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The issue originated from Target’s strategy, along with other retailers, to stockpile merchandise to prevent inventory shortages experienced during the early stages of the pandemic. However, once government stimulus checks ceased and most COVID-19 restrictions were lifted in the U.S. in early 2022, consumers shifted their spending habits away from home goods and clothing – Target’s primary offerings – towards experiences like dining out and vacations. This shift led to an oversized inventory backlog at Target, resulting in deep discounts that eroded profit margins.
The company’s Earnings Before Interest and Taxes (EBIT) margins fell drastically in 2022 to about 3.5%, roughly half of the nearly 7% average maintained over the previous 14 years since the Great Financial Crisis, and lower than even the margin recorded during the crisis year of 2008.
However, signs of recovery have emerged in the first half of 2023 with margins improving by approximately 0.9%. Analysts, including D.A. Davidson’s Michael Baker, predict this positive trend will continue with an additional improvement of 0.3% expected in the second half of the year, potentially restoring EBIT margins to around 4.7%.
Shipping and distribution costs have been significant factors affecting Target’s margins since 2017. In the first half of 2023, these costs were reduced compared to the previous year, contributing to a 0.45% lift in margins.
Inventory shrinkage, which includes theft, another challenge for the retail industry has reportedly reached its lowest point and Target expects it to decrease year-over-year by the fourth quarter. Analysts also note that Target’s inventory is now healthier, which typically aids merchandise margins. The merchandise mix could be a minor drag next year, but analysts believe that margins should rebound close to 2017 levels and estimate a rise of 1% to reach 5.7% next year, above the consensus of 5.4%.
If these forecasts hold true, Target could earn $9.84 per share in fiscal 2024, surpassing the average analyst estimate of $9.04 per share. While only 38% of the 31 analysts tracked are bullish on Target stock, the average analyst price target is $149.21, more than 24% above the current trading level.
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