We have discussed the challenges, if not carnage, in the retail pace for some time. For Target specifically, we discussed management’s missteps concerning inventory management and suggested option traders sell a May 160/170 call spread on March 18. That spread expired worthless, putting a few bucks in traders’ pockets.
Target competes head-on with Walmart and Dollar General. The big difference between Walmart and Target is that Target tries to be a little more upscale in the middle market of shopping. The stores are more open, bright, clean, and organized.
Since Target sold food, it was one of the stores that benefited from the C19 lockdown. This, of course, allowed them to sell everything. Since production was shut down, there were product shortages globally. Companies like Target tried to game the system and order more than they needed figuring they would not get what they ordered but get what they needed to service their customers. It turns out they ordered the wrong things incorrectly, and the company is still dealing with excess inventory. This signifies a company’s unwillingness to admit a mistake, clear the shelves and move on.
The chart above shows that the share price started a bull run in 2017. That move hit the nitrous button at the March 2020 bottom and rose 190% in about 15 months. Then as the world began to normalize, Target lost its government-granted advantage as all retail stores were allowed to reopen. TGT stock has been in a bear move ever since. Our reading of the tea leaves suggests there is more downside and potentially a lot.
Why is this? Target sells consumer staples like food, clothing, housewares, etc. As mentioned above, they still have not addressed their inventory problems, causing their margins to fall. We suspect earnings will be down in the year ahead as a result. This is particularly troublesome as the shares trade at 24 times trailing earnings. Analysts are expecting earnings to grow. Since we think it will fall, we believe investors will be disappointed and eventually sell the shares.
So how low can they fall? If we follow our rule of equal movements, the shares could fall by as much as 50%. We suspect it will take a year or two to get there if it does. Target has been a great performer for decades, and they have a loyal stockholder base. These folks are patient and will probably stick with the company. But a 50% drop is quite dramatic. We think the company’s mistakes are big enough to warrant a change in management. If that happens, the company’s prospects may turn around.
Technically, the shares are trading just above a support level of $140. Given the share’s recent fall, we suspect there could be a bounce before it ultimately breaks this level. A catalyst for the breakdown may be the backlash building about the company selling LGBQ+ products for children and even infants. They now sell girls’ clothing in the boy’s department. There is an online campaign to boycott Target, which could be damaging. InBev made a drastic mistake using a trans influencer to promote Bud Lite. Now that cannot give it away. That stock is down 15% since they started that campaign. That is a loss of $20 billion in market capitalization. Target has responded to the online boycott campaign by removing the product from some stores, but their big move was to move the displays to the back of the stores. It seems they have another inventory problem and are unwilling to admit another mistake. TGT is at risk of suffering the same fate as Anheuser-Busch InBev.
Given our bearish view, we think traders should sell a call spread on the name. With TGT trading at $143.10, consider the following structure.
In this trade, the investors will collect $393 upfront from initiating the transaction, which they can keep if the share price trades below $155.00 at expiration. Since there is $10 between the strikes, the most one can lose is $607. This loss will occur if the share price trades above $145.00 at expiration. The breakeven level is $148.93, $5.83 (4.1%) above the current price. Since this is a low-volatility stock (29%) and this spread is out-of-the-money, the probability of profit is about 64%, assuming a random walk. If the trade works, the investors will make a 65% (393/607) return on their capital, put at risk for 57 days.
