On Wednesday, Target (TGT, Financial) reported financial results for the second quarter of fiscal 2019.
Revenue increased 4% to $18.4 billion as a result of a 3.4% increase in same-store sales. This was driven by a combination of ticket (up 1.0%) and traffic (up 2.4%) growth.
The two-year stack comp (which removes some of the noise in any given quarter) was up 10% - “our best two-year stack performance in well over a decade”. In addition, this was the strongest two-year stacked traffic compTarget has ever reported. Importantly, management expects the strong results to continue, with guidance for the back half of the year implying the two-year stack will hold in the high single digits.
Much of Target’s growth has come from digital (up 34% year over year), particularly the company’s same-day fulfillment options (Order Pickup, Drive Up and Shipt). The significant growth in digital sales contributed roughly 180 basis points to the comp increase.
As Chief Operating Officer John Mulligan noted on the conference call, these fulfillment options are resonating with consumers:
“In the second quarter, these three services accounted for more than 33% of our digital sales, up from about 20% last year. In other words, our same-day options are growing much faster than our digital sales. Specifically, combined sales for in-store pickup, drive-up and Shipt have more than doubled over the last year, accounting for nearly 75% of Target's 34% digital comp in the second quarter… For many guests, they are becoming the go-to choice for their digital shopping because they offer unique advantages. They are immediate. They allow guests to shop and receive their order on the same day. They are convenient. Guests can choose where they receive their order, either at the front of the store, in the parking lot or at home. They are fast. Our standard is for drive-up guest to receive their order in less than two minutes and our average is comfortably better than the standard. And finally, these services provide certainty. Guest don't have to wonder when a package will arrive at their house and what will happen to the package if they are not at home. And it eliminates the need to deal with opening and recycling a stack of cardboard boxes every week. With these advantages, it's no wonder that our same-day offerings receive some of the highest net promoter scores of anything we offer, which means the guest want to use these services again and again after they have tried them.”
Despite business mix shift towards digital, Target reported 80 basis points of operating margin expansion in the quarter (to 7.2%), with 30 basis points from higher gross margins (helped by outsized growth in categories like apparel) and 50 basis points of operating leverage. This was the first time in nearly three years that gross margins expanded. Year to date, operating margins have expanded by 50 basis points to 6.8%.
Cash flow from operations in the first half increased 3% to $2.8 billion. Roughly half of that has been reinvested in the form of capital expenditures. In addition, Target has spent $662 million on repurchases (with the share count down 4% year over year to 516 million shares) and $658 million on dividends. Repurchases in the second quarter were at an average price of $80 per share.
With the combination of revenue growth, margin expansion and a lower share count, adjusted earnings per share increased by more than 20% in the quarter (and by a comparable amount year to date). I give CEO Brian Cornell and his team a lot of credit for the strong results they’ve delivered in the past several quarters.
Conclusion
The updated full-year guidance calls for adjusted earnings of $5.9 to $6.2 per share. At the midpoint, that implies an increase of roughly 12% from fiscal 2018.
At $106 per share, the stock currently trades at roughly 17 times forward earnings.
I have not followed the Target story that closely (clearly I should have). That said, I'm quite impressed by the results it has put up in the first half of the year. Clearly the fulfillment offerings the retailer has rolled out are resonating with customers. And the fact the company has managed to shift to these offerings while simultaneously driving outsized profitability speaks volumes. Again, kudos to management and the associates.
I’ve never really considered owning Target. Personally, my sense has been that the Amazon (AMZN, Financial) risk is quite a bit higher than it is for a retailer like Walmart (WMT, Financial). But if Target continues to deliver these kinds of results, I won’t be able to overlook it for much longer.
Disclosure: None.
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