Sorry, but Target’s Q2 results weren’t as great as the stock’s rally suggests

Congratulations for Aim (TGT 1.07%)and congratulations to its shareholders. The retailer’s stock rose more than 10 percent on Wednesday in response to better-than-expected second-quarter numbers. It also raised its full-year profit guidance, further fanning the bullish flames.

However, there are a few footnotes regarding the company’s second-quarter results that may make you rethink the idea that Target is completely back on track. Indeed, you may want to at least wait until the current quarter’s numbers are in before making a decision on owning this stock.

Red flags on target

For the three months ended in early August, retailer Target turned revenue of $25.45 billion into earnings per share of $2.57. Sales improved 2.7% year-over-year, leading to a 42% increase in earnings, which were depressed by tough economic conditions in the comparable quarter of 2023. Last quarter’s results also beat estimates for sales of nearly $25.2 billion and earnings of $2.18 per share. Same-store sales rose 2 percent, ending a four-quarter streak of comparable sales declines.

Investors understandably celebrated the report, especially given that the company raised its 2024 earnings-per-share outlook from a range of $8.60 to $9.60 to somewhere between $9.00 and 9. $70.

But there are some additional details you should know about these numbers. Chief among them is that the year-ago comparison was an unusually low bar.

The chart below tells the story. In most years, sales move higher than the Q1 number in Q2. Last year, they didn’t. They moved lower. So a modest 2.7% increase is not necessarily a reflection of strength this time around.

Data source: Target Corp. and Macrotrends. Chart by author. The numbers are in the millions.

At the same time, inventory levels moved significantly higher again in Q2 of this year. This could be a sign that Target is easing its way back to the bloated inventory levels seen in early 2022 that caused profit problems later that year.

How is that a problem? Here’s the deal.

Of course, the amount of merchandise a retailer has in its stores and warehouses seems irrelevant on the surface. After all, inventory is inventory — you sell it when you sell it.

It’s just not that simple. Not all inventory is always marketable. School supplies sell better in August, for example. Swimwear can only be sold in spring and early summer. Demand for holiday decor doesn’t pick up until November. Sitting on too much of the wrong merchandise at the wrong time not only overcrowds stores, but can prevent a retailer from being able to buy the goods they might be able to sell more easily in the near future. There is also the not-so-small challenge of shrinkage, loss and deterioration of longer goods lingering on store shelves.

Target isn’t waist-deep in the kind of inventory mess it was mired in a few years ago, to be clear. And for the record, gross margins remain strong. It is not forced to discount its merchandise to convert browsers into buyers.

Still, it’s a worrying quarter-on-quarter increase. Inventory levels are back to frothy 2022 levels, but sales are flat (at best). The pre-holiday inventory build-up shouldn’t happen as much until the current quarter. A slight increase in retailer sales is likely only the result of an even greater stock build that offers more selection than usual. Underscoring all this concern is the fact that Target isn’t anticipating any real sales growth for the fiscal year we’re now halfway through.

Too much bad news to bet on Target stock right now

It’s not all bad news… at least not yet. As noted, Target still enjoys solid pricing power. Gross margin rates are rising, approaching levels last seen at the height of the COVID-19 pandemic in 2021, when bored consumers were ready to spend money on almost anything.

Data source: Target Corp. and Macrotrends. Chart by author. Inventory figures are in the millions.

Perhaps these strong profit margins will subsequently persist.

Pricing power is, however, largely a function of the health of consumerism, and this is increasingly being questioned. While seemingly on a stable footing at the moment, data from consumer research team Numerator indicates that Americans’ outlook on the economy, labor market, household finances and comfort with discretionary spending all took slight hits last month, optimism for employment labor force decreasing the most. .

In other words, we may be closer to a failure that stifles spending — and therefore pricing power — than it appears on the surface. If that’s the case, Target’s apparel, decor and other discretionary lines will be the first to suffer a setback. WalmartT2’s impressive report included color explaining that consumers remain quite value conscious. Ditto for recent reports from PepsiCo and McDonald’s.

The bottom line? At the very least, interested investors will want to wait for the retailer’s third-quarter numbers, due in November, to decide whether or not Target’s Q2 results mark the beginning of a rekindling of strength. However, we may have to wait even longer than that.