Target's profit warnings over the last month paint a grim picture for retail stocks — and there's likely more pain ahead even after the sector has dropped 25% in 2022

• Target shares fell Tuesday after the retailer reduced its Q2 profit margin outlook.
• The consumer discretionary sector may see more cuts to earnings-growth estimates.

Target's margin warning Tuesday sparked a decline in other retail stocks, and there could be more pressure to come on the consumer discretionary sector, which was already the worst-performing group this year on the S&P 500 index.

Target shares fell as much as 8% after the big-box retailer reduced its second-quarter profit margin outlook for the second time since mid-May. It said Tuesday it's planning sales to get rid of unwanted inventory and said customers are spending less on discretionary items such as home furnishings and decor while continuing to spend on essentials such as food and beauty items.

Target now projects its second-quarter operating margin rate will be around 2%. It previously expected an operating income margin rate in a wide range centered around 5.3%. Target shares plunged in May after the company's first-quarter earnings missed expectations.

Investors pulled down shares of rival retailers in the consumer discretionary group on Tuesday. Amazon and Best Buy each lost 2.3%, and TJX gave up 1.9%. Home Depot was off 2%. On the consumer staples side, Walmart fell 2% and Costco moved down 1.6.%.

The S&P 500 Consumer Discretionary Sector on Tuesday fell 1% and has slumped 25% so far in 2022, marking the largest decline among the S&P 500's 11 sectors. The communication services and information tech groups weren't far behind, with slumps of 24% and 20%, respectively.

"Tech, consumer discretionary and communication services are the primary groups that are being beaten up by higher interest rates and expectations for lower consumer spending," Sam Stovall, chief investment strategist at research firm CFRA, told Insider in a recent interview. US retail sales have been slowing down since a mid-2020 boom, when sales snapped back from COVID lockdowns.

"If I look to earnings, one of the new headwinds that investors will have to contend with is downward revisions to forward earnings estimates," Stovall said. The consumer discretionary sector as of last week had a 16% cut in second-quarter earnings growth estimates.

The consumer discretionary sector on March 31 had been expected to earn $12.74 a share, but it's now $10.73, marking the deepest revision of any of the 11 sectors, said Stovall.

Overall, "if earnings estimates are coming down as the fear of recession rises, I think we have to anticipate that there could be additional downward earnings revisions," he said. "That's the tug of war that is going on right now. Is that already factored into share prices or is there more to go if we do likely fall into recession? I think there's more to go."

Separately on Tuesday, CFRA retained its hold opinion on Target shares and cut its 12-month price view on the stock to $160 from $165. Analyst Arun Sundaram said Target is likely struggling more than other big-box retailers such as Walmart and Costco given its sales mix is more discretionary in nature, with food and beverage making up 20% of its annual sales compared with at least 50% at Walmart and Costco.

For Target, that is "compounded by its lack of fuel stations (a disadvantage when consumers are consolidating shopping trips) and relatively smaller stores, which makes it difficult to store excess inventory without compromising guest experience," he wrote.