Target reports earnings next Tuesday. It may seem, given that Walmart has reported already, that investors have what they need to know about the retail environment, but the two companies do have key differences that have an impact on earnings volatility; an important implication for equity and options investors. Let’s review the set-up on Target into the numbers and a lower cost way using options to get long the name. Target (TGT) cultivated a trendy and upscale image compared to Walmart. Known for stylish, high-quality products at affordable prices, the perception was that the company appealed to a more affluent demographic. Target did exclusive collaborations with designers and brands, offering unique products that weren’t available elsewhere, seeking to attract customers looking for designer styles at lower prices, sometimes referred to as “cheap chic”. The good news is that the average household income for Target shoppers has historically been higher. The bad news is that Target has a much higher percentage of so called “impulse buys” than Walmart. In other words, Target is more sensitive to changes in discretionary spending than Walmart. Similarly, while Target offers value through quality and design, its prices can be higher than Walmart’s, which might deter the most price-sensitive customers. This presents a more meaningful challenge after a couple years of high inflation. How it stacks up vs. Walmart Walmart’s biggest advantage is its ability to offer low prices across a wide range of products, making it the go-to retailer for budget-conscious consumers, and with a larger number of stores, including supercenters, Walmart has a more extensive geographic footprint in the U.S. and internationally, making it more accessible to a broader customer base. Walmart offers a wider variety of goods, arguably the most important of which lately is groceries, which, while typically also a low margin business, brings customers in regularly . Walmart also has larger and better supply chain/logistics and is making meaningful strides in digital. Given these differences, it’s less surprising that Target’s revenues have been lumpier than those of its larger competitor, particularly in recent years. Retailing is a low margin business, so the impact of less consistent revenues is magnified when we look at net income, and earnings per share. Consequently Target’s share price has been much more volatile after reporting quarterly earnings. The options trade Over the past decade Target has moved an average of almost 7% after reporting earnings, twice as volatile as Walmart’s average move of 3.5% over the same period. TGT 6M mountain Target, 6 months Target options prices are, a bit like the prices inside the retailers themselves, more expensive than Walmart’s, deservedly given the big moves it’s share price has seen. Given the more than 40% rally since November, it may be tough to chase Target here, so to mitigate both the risk of an earnings disappointment and the higher options prices, consider a call spread if one is inclined to get long Target going into earnings. The trade: Bought Target Apr. 19 $155 call for $6.15 Sold Target Apr. 19 $170 call for $1.71 The disadvantage of the options trade versus purchasing the stock is that to see profits at expiration, Target must appreciate above the strike of the call that is purchased by at least the net premium spent. Because the share price needs to rise by almost 5% to see profits, the probability of profit is reduced. However, because one would be risking only the premium spent on the trade (in this example $4.44) the risk of loss if it doesn’t are limited to less than 3% of the current stock price. Given that Target has seen 3 double digit declines in the month following earnings over the past 2 years, those concerned about a disappointment my be inclined to accept the trade-off. DISCLOSURES: THE ABOVE CONTENT IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY . THIS CONTENT IS PROVIDED FOR INFORMATIONAL PURPOSES ONLY AND DOES NOT CONSITUTE FINANCIAL, INVESTMENT, TAX OR LEGAL ADVICE OR A RECOMMENDATION TO BUY ANY SECURITY OR OTHER FINANCIAL ASSET. THE CONTENT IS GENERAL IN NATURE AND DOES NOT REFLECT ANY INDIVIDUAL’S UNIQUE PERSONAL CIRCUMSTANCES. THE ABOVE CONTENT MIGHT NOT BE SUITABLE FOR YOUR PARTICULAR CIRCUMSTANCES. BEFORE MAKING ANY FINANCIAL DECISIONS, YOU SHOULD STRONGLY CONSIDER SEEKING ADVICE FROM YOUR OWN FINANCIAL OR INVESTMENT ADVISOR. Click here for the full disclaimer.
