Target Corp. (TGT, Financial) has been one of the best performers over the past few years, with the stock nearly doubling over the last two years and gaining almost 51% year to date.
The company reported a very strong third quarter, made even more impressive that it came on the heels of some of the best numbers Target had ever seen in the same period last year.
Still, shares of Target fell 5% following the report, most likely in response to a decline in the margins, as it did not pass inflationary costs along to consumers.
Looking at the numbers as a whole, it is clear that Target’s business is performing well even if the margins did contract.
Let’s look deeper into why investors concerned with only the margin pressure might be missing the whole picture with regards to Target.
A rundown of earnings highlights
Target reported third-quarter earnings on Nov. 17. Revenue grew 13.3% to $25.7 billion, clearing Wall Street analysts’ estimates by more than $1 billon. Adjusted earnings per share of $3.03 compared favorably to adjusted earnings per share of $2.79 in the prior year and was 23 cents above expectations.
Comparable sales grew 12.7%, led by a 9.7% increase in same-store sales and a 29% improvement in digital sales.
Nearly every category within the company experienced gains from the prior year, led by essentials, beauty and food and beverage. All of these categories had at least comparable sales growth in the mid-teens range from last year. Electronics were up 6%, but this follows a 60% improvement in the prior year.
Margins were weaker compared to the prior year. The gross margin contracted 260 basis points to 28% while the operating margin was lower by 70 basis points to 7.8%. Increased merchandise and supply chains costs weighed on Target’s margins. A higher employee headcount at distribution centers and wage increases also pressured margins.
Target distributed $440 million in dividends during the quarter and repurchased 8.8 million shares of stock at an average price of just under $247.
Finally, the retailer provided updated guidance for the fourth quarter of the year, forecasting revenue that is up high single digits to low double digits, up from high single-digit growth previously. The company does expect its operating margin to be above 8% for the year.
Takeaways
On their own, the company’s quarterly numbers are very good, ones that any retailer would love to have. High same-store sales and earnings per share gains would be a good sigb in any quarter for a mature retailer like Target.
But this follows the third quarter of 2020, which was one of the company’s best ever for year-over-year revenue and earnings growth. Same-store sales improved nearly 21% last year while adjusted earnings per share more than doubled. As a result, Target has a two-year same-store sales growth rate of almost 34%.
Digital has been one of the driving forces of growth. The most recent quarter saw solid numbers for this channel, which came on top of a 155% increase last year. Digital sales have a two-year stack rate of 184%. This channel has seen its total sales expand by more than $3 billion over the last two years, which means the company could still be in the early innings of the importance of digital sales.
Same-day service also continues to see robust figures. The amount of money spent on this service has quadrupled over the last two years and speaks to the flexibility of shopping that Target can offer its customers.
The growth rates compared to the prior year show that Target is not only retaining the customers it gained during the worst portions of the pandemic, but it has gained additional customers as well.
All of the same-store sales growth was related to higher traffic in the third quarter. Prices haven’t really been a factor as it’s just the increase in the number of people visiting stores or making purchases online that have driven results. In addition, the average basket size also grew. Target seems to be in the sweet spot where more people are buying more of the company’s products.
Importantly, it isn’t one or two areas that are carrying Target as the company’s strength is broad based throughout the store.
And with the ramp-up to the holiday shopping season beginning, the momentum that Target has enjoyed over the past few quarters is likely to continue.
One way leadership plans to attract guests throughout the remainder of the year is by spreading out its promotions. This actually came about thanks to Covid-19 as what are usually condensed promotions were spread out through November and December as a means to keep stores from becoming congested. Demand was high as a result throughout the whole period, something Target aims to leverage to a greater extent this year as social distancing requirements have eased in many regions.
While many investors were disappointed that the company couldn’t or wouldn’t pass along inflationary costs to consumers, it appears that Target was more focused on expanding its customer base rather than raising prices. This may have helped keep its prices lower than the competition, inspiring more people to frequent a store location.
Plus, with the holiday shopping season coming up, the buildup in inventory and staffing is likely a prudent maneuver given how high demand for products has been. Leaderships expectations for a very good holiday season is reflective in its upwardly revised guidance for the fourth quarter.
It remains to be seen if the margin pressure will be much of a factor going forward. For reference, adjusting for higher sales returns, the second-quarter gross margin was flat from the prior year.
Despite the runup in stock price over the past two years, Target isn’t overly expensive. Using the current share price of $251 and analysts estimates of earnings per share of $13.25 for the year, the stock has a forward price-earnings ratio of 18.9. The stock has a five- and 10-year average price-earnings ratio of 14.5 and 15.
The stock’s multiple is elevated compared to the medium- and long-term averages, but it isn’t exactly in the nosebleed section for a company performing as well as Target has over the past few quarters.
Final thoughts
Target turned in another excellent quarter, one that looks even better when compared to what was a great third quarter last year. On nearly every metric, including same-store sales, digital sales, same-day service, foot traffic and basket size, Target delivered better results than the prior year.
Following the returns of the stock over the recent term, investors were expecting inflationary pressure to be offset with pricing. This, of course, was not the case as pricing wasn’t much of a factor in results.
That the company did not increase product prices as a result of inflationary costs, such as higher compensation and freight, did mean a lower gross and operating margin, leading to the decline in share price. Instead, Target counted on more customers buying more things to grow results and this is what took place.
Is this a long-term solution to combat rising input costs? Time will tell, but looking at the results for the quarter, the answer appears to be yes as Target is having no problem seeing a lift in its business as more people are spending money at the store and online.
Inflation is an issue right now, but what is not an issue is the strength of the Target brand amongst consumers. This suggests that the selling in shares of Target could be a short-term issue as weak hands are shaken out and some profits are taken, with the stock possibly pushing upward once again as the highly anticipated holiday shopping season gets underway.
