Walmart (WMT) shares moved sharply lower Tuesday, with Amazon (AMZN), Costco (COST) and Home Depot (HD) following suit, as investors dumped retail stocks in the wake of Target's (TGT) surprise warning on profit margins and the prospect of deeper near-term discounts from overstocked merchants over the summer months.
Target, which cautioned earlier this year that its bigger-than-expected 35% build-up in overall inventories would likely trigger price cuts, said Tuesday that deeper discounts would be needed to shift the excess goods, adding that operating margins would narrow to around 2% over the current quarter before rebounding into the second half of the year.
Citigroup analyst Paul Lejuez noted that average U.S. retail inventories are outpacing sales gains by around 10 percentage points, the widest gap since the pandemic, as retailers struggle to manage both supply chain disruptions, fuel and freight costs, and rapidly shifting consumer habits.
That effect was no more evident than in the surprisingly solid first quarter results from Macy's (M) and Nordstrom (JWN), both of which saw significant shifts in demand from casual to more formal attire for the spring and summer seasons.
Larger, more diverse retailers, however, might be stuck with bulging levels of unwanted merchandise as a result of their eagerness to get in front of supply chain snarls, and that could mean deeper price discounts for inflation-strapped customers.
Walmart, which saw a 33% increase in overall inventories last quarter, said in early May that it would keep prices "as low as we can" in order to shift inventories over the coming months.
Costco inventories were up 26% over its fiscal third quarter, which ended on May 8, thanks to both the ongoing inflation surge and the addition of a "few hundred million dollars" worth of late-arriving holiday merchandise.
Home Depot, which said inventories rose 31.7% to $25.3 billion -- outpacing sales for the past four quarters -- only saw a modest narrowing of its operating margin, which was pegged at 15.2%, but could find itself facing tougher consumer patterns as the housing market slows.
"As the operating environment remains difficult for retailers, and perhaps more so than even a few weeks ago, Target is taking several aggressive steps in the near term to more aggressively clear inventory, which will result in lower 2Q22 margins and earnings than previously anticipated," said D.A. Davison analyst Michael Baker, who lowered his price target by $34, to $171 per share, while holding his "buy" rating in pace following Tuesday's margin warning.
"While this is a painful period for Target, taking their medicine (again) in 1Q22 and 2Q22 does set up for a better second half with cleaner inventories," he added. "We think this can set up for a better second half for the stock as well."
Walmart shares were marked 1.45% lower in early afternoon trading Tuesday and changing hands at $123.19 each, while Home Depot slumped 1.44% to $299.44 each. Costco was marked 0.4% lower at $470.70 each while Amazon fell 2% to $122.52 each.
Target was last seen 3.5% lower at $154.35 each.
The S&P 500 Retailing Group is down around 24% so far this quarter, its worst performance since 1990, as investors expect more pain to come from both the Fed's rate-based inflation fight and the highest nominal domestic gas prices on record, which continue to pinch household budgets and discretionary spending.
U.S. retail sales growth steadied in April, data from the Commerce Department indicated earlier this month, as record high gas prices and surging inflation failed to deter spending in the world's biggest economy.
Inflationary pressures remain acute, however, even as the Commerce Department's headline April reading eased from a 40-year high to 8.1%, with so-called core inflation, which strips-out volatile components such as food and energy prices, rising 6.2%, near the highest since February of 1991.
