Target Turns in a Significant Beat on Profits

In this segment from the MarketFoolery podcast, host Chris Hill and David Kretzmann of Supernova and Rule Breakers consider the latest earnings report from Target (TGT 0.70%), which shows the discount retailer is doing better at fighting the riptides dragging much of the brick-and-mortar segment under. How is it succeeding where others aren't? And what's the company's plan from here?

Chris Hill: We have some restaurant earnings we're going to get to, but let's start with Target. Their first-quarter profits came in higher than expected, I would say significantly higher than expected. Same-store sales fell a little bit. It wasn't too bad. Management, I love this quote, pleased with Target's performance in light of "a very choppy environment." God, that's putting it mildly when you think about retail over the last six to 12 months.

David Kretzmann: Yeah, it has not been an easy time for retailers or restaurants. Definitely a lot of changes and disruptions happening for companies in those spaces. Comps were still down 1.3% for the quarter, but Wall Street was expecting it to fall closer to 4%, so this really is a case of, "It wasn't as bad as we thought, so we won't punish the stock."

Hill: And Ron Gross made this comment on Motley Fool Money last week, we were looking at, particularly last week, when you looked at some of the big general retailers, Macy's, Kohl's, J.C. Penney, that sort of thing, and the results were so bad across the board. And Ron made the point that, some of these are going out of business. This is capitalism, not everybody gets a trophy. And it's unfortunate for the people who are going to lose their jobs, but some of these aren't going to survive. I feel like Target is in a position where they can be one of the survivors. I haven't looked too closely at what they're doing in terms of e-commerce lately. But it does seem like they've put up good enough numbers often enough that they're in better shape in general.

Kretzmann: Yeah. I think they're better-managed. They don't break out what percentage digital makes up of their overall sales, but for this quarter, digital sales were up 22%. It seems like, pretty consistently over the past year or two, their digital sales have been going between 20% to 30% clip. That's nice to see. It's probably still a pretty small portion of overall revenue. They're also investing $7 billion over the next three years into technology, improving their supply chain. They're remodeling a bunch of stores, they're launching a small-format concept where they'll have about 100 of those locations rolled out over the next three years or so. So, they're being more proactive than a lot of retailers, which are just taking the bad news as it comes and not really changing a whole lot in any meaningful way.

And Target is still in pretty solid financial shape. They generated almost $5 billion in free cash flow over the last year. So they're not going anywhere. Their dividend and share repurchases will be able to continue. I wouldn't be surprised if Target or Wal-Mart buys someone like Wayfair or something, because I think this e-commerce battle is really going to heat up. And these companies are only going to be able to do so much internally, as far as ramping up that e-commerce strategy. So I think, you'll see more and more companies, like PetSmart recently buying, I forget what the name of it was, but it was the largest e-commerce acquisition ever. It might have been Chewy.com. Essentially an online pet food business. PetSmart spent several billion dollars acquiring them within the past month. I think it's inevitable that you will see Wal-Mart, Target, and some of these other retailers that, despite the troubles, are still generating a lot of cash, and they have cash they can put to work buying some of those pure-play online retailers.

Hill: I think the smaller footprint locations are going to be interesting to watch. I don't know if they've gone public with where the locations -- I would be curious to actually walk through one of those and see how it differs from the big Target that's a few miles from Fool HQ, and see what they're doing differently, because like you said, done correctly, that could be something that they look to grow even more.

Kretzmann: Yeah, they're expecting to build 30 of them this year. I haven't looked into this too much, I would assume it's a similar strategy to what Whole Foods is doing with its small 365 concept, where essentially you're able to get the stores closer to consumers. I think, especially for younger consumers, for the millennials, they value convenience more than anything else, and getting those smaller stores with the key, essential, top-selling items closer to consumers, that could be a good way to go.