Target Cuts Q2 Operating Margin Rate Guidance on Bloated Inventory

Target warned Tuesday that rising inventory will squeeze profits in its July quarter, and it slashed operating margin rate guidance to “around 2%.” That’s down from the “wide range” around 5.3% guided to by Chief Financial Officer Michael Fiddelke last month on the company’s fiscal Q1 earnings call for the quarter ended April 30 (see 2205180037).

The 5.3% Q1 operating margin “was well below expectations,” Fiddelke said then. The company was “carrying too much inventory” in several categories, including electronics. In its Tuesday update, Target announced a “set of actions to right-size its inventory for the balance of the year and create additional flexibility to focus on serving guests in a rapidly changing environment.”

Actions include additional markdowns, beyond the ones Target cited last month on TVs, as Target reacted to consumers' demand shift away from “bigger, bulkier products,” such as TVs and furniture, to make room for fast-growing categories. Shares closed 2.3% lower Tuesday at $155.98.

It's now “removing excess inventory and canceling orders,” and plans to bump up its holding capacity near U.S. ports to add flexibility and speed in the parts of the supply chain most affected by “external volatility.” Its plan includes “pricing actions to address the impact of unusually high transportation and fuel costs,” and it's working with suppliers “to shorten distances and lead times in the supply chain." The company is planning five distribution centers over the next two fiscal years to support future growth.

Target is accelerating work “already in flight,” including “rapid revisions to sales forecasts, promotional plans and cost expectations by category,” it said. It will focus on strong categories, while planning “more conservatively" in discretionary categories such as home, “where trends have changed rapidly since the beginning of the year.” It's pursuing “aggressive options to control costs,” including working with vendors to offset inflationary pressure, driving operating efficiencies and cutting costs, it said.

Traffic and sales remain healthy “despite sustained volatility in the macro environment, including shifting consumer buying patterns and rapidly changing operating conditions,” said CEO Brian Cornell. Steps Target is taking to “remain nimble” will result in additional Q2 costs, Cornell said, saying the company expects the “rapid response” to changing conditions to pay off “over time.” Management projects improved profitability in the second half with an operating margin rate of around 6%. It maintained revenue growth guidance in the low- to mid-single digit range.

Target’s alarm bells followed comments by Walmart executives about excess inventories at a Friday investor event. Getting the inventory level right is key, said CEO Doug McMillon: “When you get too much, you get too many markdowns … You get too little, and you don’t have enough to really drive the margin mix.”

Walmart’s inventory was up over 32% at the end of the April quarter, said Walmart U.S. CEO John Furner: “Probably 20% of it, if you could just wish it away and make it disappear, you would.” A third of the inventory was getting the retailer back to more normalized levels after outsized out of stocks throughout the COVID-19 pandemic, he said.

Furner said it will take this quarter and “maybe a couple of quarters” to get where Walmart wants inventory to be. It brought some inventory forward in response to long lead times at ports, and has “late Q2 and Q3 inventory already here.” A lot of inventory that had been backed up in ports came through in early February, he said, "and it came through much quicker."

McMillon described the pandemic spending on goods, and not services, as “not a real world” period. It was “a temporary situation all along, and we knew that.” Walmart’s plan is to grow share whether consumers are buying goods or going on vacations, he said.