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Target (TGT +3.5%) is trading modestly higher after reporting Q1 (Apr) results that were perhaps slightly better than feared. Target again beat handily on EPS, just as it did in Q4 (Jan), although it missed on revs. We said in our preview that our main concern was the guidance and TGT guided Q2 (Jul) EPS well below consensus. But TGT has been conservative with its EPS guidance lately and we think investors are catching on to that and not punishing them. Also, TGT reaffirmed full year EPS guidance.

• After three consecutive large EPS misses, Target has now posted back-to-back large EPS beats. Target had too much inventory just as the consumer slowed spending on discretionary items. Having to discount that hurt EPS last year, but TGT said it entered this fiscal year in a much better inventory position. Q1 ending inventory was about 16% lower yr/yr, including a 25+% decline in discretionary categories.
• The Q2 EPS guidance of just $1.30-1.70 was disappointing, although not entirely surprising. TGT saw a further softening in discretionary categories in March-April. This coincided with the deterioration in consumer confidence reflecting recent events such as the banking crisis that emerged in March. TGT also said inventory shrink (theft, organized retail crime) and violent incidents are becoming a worsening trend and increasingly urgent. TGT now believes shrink will reduce full year profitability by more than $500 mln compared with last year.
• Same store comps were flat, in-line with prior guidance (in-store comps +0.7%, offset by a -3.4% decline in digital comps). TGT is benefitting from traffic and sales growth in its frequency categories, like Food & Beverage, Household Essentials, and Beauty was notably strong with mid-teen comps. That helped offset soft comps in discretionary areas, like Home, Apparel, and Hardlines.
• Perhaps most troubling was that comps were strongest in February, then began decelerating in March (banking crisis hurt consumer confidence), and softened further near the end of April and thus far in May. As such, TGT is guiding to a wide range for Q2 comps, centered around a low single-digit decline.
• Besides comps, another key metric was operating margin. Operating margin in Q1 dipped to 5.2% from 5.3% a year ago, but that was above 3.4% in Q4 and above prior guidance of 4-5%. Margins in Q2 should benefit from lower freight and transportation costs but inventory shrink looks to be a significant headwind and softer comps will impact margins. TGT expects Q2 operating margin will be much higher yr/yr, but lower than Q1's 5.2% result.

Overall, this was a mixed report. Target's comments on comps declining as the quarter progressed plus Home Depot (HD) cutting its forecast yesterday are clear signals that consumers are tightening their wallets. A consumer shift to experiences is also likely impacting retailers. The stock is holding up pretty well because we think investors are maybe discounting that downside EPS guidance. Also, we think investors had already priced in a cautious consumer. Finally, we think this report adds caution to Walmart's (WMT) Q1 report, which is set for tomorrow morning.