There’s been a lot written over the last few years about the impact of COVID-19 and the supply chain crisis that left retail shelves nearly empty since March 2020.

COVID caused a run on things like toilet paper, lockdowns in China closed factories that produced goods we buy here in the US, and the supply chain crisis caused ships to back up in ports which kept goods off of shelves around the country.

As a result, retailers, not knowing when they would ever be able to re-stock shelves, ordered a lot of inventory in hopes that it would make it to shelves in time to fill demand.

That was then, but now retailers face a new dilemma.

The inventory they ordered during COVID-19 has finally made its way to shelves, and now they’re sitting on huge excess inventories at a time when consumers are cutting back on discretionary spending due to sky-high inflation. Clothes now out of fashion, undesirable appliances, and unaffordable tech are now overloading shelves and warehouses around the country.

Retailers have to get rid of these products somehow, which means…

After months of out-of-control inflation afflicting consumer goods, the prices on some of those goods will be slashed. It could be a bad day for certain retailers. But for us, this is an opportunity.

Read on and learn how we’ll benefit from inventory overload.

Dealing in Necessity

To understand just how much excess inventory US retailers are holding right now, consider that (based on recent quarterly earnings reports), Dicks Sporting Goods, Kohl’s, Abercrombie & Fitch, TJ Maxx and Walmart reported inventory excesses of 47.9%, 44.5%, 40.7%, 39.1%, 35.2%, and 29.7%, respectively.

That’s an enormous amount of inventory that’s building up on shelves and clogging up warehouses. These companies must get rid of that inventory to make way for seasonal products and the latest trends.

That means we can expect these companies to start slashing prices to clear out that inventory. If those lower prices show up in the next quarter’s results, that could be tough for companies that haven’t already started to deal with their excess inventory.

Of the above-listed stores, a few names pop out as being in trouble, while a few have the diversity in products to weather the markdowns in pricing.

For instance, Dicks Sporting Goods, Kohl’s, Abercrombie & Fitch, and TJ Maxx all sell things that people can live without. And they don’t sell many things people must have.

On the other hand, Target and Walmart sell consumer staples such as food, medicines, and toiletries. Those are all items where the companies can hold (or even raise) prices to offset the lower prices on discretionary items such as televisions, furniture, clothing, and housewares.

Of those two companies, though, I really like Target Corporation (TGT).

On May 18, 2022, Target Corporation reported its first-quarter results of 2022 , which missed analyst expectations, and the stock dropped 25% – its worst day since 1987.

For the quarter, the company reported revenue rose 4% to $25.2 billion, well above analyst expectations of $24.3 billion.

Not only did the company easily beat revenue estimates, but it’s on track to generate $100 billion in sales for the year. And yet, the stock dropped more than 25% in a single session.

Comparable sales climbed 3.3% in the first quarter, almost three times the average of analyst estimates compiled by Bloomberg.

Once again, the company beat estimates, which is good news, but the stock dropped.

If sales were above estimates, what knocked shares down?

For the quarter, adjusted earnings and operating margins were $2.19 a share and 5.3%, which were below analyst expectations of $3.06 and 9.5%.

The company blamed supply chain disruptions (which led to higher expenses) and a shift in shopping habits that favor daily essentials, such as food and beverages and beauty products, rather than bigger-ticket items like televisions and exercise equipment.

Additionally, like many other retailers, Target has needed to boost hourly pay to attract workers, contributing to lower-than-expected earnings.

The earnings and operating margins account for much of the 25% drop. Still, the company was also grappling with the fact that last year’s earnings were boosted by federal stimulus checks from the government, a phenomenon that has largely disappeared in 2022.

To put that in context, consider that the company’s operating margins averaged 5.76% in 2018 and 2019 (prior to the pandemic), and they ballooned to 8.73% from Q2/2020 to Q3/2021 when consumers were flush with government stimulus checks.

Analysts expected operating margins to come in at 9.5%, even though the bulk of the COVID stimulus money had already worked its way through the economy. That’s a significant error from analysts, and it has led to a great opportunity for us.

Operating margins in the recent quarter, of 5.3%, were only slightly below numbers prior to the stimulus, which means the company is doing just fine, albeit with a different revenue blend due to inflation.

And recently, On June 7, 2022, the company announced plans to mark down unwanted items, cancels orders and takes aggressive steps to get rid of extra inventory caused by the shift in consumer spending habits. That pushed shares down another 7% on the news, which made the company even more attractive at this point.

While the recent selloff was painful for investors holding shares of TGT prior to the recent earnings report, the stock looks like a great value at the current price.

Shares of TGT are trading at just 11.97x trailing 12-month earnings, which is well below the S&P500 that is trading at 20.33x trailing 12-month earnings, according to the Wall Street Journal.

In addition to trading at a steep discount to the broad market, the company’s dividend yield is 3.10% with a payout ratio of just 27.96%.

At this point, the recent quarters’ results, and the company’s plans to reduce inventory are already priced into the stock.

Moving forward, any good news will drive shares sharply higher, which is why I like establishing a position now, ahead of a shift in narrative.

With markets still trending lower, I like averaging into shares of TGT, buying a 1/3 position once a month over the next three months. Of course, you could just buy a full position of TGT, right now, but I like spreading the purchase over the next three months in an attempt to lower the cost basis.

Cheers,

— Shah

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Source: Total Wealth