Few retailers have as wide and deep a view into the American consumer as Walmart and Target. 

Their combined sales in the U.S. totals out to nearly half a trillion dollars. With both physical and online stores, and merchandising that spans everything from clothing to televisions to dumbbells to organic coffee, and much more, Walmart and Target both function to some degree as barometers for the American consumer and the wider retail market. 

Which is why everyone is watching them so closely in this topsy turvy year of 2022. So what can their most recent earnings reports tell us about the health of the consumer and retail economy?

Spending hasn’t collapsed, and may be improving, but consumers are still on the defensive

By now, everyone knows discretionary spending is down as consumers manage rapid rises in food and gasoline prices, which are closely entwined.

“We expect inflation to continue to influence the choices that families make and we are adjusting to that reality so we can help them more,” Walmart CEO Doug McMillon told analysts on the company’s Q2 conference call. 

The shift in consumer confidence happened quickly, much of it happened in Q2 and it left a deep impact on Walmart and Target’s earnings. Both alerted investors during the quarter that results would come in below previous forecasts.

The end results were divergent: Walmart beat its lowered forecast and analyst estimates, while Target disappointed investors even after dropping its guidance significantly during the quarter. But in many ways the stories were similar, with both retailers taking markdowns to manage demand declines in some areas. For example:

• With consumers shifting more dollars to food, Walmart Chief Financial Officer John Rainey noted that its general merchandise inventory growth rate is down more than 15 percentage points from Q1. General merchandise’s contribution to Q2 sales mix was down 350 basis points.
• As discretionary spending came under pressure, Walmart has canceled “billions of dollars” in planned orders to align inventory with demand. Rainey said the company is still reducing exposure to some areas, including electronics, home and sporting goods. 
• Target came under margin pressure as sales of higher-margin categories such as apparel and home goods slowed.
• Target, too, canceled planned orders as demand shifted away from many nonessential categories. The retailer said fall receipts for discretionary categories was reduced by $1.5 billion.

Things could be easing as we move through Q3. On the call, Rainey said that the back-to-school season was “off to a solid start” so far in the period, while sales at the end of July were strong — and better for the bottom line with better-than-expected costs. Notably, Rainey also said that “early Q3 traffic count was a bit stronger than what we have seen in the businesses in two months.”

Hopeful signs aside, the wider retail market still appears to be struggling on the whole. According to a Cowen analysis, retail foot traffic was up sequentially in the second and third weeks of August but growth remains below 2019 levels by double digits.

In a separate note, Cowen analysts said that unit sales in retail “remain weak,” with “real sales” down from last year in sporting goods, department stores, and clothing and accessories. For most of the retailers Cowen covers, the sales to inventory spread has turned negative this year, with trends worsening in Q2 for those that have reported so far.

As traffic improved, Walmart management held its guidance for the second half of the year, with estimates of comp growth of 4% in the U.S. for the full fiscal year. Target also stood by its prior guidance of top-line growth in the low to mid-single digits. 

Walmart and Target have benefited from inflated food sales, but both need food prices to come down

For both Walmart and Target, food sales drove gains in the top-line — much of that due to price increases. Yet that has also pressured profits because of the low margins on food and other consumables.

Rainey noted that food sales growth in the U.S. was in the mid-teens — and food inflation at Walmart was up double digits as well. Meanwhile, general merchandise sales — particularly in electronics, apparel and home — lagged. More specifically, grocery’s share of Walmart’s sales mix in the U.S. was up 300 basis points while general merchandise was down 350 basis points, the latter driving costly markdowns. 

The story was similar at Target, where food and beverage as a category is up 50% since Q2 2019 — amounting to an extra $1.8 billion. But the company took an 87% hit to its operating profit due in part to markdowns on discretionary items to clear floor space for faster-growing categories, including food and consumables — which, again, typically carry lower margins.

Walmart and Target haven’t completely given up on general merchandise

Asked about Q3, Target executives emphasized strong traffic and unit share growth. Despite a “cautionary” consumer environment, Cornell said that “one thing that seems to be very consistent is a guest and consumer who says they want to celebrate the holiday seasons.” That means sales of seasonal items in its general merchandise assortment.

McMillon pegged how the retailer thinks about general merchandise to fuel prices and food inflation. But the Walmart chief also noted that the retailer is being strategic about its buying.

“[A]s we've worked with the merchants over the last few weeks, it's been kind of fascinating to think through how you make choices item by item [and] category by category, because you don't want to go into too much of a defensive mode,” McMillon said.

He specifically called out Halloween decor categories, inflatables in particular, “that are really fun, cool new items” and noted "we're going to blow out of some of those."

The same principles apply to apparel. McMillon pointed out surprisingly strong sales in men’s flannels while other seasonal apparel categories are being marked down.

Strategy factors in when it comes to assortment. In emailed comments after the company’s Q2 release, Neil Saunders, managing director with GlobalData, pointed to three factors in Walmart’s “inability to stimulate the general merchandise part of its business”: the price sensitivity of its core customers, too much general merchandise inventory hurting the shopping experience and its “more basic approach to non-food,” which Saunders said hurts Walmart’s ability to attract customers to its assortment. 

Saunders and others dinged Target as well for building up excess inventory in items for which demand has waned. However Cowen analysts said they were “constructive” on the retailer’s strategy to clear out inventory and appeared optimistic going forward. 

Target’s “back to school momentum is encouraging, and we believe its traditionally strong event and occasion oriented appeal as well as unique merchandise partnerships and planned promotions bode well,” Cowen analysts led by Oliver Chen said in an emailed research note. 

Keep your eyes on gas prices

High gas prices have had a layered effect on Walmart and Target. Target Chief Financial Officer Michael Fiddelke said the company expects rising fuel and transportation rates to add “well over” $1 billion to the company’s costs this year.

High gas prices are also squeezing customers, diverting spending away from discretionary purchases. Customers “still have spending power, but they're increasingly feeling the impact of inflation,” Target Chief Growth Officer Christina Hennington said on its earnings call. “And while the recent reduction in prices at the gas pump have been encouraging, guest confidence in their personal finances continues to wane.”

Finally, fuel is a major input into food prices, as Walmart executives explained. And while price increases on food raise sales levels, it is also stealing from Walmart and Target’s profits as consumers forgo purchases of higher-margin items. McMillon summed it up when the chief said, “The cost of food and fuel, a heavier mix of sales in food and consumables, and excess inventory in general merchandise categories were among the most challenging items for us at the time.”

John Furner, chief of Walmart U.S., pointed to drops in fuel prices in July as one factor when explaining improving traffic and higher spending. “Fuel prices are still moving, and [if] they continue to move down, that would be a great thing,” Furner said. 

Supply chain costs and disruption are still elevated but easing

This time last year, retailers just about across the board were racing to secure inventory and paying steeply for ocean or air freight, or, like Walmart, chartering their own ships.

As with the other factors listed above, Walmart and Target are not perfect proxies for the industry because their scale gives them money, leverage, flexibility and other advantages that few have in anywhere close to the same measure. But, again due to their size, they have a wide window into what’s happening in the world, including shipping and supply chain. 

Target Chief Operating Officer John Mulligan said that global shipping lead times have started to decline, fuel surcharges are easing and spot rates to move containers have fallen (with Mulligan adding the qualifier “somewhat” to the latter two cost areas). 

However, Mulligan also said that “conditions remain highly unfavorable” compared to pre-pandemic years, while risks remain in the coming months around energy costs, potential slowdowns at West Coast ports and the possibility of COVID-19 lockdowns in China. 

The executive added that Target is encountering “far too many delays” in overseas shipping, which have forced the company to pay spot rates above pre-negotiated shipping rates and leading Target to move up receipt dates to “mitigate the business risk from receiving shipments later than expected.”

Walmart’s McMillon said the retailer has reduced the number of shipping containers in its system by more than half since Q1 and “much closer to our historical averages.” That, as Rainey noted, has reduced storage costs from the container backlog. 

Furner said Walmart has “largely gotten out of the container storage and movement business” as supply chain constraints have eased, though costs around containers remain inflated above past levels.