Target Stands by Q2 Price Cuts Despite Operating Income Hit

Target management defended its decision to push out inventory in Q2 at the expense of profit on the company’s Q2 earnings call Wednesday. The strategy cleared a path for it to lock in high-demand items for the second half, executives said. Target’s Q2 operating income plunged 87% year on year to $321 million for the quarter ended July 30, the company said. Cost of sales rose 16.6% to $20.4 million. Comparable sales were up 2.6%, and store traffic grew 2.7%; total sales increased 3.3% to $25.7 billion.

“We could have held on to excess inventory and attempted to deal with it slowly, over multiple quarters, or even years,” said CEO Brian Cornell, saying that might have reduced the near-term financial impact, but “it would have held back our business over time.” Excess inventory would have “hampered our ability to present new, fresh, and fashionable items,” he said, so Target took the path of “aggressively reducing the inventory we already owned and cutting back on receipts for the back half of the year.”

Target “meaningfully reduced” ownership and commitments in categories with softening demand, Cornell said, allowing it to grow in-stock positions in high-demand food and beverage, beauty and essentials categories. Mix accounted for about 10 basis points of gross margin pressure in Q2, said Chief Financial Officer Michael Fiddelke: “The softness in higher-margin categories like apparel and home was largely offset by softness in lower-margin discretionary categories, most notably electronics.”

Chief Growth Officer Christina Hennington said action plans implemented in Q2 called for working through excess inventory “at every point along the product journey from vendor to guest” and “rigorously reforecasting expectations for the balance of the year, and beyond.” In some cases, that meant cutting fall receipts in light of updated expectations, she said.

Despite aggressive price cuts, inventory grew to $15.3 billion in Q2, from $13.9 billion at the end of January. Fiddelke attributed higher inventory dollar volume to the retailer having “leaned into” high-volume categories during the quarter, along with higher unit costs across categories that caused the dollar value to rise.

Target’s team “took a hard look at sales trends and determined ideal inventory levels across every category for the remainder of the year,” said Chief Operating Officer John Mulligan: “As a result, we've meaningfully reduced our fall season receipt commitments in many discretionary categories.” Distribution centers will remain at or below 85% capacity through 2022, down from a peak of “well over 90%” in June, Mulligan said.

Mulligan said there’s “a little bit more to do” to clean up inventory in Q3, emphasizing that the amount of receipts cut from discretionary categories in Q3 and Q4 were “just huge for us.” Because of uncertainty in discretionary categories, if “sales end up a little bit higher, we’ll have a little bit higher sell-through, and that will be a great day,” he said: “But that really de-risks those categories going forward.”

External supply chain issues were a “close second” to excess inventory in the challenges Target faced in Q2, Mulligan said, but there are signs that costs and volatility have peaked. Lead times in global shipping have begun to come down, and “spot rates to move shipping containers have fallen, somewhat.” With lower petroleum prices, fuel surcharges have begun easing from June highs, he said. Mulligan tempered optimism, though, saying conditions remain “highly unfavorable” when compared with pre-COVID-19 pandemic times.

Target remains mindful of continued risks in the months ahead from potential slowdowns at West Coast ports, a reversal of energy cost declines and the potential for further COVID-19 lockdowns in China, Mulligan said. It continues to encounter “far too many delays affecting overseas shipping,” forcing it at times to still pay spot rates to move containers at levels that are “well above our prenegotiated shipping rates.”

To guard against shipping rate increases, Target is moving receipt dates earlier than in the past, “which allows us to mitigate the business risk from receiving shipments later than expected,” Mulligan said. The company plans to “meaningfully reduce our reliance on air freight,” which it had to resort to in second-half 2021 to ensure delivery of seasonal inventory, he said. Target has secured temporary capacity “to store and stage shipping containers near the ports where we receive them,” he said.

Target is on track to complete 200 store remodels this year; over 100 are underway across the country, Mulligan said. It's investing in “several hundred locations” to add Ulta Beauty at Target, co-branded Apple shopping spaces and Disney store presentations to sales floors, he said. It’s on track to add 24 new store locations this year.