at the earliest. So the elevated costs we’ve been facing will continue to affect our profitability for the remainder of the year.”
Target raised prices on a lot of items during the quarter but overall costs rose much faster than retail prices. This caused a year-over-year decline in gross margin.
Target doesn’t expect the challenging conditions that are occurring to improve right away.
Target delivered 3% growth in comparable sales in the 1st quarter with growth being the strongest in frequently purchased items like beauty and food & beverage.
Here is what Target’s Chief Growth Officer said on the call,
“As [the chairman and CEO] Brian mentioned, first quarter gross margin performance was well below our expectations. This was driven by a number of factors. The most impactful of which was softer than expected sales in several categories, resulting in too much inventory in those areas. As we developed our plans for the quarter, our task was to anticipate how spending would change under circumstances no one had ever seen before given that we were about to compare over 2 years of historically high federal stimulus payments. As such, we relied on numerous forecasts and estimate, both internal and external, to help determine our view for the quarter. Despite this careful approach, the mix of actual demand materialized differently than we had anticipated.”
Some of the challenges Target is seeing are their vendors are facing multiple constraints in their businesses and there are capacity constraints in the global and domestic freight markets. This is making it more difficult to move inventory to get it where it needs to be, and it is lowering gross margins because of higher freight costs.
Freight and transportation costs were hundreds of millions of dollars more than management expected. Incremental freight and transportation costs for the year are now expected to be $1 billion. Slow delivery times due to supply chain issues hurt gross margins also.
Higher headcount and compensation in their distribution centers weighed on gross margin.
Target’s construction team saw volatile raw material and labor prices for their new store and remodel projects. There was also mention on the call of permitting and inspection delays in some communities.
Target’s first quarter operating margin rate of 5.3% was 4.5 percentage points lower than last year’s. (This was a sizable drop)
The only positive news I heard on the call was management plans to recommend to the board an increase in the quarterly dividend later this year and they will repurchase $2.75 billion of stock by June. The downside of the share repurchase though is that it will be below the $7 billion of shares that were repurchased in 2021. And the stock price was higher in 2021 than it currently is at now because of the the large drop after they reported Q1 22 earnings.
Trailing 12 month after tax ROIC is still high at a rate of 25.3%, but it was much lower than management expected.
Prior guidance for Target’s full year operating margin rate was 8%, but management said it will end up being well below this percentage after the unexpected cost headwinds.
The analyst at Barclays asked Target about an Analyst Day they had in March on the earnings call. I thought Target’s response was very interesting.
Here is what the CEO said:
“Karen, as we stand in front of you and others in March , we did not anticipate the rapid shifts we’ve seen over the last 60 days. We did not anticipate that transportation and freight costs would soar the way they have as fuel prices have risen to all-time heights… And we certainly didn’t anticipate the impact that would have on our supply chain costs. So things changed rapidly after we sit on stage in New York. We own that.”
I find it interesting because Target is referencing an event that was only two months ago. It’s not like this was a year or even 6 months ago. Two months is a very short period of time for such a change to occur.
Target increased average selling prices a little, but it was offset by a reduction in units per basket. They are more focused on driving traffic and creating a positive guest experience.
CEO Brian Cornell said:
“And you should expect us to surgically pass along cost where appropriate. But we’re also laser focused on protecting our value position in this environment and making sure we provide great affordability to the guests in a time of need.”
Management mentions that margins will improve later this year. Being as how bad they were in Q1 22, I believe them, but how much will they improve is the real question.
Also mentioned on the call was their inventory was higher in Q1 than it has been in the past. Management mentioned the following reasons for this:
They have some categories where they have too much inventory so they need to work through it.
Product cost inflation is reflected in that inventory balance.
Management is trying to land product sooner so they have it available for their customers because of the supply chain issues.