Target warns of shrinking profits from aggressive inventory plan

Target warned investors Tuesday that its earnings will take a short-term hit, as it identifies unwanted items, cancels orders and takes aggressive steps to get rid of extra inventory.

The retailer lowered its profit margin forecast for the second quarter of the fiscal year to account for a wave of merchandise ending up at a huge discount or on the clearance shelf. Shares were down more than 9% in premarket trading after the news.

“We thought it was prudent for us to be decisive, to act quickly, to get ahead of this, to deal with our inventory and improve it in the second quarter — take action to remove excess inventory and prepare ourselves to continue to be a guest,” CEO Brian Cornell said in an interview with C.E. NBC.

By taking quick action, Cornell said the target can stave off more pain and make room for merchandise customers want, such as groceries, toiletries, household essentials and seasonal items like back-to-school supplies. He said the company’s stores and website were seeing strong traffic and a “very resilient customer,” but that he was no longer shopping in popular Covid pandemic categories.

“We want to make sure that we continue to rely on those relevant categories today,” he said.

Target expects Q2 operating margin to be around 2%. That’s lower than the forecast I made less than three weeks ago, when I expected the average operating margin rate for the first quarter of 5.3%.

In the second half of the year, Target expects profit margins to be in the around 6% range — better than its average fall season performance in the years leading up to the pandemic. The company said it still expects revenue growth to be low to average single digits for the full year and to maintain or gain market share in 2022.

Retailers from Walmart to Gap are facing an inventory glut as bloated shoppers skip categories that were popular during the first two years of the pandemic. Gap said, for example, that customers want party dresses and office wear rather than the company’s sweatshirts and activewear. Walmart said some families are making less discretionary purchases as gas and groceries prices rise. Abercrombie & Fitch and American Eagle Outfitters both reported a sharp jump in inventory levels, up 46% and 45%, respectively, compared to last year from a combination of out-of-sell items and supply chain delays.

The extreme shift in consumers’ spending habits comes as retailers begin to return to healthy levels of inventory. This means that some have just as many sports shorts, pillows, and pajamas as consumers look for swimwear and travel bags. Additionally, some shoppers are pulling back on spending due to inflation or allocating more of their dollars to experiences such as dining out and travel.

Cornell said Target decided to roll out its new inventory plan after hearing that its retail competitors had similar problems. He said the company also wanted to precede key sales seasons, such as back to school and the holidays, when vintage merchandise can spoil stores and drive customers away.

Target said it had nearly $15.1 billion in inventory as of April 30, the end of its first fiscal quarter. This is about 43% higher than the same period last year.

Target shocked Wall Street on May 18 with a significant profit loss for its fiscal first quarter, impacted by fuel and shipping costs, higher levels of discounting, and rotations away from items such as televisions, kitchen appliances and bicycles. Its shares fell about 25%, marking the company’s worst day on Wall Street in 35 years.

Walmart missed the earnings forecast, too. Its inventory levels are up about 33% compared to last year. About 20% of these merchandise the retailer would like not to own, John Woerner, CEO of Walmart US, said at an investor event Friday. Roughly a third is additional stock to help the retailer restock key items. He said it would take “a few quarters to get back to where we want to be”.

That company’s shares also fell after Target’s announcement on Tuesday. Walmart shares are down about 4% in pre-market trading.

Cornell said Target is sorting through its inventory, in some cases deciding to pack goods to sell at full price in the future and in others to promote or come up with ways to sell through them now.

For example, he said, Target had a major sales event over Memorial Day weekend to remove bulky outdoor items like patio furniture from his back rooms. It’s also got extra space near US ports to carry cargo, so it has room to move cargo – some arriving very early or very late.

– CNBC channel Lauren Thomas Contribute to this report.

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