The Future of Target Depends on This

Target has a specific goal in mind. If it can achieve this goal, the market will see significant margin improvements, which would lead to increased profits.

Jul 13, 2014 at 11:19AM
Target In Store Pickup

Target.com

Target (NYSE:TGT) recently made it clear what it wants to be: a leading omni-channel retailer.

Target had a late start in this space, but it's now looking to make up ground. If Target can implement the correct initiatives and grow in the omni-channel space, then it will greatly increase its odds of long-term profitable growth. A big part of omni-channel retailing is e-commerce, which equates to better margins because of lower costs.

What is Target doing to improve its omni-channel presence? And is it likely to work?

One of three key objectives
Target recently announced its three key objectives:

  • Drive traffic and sales in the United States.
  • Accelerate operational improvement in Canada.
  • Accelerate transformation in omni-channel to become a leading retailer in this channel.

In order to become a leading omni-channel retailer, that retailer must have strong digital sales. At the moment, Target's digital sales only account for 2.5% of total sales, but this does leave a long runway for growth.

Target's primary focus is on mobile growth, which makes sense since approximately 67% of its digital traffic comes from mobile devices. While no numbers have been provided, Target has stated that conversions for both online and mobile have improved. That's good news, but what will drive future digital growth so it accounts for much more than 2.5% of total sales?

Follow the leader
Target currently offers REDcard members free shipping with online orders. This had led to a lot of penetration online. Buy online and in-store pickup have been performing well, and Target plans on expanding its online items to almost every item you find in a physical store.

Target has also launched rushed delivery for ship-from-store in Minneapolis, Boston, and Miami for a fee of $10. Early feedback has been good.

Later in the year, Target will offer standard shipping from 135 stores in 38 markets. Delivery times will be one to two days, and the assortment will be better than what's currently available at Target.com.

Target's primary goal right now is to drive sales -- not profits. Its game plan is to pilot different initiatives in the omni-channel space (physical, online, mobile platforms), see how customers respond, and then tailor that initiative to allow for long-term profitability. So, in essence, it wants to be a lot like Amazon.com (NASDAQ:AMZN). Is it possible for Target to steal online share from Amazon in the future?

Stealing from the king
Kathee Tesija, Target's Chief Merchandising & Supply Chain Officer, made a telling statement in the first-quarter conference call's Q&A session: "Clearly, Amazon is doing very well." 

According to comScore, Target's online traffic grew faster than Amazon's in the first quarter. Don't get too excited, though. This is expected given the difference in sizes. In truth, Amazon is a major threat to Target in the e-commerce space. Amazon is now getting a lot of business in consumables, which could lead to Amazon thwarting the threat of e-commerce share gains by traditional big-box retailers. Target is ramping up its e-commerce consumables with an improved product mix, but stealing share from Amazon won't be easy.

One potential positive for Target is that Amazon must now collect sales tax. The biggest impact has been seen in states that already have a higher sales tax. Any hit to Amazon is a small opportunity for Target. If Amazon must charge more to make up for the sales tax, then Target finds itself in a better position than before.

Amazon still has an enormous e-commerce advantage thanks to its established online presence, but here's something that might surprise you. Target has delivered a higher return on invested capital than Amazon over the past five years:

TGT Return on Invested Capital (Annual) Chart

TGT Return on Invested Capital (Annual) data by YCharts.

This doesn't mean Target will continue to outperform Amazon on this key metric, but its stability should be kept in mind as a potential positive. On the downside, Target's sustained yet low ROIC may very well fail to hurdle its cost of capital. Investors should keep a very close eye on this relationship going forward.

The bottom line
Target will likely grow its digital presence, which will make it a bigger player in the omni-channel space. This should lead to margin improvements, which would then lead to increased profitability and returns on invested capital. However, Target is still facing significant competition, and it was late to the party. Therefore, investing in Target isn't for the risk-averse because this will take a long time to play out. You would be best off tracking Target's progress in the omni-channel space prior to making any investment decisions on the company. 

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Dan Moskowitz has no position in any stocks mentioned. The Motley Fool recommends Amazon.com. The Motley Fool owns shares of Amazon.com. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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