Target's latest pivot was a 'rip the bandaid off type event': Analyst

The general read from Wall Street in the wake of Target's surprise warning on Tuesday is that things can't get much worse from here.

"While this news is painful to digest, we are hopeful that this is a rip the bandaid off type event that will allow the company to operate more efficiently in the second half and beyond," RBC Capital Markets analyst Steven Shemesh wrote in a new note to clients. "We expect investors to tread with caution near-term, but believe this decision ultimately makes the name more investable."

Shemesh maintained an outperform rating on Target but cut his price target to $231 from $239.

"Our #1 question at this point is what changed in the 3 weeks since the company reported 1Q results"? Shemesh added. "While we don't yet have a definitive answer, we suspect management came to the realization that discretionary categories are perhaps in worse shape than they initially assumed."

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 Tuesday's session, and the company's ticker page was the most active ticker on the Yahoo Finance platform by midday. The stock gained .46% on Wednesday's session.

"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 stopped short of saying 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 the first quarter's operating margin rate of 5.3%.

Ourtone band-aid bandage strips made for a variety of skintones, by Johnson and Johnson, Target, Queens, New York. (Photo by: Lindsey Nicholson/UCG/Universal Images Group via Getty Images)
Band-aid strips made for a variety of skin tones in a Target in Queens, New York. (Photo by: Lindsey Nicholson/UCG/Universal Images Group via Getty Images) (UCG via Getty Images)

Other analysts were less optimistic than RBC's Shemesh: Bank of America analyst Robby Ohmes cut his rating on Target to neutral from outperform and warned about a potential consumer-led recession in 2023 that could further pressure the retailer.

"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 note. "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."

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

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