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  • Walmart and Target reported disappointing earnings.
  • Their technical outlook reflects significant risk.
  • It's going to take time before inflationary headwinds abate.

Walmart and Target are arguably among the best-run retailers in the country. Their sheer size gives them massive bargaining power with suppliers, and since their stores criss-cross the country, their results provide important insight into the industry's (and consumers!) financial health. Unfortunately, quarterly results from both companies suggest retailers are reeling because of soaring costs, and consumers are ratcheting back spending on discretionary items, like clothes.

On Monday, Walmart's results caused its shares to fall by 11%. It was worse for Target. After reporting its quarterly earnings, its shares plummeted by 25%. If you're a shareholder, you're likely wondering if that's as bad as it gets, and if you're on the sidelines, you're probably wondering, "are they a bargain-bin buy?" So let's take a closer look.

Costs took a toll

First, let's take a high-level look at the figures that caused the carnage.

In the following table, Walmart reported sales growth of 2% to $141.6 billion, while Target expanded 4% to $25.2 billion. Walmart is a mammoth, so low-single-digit growth is expected. Its revenue grew 2%, 4%, and 1% in the prior three quarters. Target is also a big company, but it's been growing faster. Its revenue grew 10%, 13%, and 9% in the prior three quarters.

TABLE-Street-Smarts-0518

The real problem for these companies, however, was their profitability. Walmart's operating margin tumbled from 5% to 3.7%, and Target's operating margin fell to 5.3% from 9.8%. As a result, earnings per share fell 23% to $1.30 at Walmart and 41% to $2.19 at Target. So, while both companies made money, they made far less than one year ago.

Why did profits tumble? Unsurprisingly, they paid more wages than one year ago, but they also took a hit because of the product mix. Because wage growth is trailing food inflation, more of consumers' wallet share went to food, which offers retailers a lower margin than apparel. As a result, they had to mark down prices on more products than usual. Also, supply disruptions and diesel fuel costs caused shipping expenses to climb more than expected. And despite strong-arming suppliers, price increases passed on to consumers failed to offset higher expenses. In short, it was a perfect storm of inflationary pressures that took a toll on the bottom line last quarter.

Real Money's Stephen Guilfoyle summed up the situation for Walmart on Monday. In "Walmart's Results Are Ugly, But For Now It's Tradable," he wrote plainly, "The bottom line number missed by a country mile."

In "I Certainty Wouldn't Invest in Target Right Now, But I Would Trade It," Guilfoyle tackled the one-two punch of disappointing results out of the duo, writing, "[I]t does appear that ugliness, like lightning, can indeed appear twice."

Can you buy now?

The big question isn't if the picture was ugly last quarter, but if it will remain so.

Guilfoyle's headlines suggest traders may make some hay on these stocks, but it's a harder road to pave for investors. Traders can nimbly jump in and out of stocks, profiting here and there, but, as Guilfoyle reminds us, "Investors must plant a flag, and that is dangerous, especially when talking about falling knives like these."

In addition to the risk of stagflation (lackluster GDP with persistent inflation) continuing to take a bite out of margins, we may also have to worry that the race to stockpile inventories last year results in bloated inventories and more markdowns this year.

In his article on Walmart, Guilfoyle writes: "I dare say that depending on how well the firm manages that oversized inventory could impact the firm's ability to meet short-term cash needs should the "unexpectedly tough" environment get "unexpectedly tougher."

His worry stems from Walmart and Target having less than stellar balance sheets.

After considering the puts and takes on Walmart's financial statement, Guilfoyle was blunt, "Walmart's balance sheet does not pass the Sarge test. In fact, Walmart is not even close. I am embarrassed that I am long this name.

Guilfoyle's review of Target's balance sheet was concerning, too, writing, "I think that the debt-load is a bit high relative to cash on hand. Like with Walmart, this balance sheet does not pass the Sarge test."

The current ratio (a liquidity measure that compares easily-accessible short-term assets to short-term liabilities) is below 1 for both companies. Walmart's is 0.86, and Target's is 0.87. Of course, low ratios aren't abnormal for retailers, especially those who sell groceries, but it's still something worth watching, given slumping earnings. Food retailers have low current ratios because they have low receivables, high inventory, high payables, and low cash balances because of reinvestments. Walmart is the largest grocery retailer in the U.S., and Target is in the top ten.

The companies' guidance isn't reassuring, either.

In February, Walmart's full-year guidance was for earnings per share to increase mid-single-digits this year. Now, it expects them to fall by 1%, despite comparable stores sales growth of 3.5%. At Target, full-year guidance is for low-to mid-single-digit revenue growth and an operating margin of about 6%. The company thought its operating margin would be 8% this year as recently as March.

The technical take

The fundamentals for these companies offer question marks, and unfortunately, the technical setups don't provide solace.

In "Target Misses the Earnings Mark and Throws Its Charts for a Loop," Real Money technical expert Bruce Kamich writes:

“Prices were weak ahead of today's earnings report. Prices were below the declining 50-day moving average line and the declining 200-day line. The On-Balance-Volume (OBV) line is weakening while the Moving Average Convergence Divergence (MACD) has fallen below the zero line for an outright sell signal.”

After reviewing Point and Figure charts, Kamich sees a downside target of $186 on the daily chart. We sliced through that level like a hot knife today.

Overall, Kamich writes:

“The opening of trading for TGT longs will be very painful. The trading volume is likely to be very heavy for the first 90 minutes of trading. It will be interesting to see where traders might come in to cover shorts or try to pick a bottom. A 50% haircut from the $270 cannot be ruled out.”

That could mean, ultimately, the risk is $135.

Walmart's technical outlook suggests it is risky too. Its shares may find support near $115 to $120 (the July 2020 lows), but that may only be a trading opportunity. It will take time to build a base and work its way higher.

The Smart Play

Consumer discretionary stocks perform best in the early stages of the business cycle when consumers are emerging from recession and becoming more optimistic about wallets thickening rather than narrowing.

In the late- and recessionary stage, the basket is a poor performer because of inflation chipping away at budgets and waning job security. (You can see the sectors I recommend based on the economic cycle here.)

Short-term active traders may scalp a few dollars from an oversold bounce, but a wait-and-see approach may be best for most investors, given the Fed's tightening screws until GDP slows enough to tame inflation. 

I suspect the Fed will succeed, and eventually, discretionary stocks will benefit from a shift to the early stage of the business cycle again, but that will take time. While we wait, Walmart and Target can get their costs under control, and shares can establish actionable bases to build on.

  • Walmart and Target reported disappointing earnings.
  • Their technical outlook reflects significant risk.
  • It's going to take time before inflationary headwinds abate.

Walmart and Target are arguably among the best-run retailers in the country. Their sheer size gives them massive bargaining power with suppliers, and since their stores criss-cross the country, their results provide important insight into the industry's (and consumers!) financial health. Unfortunately, quarterly results from both companies suggest retailers are reeling because of soaring costs, and consumers are ratcheting back spending on discretionary items, like clothes.

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