Target and Walmart paint a challenging near-term picture

The news: Target and Walmart both posted Q1 results that fell short of expectations due to a host of factors that impacted their bottom lines, including rising fuel and transportation costs, staffing challenges, and a shift in the products shoppers were looking to purchase.

• While Target’s comparable sales grew 3.3% year-over-year (YoY), higher costs led its net income to fall 52% to $1.01 billion YoY.
• Walmart’s comparable sales rose 3.0%, but its net income declined 25% to $2.05 billion YoY.

Challenging days ahead: The headwinds faced by Target, Walmart, and other retailers are unlikely to resolve anytime soon, which was reflected in the companies’ guidance.

• Target, which had a 9.8% operating margin in Q1 last year, saw its operating margin shrink to 5.3% in Q1. That was “well below expectations” due to the “rapidly shifting macro backdrop and changing consumer behavior,” said CEO Brian Cornell during the retailer’s earnings call.
• The retailer expects its full-year 2022 operating income margin rate to be around 6%, which is far short of its previous forecast of around 8% of sales. In the short term, it projects its Q2 operating margin will be about 5.3%.
• Walmart expects robust consumer demand and higher prices on some products will help it grow its FY23 net sales 4%, up from the 3% it forecast in February. But rising costs will mean that its operating income and earnings per share will be “flat to up slightly,” down from the low- to mid-single-digit growth it expected earlier this year.

Divergent explanations: The two merchants offered different perspectives for their product mix misfires.

• Target says it continues to see healthy spending from consumers, but that they have abruptly shifted their behavior as they return to pre-pandemic activities. For example, luggage sales grew over 50% as people resumed traveling, while sales of items such as TVs and kitchen appliances dropped off.
• Walmart, on the other hand, noted that some cost-conscious customers traded down from market brands to private label, particularly for items such as lunch meat, bacon, and dairy products.

Short-term pain for long-term gains: Target and Walmart both benefit from cost-conscious consumers looking for a deal, particularly given the current climate in which consumers' assessment of their financial situation relative to a year ago is at its lowest reading since 2013.

• The situation has helped Walmart gain market share in grocery, which is its top sales category, per CNBC. While that suggests Walmart may be attracting more grocery shoppers, in the short term those low-margin sales pressure its profits.
• Target plans to lure shoppers by focusing on value, even if it means absorbing some costs.

The big takeaway: Retailers need to navigate a difficult terrain as inflation continues to rage, supply chain challenges persist, and consumers’ behaviors shift.

• A confluence of factors—the slowing economy, persistent inflation, high gas prices, and rising interest rates, among others—is making some consumers increasingly price-conscious.
• However, US retail sales grew 0.9% in April month-over-month, which suggests that the economy has not (yet) hit a wall and there’s ample opportunity for retailers to adjust their strategies to boost their bottom lines.