Just three weeks after a profit warning that saw its shares plunge the most since 1987, Target has slashed its outlook again as it seeks to tackle a glut of stocks amid an economic downturn and rapid abandonment of pandemic shopping habits.

Target Didn’t Anticipate Changes in Shopping Habits

The supermarket chain warned on Tuesday that it would have to take a whole series of measures to reduce excessive stocks of certain products that no longer have takers, which will reduce its margins.

Target stock sank after slashing its profit outlook for the second time in three weeks as it rushes to ease a surge in inventories by marking down items and canceling orders.

The company did not properly anticipate the changes in consumer habits, which have turned away from certain products such as televisions or household items. As a result, Target finds itself with far too many items in certain categories.

The company has therefore decided to offer even more reductions on certain products and to also withdraw certain products and cancel orders on others.

It also plans to increase its storage capacities near American ports in order to have a more flexible and rapid supply chain, adjust certain prices to include rising transport and fuel costs, and work with its suppliers to shorten lead times and distances in the supply chain.

Profit Outlook Cut, Revenue Guidance Maintained

All these decisions will weigh on Target’s profitability and the group expects its operating margin to fall to 2% in the second quarter before rising to around 6% in the second half.

At the same time, Target expects sales of food, beverages, household and beauty products to continue to increase and still expects its revenue to grow by 2% to 5% for the year as a whole.

Chief Financial Officer Michael Fiddelke said that soaring merchandise inventories and “unusually high transportation and fuel costs” prompted Target to cut its operating profit outlook to about 2% of sales this quarter. That’s well below the company’s May 18 projection that the gauge would be in a wide range of around 5.3%. 

The rapidly deteriorating outlook underscores Target’s difficulty in adapting to rapid shifts in demand amid persistent inflation that has forced consumer spending to shift to less profitable commodities and away from discretionary categories such as electronics and household products. This leaves retail businesses with a lot of merchandise that shoppers don’t want.

“Excess inventory doesn’t usually age well,” Fiddelke said in an interview. “We want to make sure that we’re being aggressive to right-size our inventory now.” Fiddelke said these decisions would improve the experience for buyers while increasing value for long-term investors.

Target’s strategy of keeping much of its products affordable is also proving costly for the retailer, with the company now saying it will raise prices to offset unusually high shipping and fuel costs.

“While these decisions will result in additional costs in the second quarter … (it will result) in improved profitability in the second half of the year and beyond,” Target Chief Executive Officer Brian Cornell said.

“Stores and online sales continue to attract healthy levels of customers and sales consumers (…) remain strong,” notes Neil Saunders of Global Data. “The problem is that consumer habits have changed, causing Target problems in certain categories where inventory has ballooned far too much due to bad habits and supply chain disruptions,” Saunders also added.

The Minneapolis-based retailer had already fallen 31% so far this year, including its biggest slippage since 1987 after the release of its first-quarter results, which included the first cut in profit forecasts and a sharp increase in inventory. This follows a huge rise in the share price during the first two years of the pandemic and years of sales growth.

So far, it appears Target’s problems are more “internal than external,” said John Zolidis, chairman of Quo Vadis Capital.  “Sadly, nearly all hard-fought goodwill earned from investors over the previous three years has possibly evaporated in just three weeks,” he said in a research report.

In the United States, excess inventory has been intentionally accumulated to guard against another potential wave of supply chain disruptions that have made some items difficult to find over the past two years. Today, however, retailers must accommodate consumers’ sudden price sensitivity while balancing their own rising operating costs for fuel, labor and other expenses. Holding large inventories of merchandise is expensive and, if merchandise isn’t moving, markdowns further hurt profitability while benefiting bargain-hunting shoppers.

Retailers’ Outlook and Results Add to Market Volatility

The fall of Target’s stock on Tuesday brought down the shares of its rivals, including Walmart Inc., Costco Wholesale Corp., and Best Buy Co. These major retailers have provided mixed results and outlooks in recent weeks, adding to stock market volatility as investors try to determine whether they are signaling the start of a potential recession or a rapid shift in consumer spending. 

The New York Stock Exchange opened lower on Tuesday after retailer Target’s outlook was further downgraded, rekindling concerns about the impact of inflation and the risk of a slowdown in demand. Excluding distribution, growth stocks also fell in a context of rising bond yields.

The market anticipates rate hikes of 50 basis points this month and in July and a probable hike of the same magnitude in September.

“Overall positioning appears to be skewed only modestly toward defense. Our sense is that the shift toward non-cyclicals and high quality will accelerate as recession odds increase in the months ahead. That said, with many investors apparently trying to time recession, U.S. equity markets are likely to remain prone to big upside and downside rips,” Chris Senyek of Wolfe Research said in a note to clients on Tuesday.

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