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“Nearly all of the slowdown was driven by our discretionary categories, Apparel, Home and Hardlines, as our guests became increasingly cautious in their spending in those categories at both Target and throughout the industry more broadly. So far in the month of November, trends have been largely consistent with what we were seeing at the end of October, in terms of our comp trends, the mix of sales between frequency and discretionary businesses and the focus on promotions by our guests.” – Target’s 3Q Conference Call
By Brian Nelson, CFA
After Walmart (WMT) reported its third-quarter earnings November 15, “Walmart Is Back on Track; Markets Looking Healthier,” we thought things were looking a bit better across the retail space, in aggregate, especially considering how bleak things were for discretionary retail earlier this year. We still think that things are improving on the margin, but Target’s (TGT) third-quarter performance, released November 16, threw a wrench in our incrementally more bullish perspective. Though we expect a healthy Thanksgiving week of sales, including Black Friday and Cyber Monday, we’re going to let the data speak for itself when it comes in–as messages across retail remain mixed, at best.
As it relates to Walmart’s third quarter, the big box retailing giant noted that “general merchandise sales declined on tough compares at a low-single-digit pace,” but on a two-year comp stack basis, sales of discretionary items still increased. A two-year comp stack is derived by adding this quarter’s comp percentage growth to that of the same period a year ago. However, on Walmart’s conference call, the firm did mention “softness in discretionary categories including electronics, home, and apparel,” which overwhelmed strength in areas such as “lawn and garden, automotive and back-to-school classroom essentials.”
In the context of Walmart’s generally positive third-quarter performance, we didn’t read too much into ongoing discretionary weakness at the time. However, when Target reported its third quarter results, the following day, November 16, our general enthusiasm was curbed, albeit modestly. Target lowered its top-line and bottom-line expectations for the fourth quarter due to what it describes as an “increasingly challenging environment.” The big ongoing concern was reiterated in the firm’s commentary in the press release where management said that “in the latter weeks of the quarter, sales and profit trends softened meaningfully, with guests’ shopping behavior increasingly impacted by inflation, rising interest rates and economic uncertainty.”
Generally, the cadence of comps in the months through the course of the third quarter may provide some valuable clues as to how the current (fourth quarter) period may be shaping up for Target and the retailing industry, in aggregate, and Target’s comments regarding decelerating trends heading into the holiday season wasn’t exactly welcome news (comps were 3% in the first two months of the quarter and then under 1% in October). Target is now planning for a “low-single digit decline in comparable sales” for the fourth quarter given indications that spending on discretionary items continued to be weak in the first few weeks of November.
On the third-quarter conference call, Target’s CEO Brian Cornell reiterated that “consumers are showing increasing signs of stress and pulling back from discretionary purchases…many consumers this year have relied on borrowing or dipping into their savings to manage their weekly budgets…But for many consumers, those options are starting to run out…guests are exhibiting increasing price sensitivity.” We appreciate Target’s candid assessment of the retail landscape. Here’s more on the current situation in retail from Target’s Chief Growth Office Christina Hennington:
The current retail environment requires tremendous levels of flexibility, resilience, stamina and focus, a balance our team continues to carry out at every guest interaction. Consumers are strained as they work to support their families’ day-to-day needs while looking for the occasional affordable luxury, prepping for the changing seasons and planning for the holidays.
It’s a difficult balance to strike in getting increasingly difficult each week as more and more of their household budget goes towards the needs of the family, which limits the amount available for discretionary purchases. So it follows that of the many considerations that our guests are currently juggling, we consistently hear that value remains at the top of the list. We see our guests holding out for and expecting promotions more than ever, spending less on regularly priced items.
When they shop our frequency categories, some guests are trading into smaller pack sizes, opening price point options or owned brands to reduce their spending on a single trip. Others are opting for larger pack sizes or stocking up when items are on promotion, knowing they will receive greater per unit value. And these trends only became more pronounced towards the end of the third quarter when spending patterns change dramatically.
With inflationary food prices absorbing more of their spending, those costs are crowding out other categories, including spending on discretionary items, and in some cases, even household essentials.
As for a category breakdown on areas of strength and weakness, during Target’s third-quarter conference call, the firm noted that beauty, skin care, and cosmetics performed well, and this may indicate demand resilience for the likes of Coty (COTY), L’Oreal S.A. (LRLCF), e.l.f. Beauty (ELF), Estee Lauder (EL) and Ulta Beauty (ULTA) during the holiday season. Target said on the call that apparel comps were down “only slightly,” and that it experienced “softness in home electronics and sporting goods.” Of particular note, however, Target indicated that it “saw a meaningful deceleration in toys this quarter, most notably in October.” Though it is far too early to tell, in our view, Hasbro (HAS), Mattel (MAT), Disney (DIS) and Funko (FNKO) may face pressure on year-over-year sales growth this holiday season.
Concluding Thoughts
Both Walmart and Target indicated that discretionary spending may face some pressure heading into the holiday season. Strength in beauty, skin care, and cosmetics may not be enough to cushion the blow that home electronics, sporting goods retailers, and toy makers may face. Though incrementally more positive than we were a few months ago, we remain cautious/defensive on the markets.
In light of the tremendous weakness share prices have faced so far this year, we think the market had been anticipating the current slowdown, as retailers continue to adjust to a more difficult economic environment. We continue to wait to see how Black Friday and Cyber Monday numbers shake out to get an incrementally better read on how holiday numbers may pan out, which will have far-reaching implications across the retail and logistics landscapes.
Now Read: Home Depot Says Customers Remain “Resilient and Engaged”
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Brian Nelson owns shares in SPY, SCHG, QQQ, DIA, VOT, BITO, and IWM. Valuentum owns SPY, SCHG, QQQ, VOO, and DIA. Brian Nelson’s household owns shares in HON, DIS, HAS, NKE, and RSP. Some of the other securities written about in this article may be included in Valuentum’s simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.
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