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John Kinsellagh
John Kinsellagh
Articles (155) 

Target and Kohl’s Adaptation Strategy Bears Fruit

Two brick-and-mortar companies are operating successfully in a Darwinian retail world

March 07, 2019 | About:

Only the strong survive.

While this adage is somewhat shopworn, it nonetheless is descriptive of the current state of the retail industry, radically upended by the untrammeled growth and oversized presence of the online Goliath, Amazon.com Inc. (NASDAQ:AMZN). In this unforgiving environment, adopt or die has now become the watchword to determine which legacy department stores will continue to remain viable.

Ever since consumers started doing more of their shopping online, two schools of thought have evolved among security analysts in terms of ascertaining the future prospects for retail chains. The first group can be characterized as the “Amazon is taking over the world” wing. These analysts are fervent in their belief that death for brick-and-mortar retail is imminent; the sickly patient eventually will be taken off life support. The second group has adopted a wait-and-see attitude of cautious optimism. These analysts, while not jubilant about the future of chain stores, will take note of those old-line retailers that demonstrate flexibility in altering their business models. The stores that demonstrate an ability to pivot to new business strategies and implement a hybrid model of joining the online shopping crowd, while offering new promotions and products to draw customers to their stores, will be acknowledged and adjudge on this basis.

Two brick-and-mortar companies have been in the process of revising their operating strategies to do business in an industry where more consumers are shopping online. Rather than fight the trend by revamping existing stores to try and compete with the new reality in terms of drawing consumers back to the stores they are leaving, Target (NYSE:TGT) and Kohl’s (NYSE:KSS) have embedded the online retail shopping experience as a significant component of their overall business operations.

Target has been investing heavily in developing an online and in-house total shopping experience by taking advantage of its strong geographical footprint to make it easy for customers to pick up online orders in nearby stores. The company has pursued this new strategy assiduously and the results are paying off

Both Target and Kohl's have downsized in terms of reducing store square footage and have revamped the smaller-store footprint with new products and new promotions to help lure customers to their stores. The success of this long-term strategy requires upfront costs to finance an extensive fulfillment infrastructure for satisfying online orders rapidly and conveniently.

The continuing and demonstrable success of Target and Kohl's to survive in a harsh new world has somewhat vindicated the posture of those on the Street who have remained cautiously optimistic to see the process of natural selection in the industry play out.

That is the backstory on Kohl's and Target’s transformation. Here are the numbers that indicate both traditional retailers can successfully compete in an Amazon world. Both companies reported higher comparable sales and gave upbeat forecasts for 2019. The market responded favorably; shares of Target increased almost 4.6%, while Kohl's rose more than 7%.

Here are the recently posted financial results for both stores.

For its fourth quarter, Target’s comparable sales increased 5.3%, supercharged by a substantial 31% leap in online orders. CEO Brian Cornell told investors last Tuesday that, “It’s clear our strategy is working.” The Street concurred, sending the stock price up more than 4.6%. Further review of the numbers is instructive for providing a measure against which its hybrid strategy can be judged.

Target’s digital channels accounted for more than 10% of its total sales last quarter. Clearly, its hybrid strategy has been bearing fruit. The number is all the more significant when one realizes that only three years ago, the online component in Target’s overall sales was a mere blip on the horizon.

After increasing 5% in 2018, Target said it expects comparable sales this year to increase by a low-to-mid-single-digit percentage. The company’s profit projections were above consensus estimates.

Although profit decreased 27% for the quarter to $799 million, this was largely due to taxes.Target earned $1.53 per share on revenue of $22.98 billion, while analysts were anticipating $1.52 on revenue of $23.05 billion. The company is confident in the success of its hybrid retail strategy and is projecting 2019 earnings of $5.75 to $6.05 per share, easily ahead of the $5.61 consensus projection.

Kohl’s, for its part, reported solid numbers, indicative of its success in embracing online and incorporating this business with the traditional store-based strategy. The company earned $2.24 per share on revenue of $6.54 billion, beating the Street’s projection of $2.18 per share on revenue of $6.55 billion. For the full year, Kohl’s expects earnings to range between $5.80 and $6.15 per share, surpassing the consensus estimate.

Comparable in-store sales rose 1%, compared with 6.3% for the same period last year. Kohl’s said it projects comparable sales this year to be flat or increase as much as 2%. Like Target, the retailer's profit targets were above analysts’ expectations. The company’s 42% decrease in profits was attributable to a non-recurring pretax restructuring charge.

Since 2017, Kohl’s has astutely adopted an “if you can’t beat 'em, join 'em” strategy by embracing Amazon through a partnership that placed Amazon boutiques in 10 of its stores in Chicago and Los Angeles. Last Tuesday, Kohl's announced it would be expanding the number of its stores that sell Amazon products to 200, up from 30 currently.

Gross margins for both companies have suffered as a result of the substantial investments made in beefing up the online component of their businesses. Since the costs of goods sold for online orders includes fulfillment costs, the investment in establishing a robust online component and corresponding fulfillment centers has, for the moment, as noted in the chart below, impacted gross margins. This phenomenon is not unique to Target. Other retailers, such as Walmart (NYSE:WMT), who are achieving success in their hybrid strategies, have seen gross margins contract.

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The latest results for Kohl's and Target should give the Wall Street naysayers pause before they publish the brick-and-mortar stores' obituaries.

Disclosure: I have no positions in any of the securities referenced in this article.

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About the author:

John Kinsellagh
John Kinsellagh is a freelance writer, former financial adviser and attorney specializing in civil litigation and securities law. He completed the Boston Security Analysts Society course on investment analysis and portfolio management.

He has served as an arbitrator for FINRA for over 25 years resolving disputes within the financial services industry. He writes primarily on financial markets, legal and regulatory issues that impact the investment community, and personal finance.

He is the author of "The Mainstream Media Democratic Party Complex" and "Election 2016," both available on Amazon. Follow him on Twitter @jkinsellagh.

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