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What Target stock needs to rally again after two big warnings

It may take a bit before Target's stock — an impressive performer in retail the past five years with a 186% gain — begins to rally back from two straight surprising profit warnings amid more cautious consumer spending patterns.

And investors will be looking for very specific things to get back on the Target bull train.

"Ongoing margin pressure is likely to constrain Target's multiple at around a 20-25% S&P 500 discount on calendar 2023 earnings, or 12-13x for the next few quarters," EvercoreISI retail analyst Greg Melich wrote in a new client note on Wednesday. "More pass-through power, clean inventory, and additional cost savings are likely needed to win back an S&P 500 multiple or better with steady share gain."

On Tuesday, the discount retailer said that it's aiming to cut inventory by offering discounts, canceling orders, and taking a harder look at expenses. The actions are meant to "right-size its inventory for the balance of the year and create additional flexibility to focus on serving guests in a rapidly changing environment," the company said in a statement.

Target stock fell 2.3% to $155.98 on the session, and the company's ticker page was the most active ticker on the Yahoo Finance platform by midday.

Shares were little changed pre-market on Tuesday as traders assessed the damage.

"We actually do see a continued strong sales environment, traffic and the top line continue to be strong," Target CFO Michael Fiddelke told Yahoo Finance. "But over the past several weeks what we have been able to continue to assess is the broader retail environment — and I think as has been reported pretty widely at this point — the level of inventory in retail is high. And we also expect inflation and higher costs to be persistent."

Fiddelke was hesitant to say the actions were tantamount to the retailer preparing for a recession, stressing that the markdowns will be most acute in discretionary categories such as home goods as consumers curtail some spending.

In light of the actions, Target cut its second quarter operating margin outlook. The company said it's now targeting second quarter operating margins in a "range around" 2%. Previously, Target was looking for margins "in a wide range" centered around first quarter's operating margin rate of 5.3%.

The logo is displayed on a Target store in Washington, DC, on May 18, 2022. - With European markets also in retreat, major US indices took cues from Target, the North American-focused big-box retailer, which plunged around 25 percent after earnings missed expectations despite higher sales. (Photo by Stefani Reynolds / AFP) (Photo by STEFANI REYNOLDS/AFP via Getty Images)
The logo is displayed on a Target store in Washington, DC, on May 18, 2022. (Photo by STEFANI REYNOLDS/AFP via Getty Images) (STEFANI REYNOLDS via Getty Images)

Target maintained its full year revenue growth outlook of low to mid-single digit percentage.

EvercoreISI's Melich noted that investor concern about Target's longer-term profit margins are likely to persist, serving as a cloud over the stock price.

"Debate will persist as to the company’s ability to recover to the 8%+ long term EBIT [earnings before interest and taxes] margin guide (or even their 6% pre-pandemic EBIT margin) with calendar 2022 likely around 5%," the analyst wrote. "A re-rating toward a market multiple will likely require both sustained positive traffic and margin recovery, in our view."

Brian Sozzi is an editor-at-large and anchor at Yahoo Finance. Follow Sozzi on Twitter @BrianSozzi and on LinkedIn.

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