Target Corp.'s (TGT, Financial) first-quarter results showed a mixed performance. Revenue increased 3.4% from the prior-year quarter to $16.8 billion, net income moved 5.9% higher to $718 million and adjusted earnings per share grew 9.4% to $1.32.
The retailer’s comparable store sales increased 3% due to a rise in customer traffic. The company recorded its best customer traffic growth in a decade, while e-commerce sales grew from 21% last year to 28% this year. It now makes up 5.2% of total revenue.
Margin performance, however, was disappointing as the gross margin moved 20 basis points lower to 29.8%. Financial guidance for the full fiscal year was left unchanged following the results.
Investment potential
Target’s stock price has risen 10% since the release of its first-quarter results, which takes its gain over the last year to 43%. This is ahead of the S&P 500’s 15% rise over the same period.
The future prospects for Target's stock price could be catalyzed by the investment the retailer is making across its business. For example, it is undertaking a program to remodel its stores, with 56 remodels having been completed in the first quarter. The company has estimated that remodeling causes a 2% to 4% increase in sales. Investment in staff may help boost customer service levels, with the company set to increase its minimum hourly wage to $15 by the end of 2020. This rise could boost employee morale and lead to higher levels of productivity.
Investment in its owned brands is also being ramped up. It launched three new brands in the first quarter of the year, with a further four brands expected to be launched in the second quarter. This is set to take the total number of new brands launched since the start of fiscal 2017 into the double-digits, with some on track to deliver $1 billion in annual sales. Owned brands provide the company with not only a unique offering to generate higher levels of customer loyalty, but also the potential for higher margins.
A changing business
As mentioned, e-commerce growth in the first quarter of the year increased to 28%. Further growth is a key goal for the company as it invests heavily in the area. The acquisition of same-day delivery company Shipt last year is set to lead to the launch of same-day grocery delivery from an increasing number of its stores over the coming months. It has also launched a free two-day shipping service on all orders over $35 as it seeks to provide an improved service for online customers. With no minimum order size for REDcard holders, the initiative may also improve customer loyalty.
Target’s online growth may also be boosted by its restock service. This includes next-day shipping for household items, for which the company charges a flat fee of $2.99 (free for REDCard holders). This could provide it with an advantage over Amazon (AMZN, Financial), which charges $5.99 for pantry delivery alongside the cost of Prime membership. Target’s expanding drive-up service, which allows customers to have their online orders loaded into their cars at a store, may also help to improve its online growth capabilities.
Margin pressure
Target’s first-quarter results showed a decline in gross margins. The company’s attempts to compete with Amazon could lead to continued margin erosion. Across the retail sector, margins seem to have become a lower priority versus sales and the development of an omnichannel presence. Target is investing heavily in providing an improved online experience for customers. While this may lead to a continued rise in online sales growth, it may also cause continued weakness in margins – especially with store remodeling and higher wages also putting pressure on costs.
The margin decline, however, was at least partly due to unseasonal weather. Late spring weather caused a later-than-usual surge in higher margin, temperature-sensitive categories. Future investment in its online offering, as well as in remodeling its stores and rewarding staff, could cause additional margin pressure. The changes being made to the business, though, could be a case of short-term pain for long-term gain, with the retailer having the potential to create a more competitive business in a fast-moving sector.
Verdict
The prospects for Target’s stock price appear to be positive even after a mixed first-quarter performance. The initiatives being followed by the business in terms of its investment in brands, increasing staff wages and remodeling stores could help to improve its competitive advantage and sales performance. Its continued focus on online sales may allow it to compete more effectively in what is a fast-growing segment, with its delivery initiatives providing improved customer service levels in a competitive marketplace.
Although margin declines in the first quarter were disappointing, they may become more common as the retailer invests in its future growth prospects. In the long run, though, such changes may increase the prospect of further stock price gains.
