Target Q3 Earnings Preview: From $500M Loss To 40% EPS Growth

Summary:

• Analysts are optimistic about Target, expecting $26B in revenue and a 9.5% YoY EPS growth, despite mixed top-line revisions.
• Target faced challenges with shrinkage, but recent efforts have shown improvement, contributing to a $500M efficiency gain.
• FY 2023 results were strong with a 50% YoY EPS increase and higher operating margins, though comparable sales were declining.
• In this article, let’s take a look at the upcoming earnings report to see what we can expect.

Target Q3 Earnings

The general consensus on Target’s earnings seems positive. Revenue should be close to $26B, a 2% YoY growth, while EPS of $2.30 should be 9.5% above last year’s Q3. Overall, analysts expect improved profitability. In fact, we have 27 upward EPS revisions versus only four downward revisions, while on Target’s top-line analysts are more uncertain with 13 upward revisions and 17 downward revisions.

After all, positive news is coming in. At the end of 2022, Target (NYSE:TGT) issued a big warning on shoplifting and investors punished the company’s lower margins. Target talked about a $500M dent in its profits. At that time, it seemed big retailers were unable to fight off this new wave of crime. The only retailer that seemed able to fight off this epidemic was Costco (COST), due to its unique business model. Some stores in major cities were shut down, security was hired, and high-ticket merchandise was locked up more frequently. Then, in August, as Target held its Q2 earnings call, it started talking about a new story: shrink was barely perceivable, and the company said it was making good progress to keep it under control.

After all, things started going well for Target in late 2023, and the company’s FY 2023 results were outstanding, with FY EPS 50% higher YoY and the operating margin being 2% higher YoY. However, while profitability improved, Target’s comparable sales were still declining. So, the main driver of the positive results was a $500M improvement in efficiencies.

Back then, Target said it expected FY2024 to show a “modest increase in comparable sales in a range from flat to two percent. GAAP EPS and Adjusted EPS are both expected to range from $8.60 to $9.60”.

Let’s look at what Target has achieved so far and what we could expect from Target’s upcoming Q3 earnings report.

So far, in Q1 Target reported -3.7% comp sales, and -4.8% in-store comp sales. EPS kept doing well and came in at $2.03, close to the high end of the guidance range ($1.70-$2.10). In Q2, Target’s comparable sales finally increased 2% YoY, with store comp sales up 0.7% YoY. EPS increased 40% YoY to $2.57. No wonder the company announced “it was back to sales growth” driven entirely by traffic. As a result, the Q2 operating margin was 6.4%, up 160 bps YoY. Surely, the 8.7% growth in digital comparable sales helped Target’s results. But also discretionary categories such as apparel reported a nice 3% growth. As positive as this may be, these results confirm my view on Target: although it enjoys strong brand recognition, it presents some vulnerability to economic downturns since its sales mix is more sensible to discretionary items than Walmart’s (WMT). In fact, among its main categories, we find apparel and home goods, which are discretionary. Moreover, it is in no way close to having a solid stream of high-margin revenue such as Costco does with its membership.

And here we are with the upcoming Q3. Three months ago, Target guided for a flat to 2% increase in comparable sales, with EPS that should be between $2.10 and $2.40. As we can see, the current consensus leans toward the high end of this range. The FY guidance remains a 0%-2% increase in sales, even though Target believes the overall result will “more likely be in the lower half of the range”. However, Target’s EPS should be in the range between $9.00 and $9.70, up from the expected range announced in March. So, we are going to see a company truly focused on getting rid of excess costs to improve its profitability in an environment where it is difficult to significantly grow the top line. To Target’s credit, this result is particularly good because since the start of this year, the company has been lowering prices on thousands of items, and with the last announcement of a price cut on over 2,000 items, Target believes that by year-end it will have lowered prices on more than 10,000 items. If EPS keeps improving, the company is truly focused on efficiency.

Target’s EPS is also growing nicely thanks to its share repurchases. Just in Q2, it bought back $155M of its shares, decreasing the share count by 1.1M.

By the way, right after Q3, we will start looking ahead to Target’s Q4 results which are traditionally a big quarter due to Christmas holiday spending. On Black Friday, Target will release unique Taylor Swift merchandise (the Eras Tour book, an anthology album on vinyl) that will drive more traffic that could offset a rather short shopping season with only 26 days between Thanksgiving and Christmas.

Valuation

Target’s current valuation is interesting: a 16 fwd PE is not demanding and a 9.8 as the fwd P/FCF ratio seems cheap, too. One of its main competitors, Walmart trades at a fwd PE of 34 and a P/FCF above 20. Costco is even more expensive. So, there is a big gap between Target and the rest of the industry. While I would not consider Costco the right comparison, I think the discount to Walmart’s valuation has become too wide. But this might mean that Walmart’s multiples will contract a bit, rather than driving a multiple expansion for Target.

However, Target has become a very interesting pick for dividend-seeking investors. Its payout ratio is 45%, which is very sustainable. Its forward dividend yield is close to 3%, and its 5-year dividend growth rate is 11.4%, even though this year Target increased its dividend by only 1.9%.

I don’t want to pull the trigger and buy Target. This is because I don’t think its business is well protected from stiff competition and pricing wars. Moreover, while I think Target’s stores offer a pleasant shopping experience, it relies more on discretionary item sales and this makes its earnings a bit more unpredictable than I would like. In addition, I usually hold good companies in my portfolio whose revenue growth is above 10%. Target doesn’t meet this criteria, yet. Nonetheless, its ability to quickly recover its margins and its profile as a reliable dividend payer might make it an interesting pick for some. In this case, I would not worry about the upcoming quarter. The chances that the report will be good are high, and I wouldn’t expect too much volatility in the share price or daily volume.

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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