Jefferies Equity Research Analyst Corey Tarlowe joins Yahoo Finance Live to discuss Target's Q1 earnings, retail thefts, what to expect from Walmart's Q1 earnings report, and the outlook for retail.

Video Transcript

JULIE HYMAN: Well, she just talked about Target and what we're seeing there, the company's underwhelming guidance for the second quarter coming as consumers are faced with economic challenges, including, of course, elevated inflation. A somber tone compared to what was a better-than-expected first quarter for the retail giant.

Joining us now with a deeper insight on the road ahead for retail, we've got Jefferies Equity Research Analyst Corey Tarlowe. Corey, thank you so much for being here. It's good to see you.

So interesting here that we now have Home Depot and Target making this kind of commentary. It's in pretty sharp contrast to a lot of the sort of consumer packaged goods companies, food companies that we heard from earlier in the quarter. Of course, the retailer's quarter is a little bit longer-- or a little bit timing goes into April. Does that mean it was April, in particular, it really started to deteriorate here? What do you think?

COREY TARLOWE: Thanks for having me, and good morning. So what I would say is that the consumer, throughout the last three months, has softened materially. And we see this in the data that Target disclosed today. So when they talk about February and March and April and even in May to date comps, February started off strong, but March decelerated a little bit, and then April actually decelerated further.

So that ended up driving about a flat comp for the overall quarter. I think that what's important here, as we dissect the sort of three major categories that I think I want to touch on here today, it's the customer trends, it's category dynamics, and the outlook.

So on customer trends, traffic was up, which is a good thing. It's been up for three years straight for Target, actually. But Ticket or basket was down slightly. So what we are seeing is people are going to stores more often, but maybe their baskets are not as big as they once were.

Second on category, so food and beverages were up. They've been up, I think, 61% since 2019 and gaining share materially in that category. That's great. However, the discretionary category continues to be pressured, and that softness has actually continued into the second quarter.

And then thirdly, just on the outlook, they reiterated the full-year outlook, but what's interesting here is that the second quarter outlook was actually below expectations. And so that just makes the full year a little bit more back-half weighted, and therefore adding a little bit more risk to the third and fourth quarters ahead.

JULIE HYMAN: And also perhaps, Corey, the risk to Target's goal of retaining that 6% operating margin, right? Because correct me if I'm wrong, but isn't the discretionary stuff versus groceries, isn't that the higher margin stuff? So if people are not buying as much of it, is Target going to have a hard time reattaining that 6% operating margin?

COREY TARLOWE: So over the last 10 years, interestingly enough, Target's actually averaged an operating margin of 7%. But the target for next year is expected to be around 6%. This last quarter, they generated an operating margin of 5.2%. For the second quarter, they're expecting the operating margin to be slightly below that. Near term, there are a lot of dynamics at play that might help to support driving better margins, like, for example, laughing all the-- lapping all the inventory and markdown issues that they had last year.

But there's also some headwinds, like shrink. That continues to be a problem. They dimensionalized that issue to be about $500 million this year, or half a billion dollars, versus I think it was $400 million through the first three quarters of last year. So shrink continues to be a problem. It continues to worsen. And it does impact the near-term profitability trajectory. But ultimately, I do see a path to returning to that 6%, or maybe even 7%, over time.

BRAD SMITH: I mean, why does there seem to be an outsized hit on Target? I mean, are they just-- bear with me on the pun. Are they just an easier target at the end of the day for theft?

COREY TARLOWE: I think that it's impacting a lot of retailers at present. Target does have mitigation efforts in place. They're working with local law enforcement. They're working with the NRF and RILA, so national retail organizations, and with other retailer-- retailers as well to help to mitigate the effect.

They're also adding in more shelf security in stores to help impact the overall shrink issue. Is it going to disappear tomorrow? No, but it's an issue that over time should lessen as these initiatives hopefully tend to bear fruit and mitigate the overall issue that Target's facing from a shrink standpoint.

JULIE HYMAN: Yeah, and, Corey, let's extrapolate to the other retailers, right? We're going to hear from Walmart. We were just talking with a guest earlier who said if people are leaning into groceries, that could be something that would benefit Walmart. But do you think we're going to get sort of a similarly cautious tone there?

COREY TARLOWE: I think you'll get a cautious tone, but you're likely to see much stronger results. And it's just because Walmart is gaining very significant share from many other retailers and across the consumer income spectrum. It's gaining share from among lower-income consumers, middle-income consumers, and even some higher-income consumers too. And so that's really going to drive outsized traffic growth as well as pricing potential because Walmart has all the footsteps to be able to command some pricing power now.

And especially as supply chains have normalized, it also unlocks the ability for Walmart to pivot into private label. So they can now emphasize their Great Value brands that they offer and, at the same time, not only drive sales, but also better margins too coming off a year which was arguably a very difficult one with all the inventory and supply chain issues that they faced that hindered margins in the prior year.

BRAD SMITH: We often talk about in the banking sector how some large banks are just too big to fail for many mechanisms or another. Is Walmart too big to fail as a retailer?

COREY TARLOWE: I think that there are certainly aspects that Walmart can improve upon. But I think that if you look back over the last 10 years, it's been quite a journey for the company. And they've really done an exceptional job controlling what they can control. And this year, they probably arguably have the most within their control that they've had since the onset of the pandemic.

And what that's unlocked is better visibility into inventory, into supply chain, and unlock the ability to also drive better sales and margins. So if we think about the automation that Walmart is adding into its distribution centers, the data that it now has available at its disposal from a digital and omnichannel standpoint to help to understand its customer better and predict where and what its customer needs and where and how the customer is going to shop, really should all unlock much more greater profitability and visibility into the financials as we look ahead.

So I don't really foresee any too significant issues for Walmart ahead because they've really de-risked, I think, the story to a substantial degree thus far this year. And I really do think that it's-- it's one of our top picks in our coverage, and it's certainly a stock where we see substantial upside.

JULIE HYMAN: And finally, Corey, just to zoom out once again and take a look at the consumer, I know this current period, it's a little bit tough to find analogs in other periods of time. Obviously, the pandemic was a big idiosyncratic event. We have rising-- still inflation that while it's moderating, it's still rising.

We have concerns about the economy. But inasmuch as we can predict, what tends to happen with consumer spending patterns in this type of environment? And how much-- like, how are you sort of gaming out the rest of the year and even going into next year?

COREY TARLOWE: Sure. So one thing that we actually pay pretty close attention to is the Senior Loan Officer Survey. And what we've noticed is that when credit tightening occurs, retail spending also tends to lag on about a nine-month basis. And what we're starting to see is loan standards are tightening significantly. So in a very short period of time, I would expect that retail sales will follow suit. And at least internally, our economist is predicting a recession in the third quarter.

But if we think about how some of these retailers like Walmart, for example, perform during recessions, they are actually fairly relatively resilient. For example, in '08, '09, Walmart comped up on a two-year stacked basis up 4%. It wasn't as strong as Dollar General, which was up 20%, but it was much better than the retail average of down mid-single digits. So it's clearly one that we expect that, despite what economic uncertainty may come, is very well-positioned to outperform.

BRAD SMITH: Corey Tarlowe, Jefferies analyst, joining us here to talk all things retail, but specifically Walmart and Target for much of the conversation here. Corey, we appreciate it, as always.