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Target Shocks as Supply Chain Costs Halve Q1 Net Profits

“Hundreds of millions of dollars” in higher freight costs drove a Target earnings miss that sent shares down 24.8 percent in late-morning trading Wednesday to $161.91.

“Target’s disappointing 1Q results and lowered guidance support Fitch’s view that retailers will increasingly contend with shifts in consumer budget toward services like travel and entertainment after two years of strong growth in consumer goods,” said David Silverman, senior director at the credit ratings firm Fitch Ratings.

In a Nutshell: Chief financial officer Michael Fiddelke said Target doesn’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,” he told Wall Street analysts on a conference call.So the elevated costs we’ve been facing will continue to affect our profitability for the remainder of the year.”

According to Target chief operating officer John Mulligan, “actual [freight] conditions and costs have been much more challenging than expected.”

More specifically, first quarter freight and transportation costs came in hundreds of millions of dollars higher than are already elevated expectations, and for the full year we’re now expecting about $1 billion of incremental freight costs, even compared to our expectations, only three months ago,” he said.

While Mulligan cited high fuel prices, he said global shipping market costs are “unusually high,” particularly when the retailer needs to rely on the spot market to secure adequate capacity.

Target “ended up carrying too much inventory in several categories where the slowdown in sales was more pronounced than expected,” Mulligan said of the retailer’s attempt to match demand in apparel, home and hardlines that ultimately missed. The company has secured temporary storage so that less of the excess inventory will be “jamming store sales floors.”

“While apparel basics moderated in the quarter, trend-based apparel accelerated meaningfully as increasingly people are returning to the office or dining out with friends,” said Christina Hennington, chief growth officer,, adding that Target saw small declines in comparable sales, which were nearly flat to last year. In addition, home also saw a small comps pullback, with customers now refreshing their homes with décor and seasonal assortments.

Target’s private brand portfolio continues to strong strength and “drive trips to Target,” Hennington said.  The retailer is partnering with actress, author and TikTok personality Tabitha Brown for limited-time-only collections launching over the next year. Starting on June 11, the first collection of over 75 apparel, swim and accessories items in sixes XX-4X will be in most Target stores and on Target.com, with most items priced at $30 or less.

Tabitha Brown for Target

Tabitha Brown for Target

Although Target expected consumers would refocus spending away from goods and services, “we didn’t anticipate the magnitude of that shift,” CEO Brian Cornell said. “This led us to carry too much inventory, particularly in bulky categories, including kitchen appliances, TVs and outdoor furniture.”

Cornell said the retailer also raised prices across a “broad set of items in multiple categories.”

Target’s business continued to grow in the first quarter, with comp sales up 3.3 percent of top of the 22.9 percent gains a year ago. Traffic increased nearly 4 percent in the quarter on top of 70 percent gain from a year ago. Digital-sales growth was led by streaming services and drive-up.

“Our first quarter gross margin rate was well below our expectations, reflecting a combination of factors that proved to be very different than expected, driven by a rapidly shifting natural backdrop and changing consumer behavior. Specifically, we saw much higher-than-expected freight and transportation costs, and a more dramatic change in our sales than we anticipated,” Cornell said.

Target’s first-quarter miss follows Walmart and Amazon‘s disappointing numbers.

Net Sales: Total revenue rose 4 percent to $25.17 billion from $24.2 billion, which included a 4 percent gain in net sales to $24.83 billion from $23.88 billion.

Earnings: Net income dropped 51.9 percent to $1.01 billion, or $2.16 a diluted share, from $2.1 billion, or $4.17, in the year-ago quarter. On an adjusted basis, earnings per share (EPS) was $2.19.

Wall Street was expecting adjusted EPS of $3.06 on revenue of $24.49 billion.

For the second quarter, Target set a wide range for its operating income margin rate, centered around the Q1 5.3 percent level.

We now believe our full-year operating-margin rate will be well below our prior guidance of 8 percent or higher, more specifically, given the elevated level of volatility we’re currently facing, and multiple sources of uncertainty going forward. We see a range of potential outcomes, centered around a 6 percent operating margin rate for the full year,” Fiddelke said.

CEO’s Take: “It’s clear that many of these pressures will persist in future quarters. But that hasn’t affected our long term plans and expectations, including… the ability of our business to grow mid-single digits and maintain an operating margin of 8 percent or higher over time,” Cornell told investors.

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