Consumption is still strong at Target, despite inventory woes

Target saw operating margins crumble after a forecasting miss pushed the company to rapidly mark down billions of dollars of apparel in a few short months. The Minnesota-based retailer typically earns around 30% gross margin across its portfolio but saw that number decline to about 23% this quarter. The numbers fall even further when accounting for operating expenses—down to about 1%. “Our focus throughout the second quarter was to ensure that we took care of the excess inventory of our network and adjust future receipts to reflect the rapid change in sales trends we’ve seen so far this year,” CFO Michael Fiddelke told investors. “We accomplished this goal to the benefit of our operations, our team and our guests.”

Inventory levels should stabilize at Target

According to management, inventory markdowns accounted for almost all margin compression, and it expects profitability to return to normal levels. “Based on the success of our Q2 inventory actions and our current performance,” CFO Michael J. Fiddelke said, “we remain positioned to deliver an operating margin rate in a range around 6% in the fall season.”

Despite the poor profitability, Target had strong sales growth. Overall, comparable sales increased almost 3%–on top of nearly 9% a year ago. Essentially, sales are up 11% from the pre-pandemic era. It isn’t just inflation. According to management, Target is growing in unit share and traffic. Even for discretionary items, where the company had significant markdowns, sales were still strong. There just wasn’t much margin. “Sales were softer than a year ago,” Chief Growth Officer Christina Hennington said, “but remained nearly $3.5 billion or more than 35% higher than the second quarter of 2019.”

As you can imagine, the composition of sales will change moving forward. Target is prioritizing food and beverage while supplementing it with high-margin categories like Beauty, toys, and its brands. The company now boasts 12 $1 billion brands.

Given that Target took a big inventory loss over the last two quarters, management feels they have an efficient machine that should start returning significant returns.