When Target (TGT) announced a profit warning, investors immediately dumped shares. How much of this was human response and how much was algorithms is hard to parse, but the response immediately afterwards tells us much about how markets respond to news and why initial responses are often worth ignoring.
First, let’s dig into the details: TGT said profit margins would be around 6%, ahead of pre-pandemic levels but lower than expectations, with an operating margin in the second quarter of just 2%. The reason, according to TGT CEO Brian Cornell, was that the company is addressing changes in demand and an over allotment of some goods that is resulting in a glut of things people aren’t buying.
What does that mean? In short, TGT has too much of the things people aren’t buying and too little of the things they are. As a result the company will aggressively discount excess inventory and try to offload it at a lower overall margin than the market had expected. Once those goods are cleared, TGT can focus on where consumer demand is today instead of where TGT expected demand to be.
Sound odd? It’s actually very common in a radically changing market—but it’s something that a mix of data analysis and experience can account for. It may sound silly, but analyzing various factors can help retailers know whether they need to stock more yellow dresses one summer or more pink ties one winter. A variety of data points and market research helps companies make these adjustments, and it also helps keep discount stock at a minimum.
So why isn’t that happening now? Simply put, COVID-19 and the post-lockdown aftermath has created a lot of confusion and unpredictability in the market—not just in the stock market, but in supermarkets as well. Just take a minute to think about it, and this is intuitively logical. At the start of the pandemic, there was a rush of toilet paper due to panic buying; when the pandemic was in full force and lockdowns underway, people realized that supply chains weren’t as badly hit as previously feared and panic buying of toilet paper subsided.
But there were other problems, like with food. Different cuts of meat are sold in restaurants than supermarkets, on average, and both are distributed through different supply chains. Less restaurant eating meant less demand for that meat, and greater meat eating at home created too much demand there. While companies shifted to adjust, this was not easy or fast—and for many, by the time they had adjusted, demand had shifted yet again. Until Delta hit and demand changed again.
Those few in the supply chain who had gotten the hang of things were again shocked twice with Omicron—first when the risk seemed dire and again when it passed quickly as a mild and relatively less dangerous strain. But the whiplash of supply and demand disruptions had established themselves, and many companies got caught unprepared. TGT is just one of many still trying to discover where demand is now.
Omicron is still a big part of the story. Americans in particular disagree vehemently on what to do with the strain, with political debates on masking, social distancing, and basic protocols for living in the world resulting in a lot of uncertainty about what companies should do to meet demand. Is hand sanitizer still a must-stock item? Maybe in just some parts of the country? But where? These are questions that companies like TGT need to address, but it isn’t easy—especially when this situation is historically unprecedented, leaving data analysts with little data to use to make the necessary adjustments.
By the way, there is a name for this among logistics—it is a well-known phenomenon. The bullwhip effect refers to radical short-term changes in demand that cause firms within the supply chain to adjust—but by the time they adjust, the short-term demand change is already over. Firms rarely opt to ignore those short-term changes because, at the time, they don’t seem short term (the hope that the pandemic would be largely over in two years was there in March 2020, but it was not a widely believed fact—and many today still think the pandemic is not largely over at all).
The uncertainty is by no means making TGT’s corporate offices an easy or happy place to work now—but investors who parsed through the profit warning realized that this is a short-term disruption due to the bullwhip effect, and it is something that will pass quickly. And such a short-term disruption that is not fundamental to a company’s long-term value does not deserve a 9% markdown—but so far, the market thinks about 2.5% is more fair.
