Target Corporation's (TGT 1.28%) third-quarter earnings report was better than anticipated. The retail giant reported both a top- and bottom-line beat by producing revenue of $16.67 billion and adjusted earnings per share (EPS) of $0.91, versus Thomson Reuters' analyst expectations of $16.61 billion and $0.86, respectively. Perhaps more importantly, the company reported a same-store sales advance of 0.9%, versus estimates of a 0.4% increase.
Instead of seeing rallying shares, Target stock fell approximately 10% in the trading session following the report. Cautious guidance for the critical fourth quarter made investors nervous. As of this writing, shares of Target are down 24%, while the greater S&P 500 is up 16%.
Target has outlined a plan to reverse its slide, but will its plan pay off?
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While retail is cutting spending, Target is going in a different direction
Target's results this year are partially due to poor performance but due more to investors' antipathy toward the retail industry. Through September, Bloomberg noted that retailers have announced more than 6,800 store closures year to date, versus 3,000 openings. In 2017 alone, approximately 20 traditional brick-and-mortar retailers have filed for bankruptcy protection.
In this environment, many retailers are going to extreme lengths to produce profits from falling sales, including downsizing locations, postponing renovations, and hemorrhaging employees. After peaking at approximately 1.8 million workers in the 2001, the number of employees who work at department stores continues to fall, dropping to under 1.3 million as of the last employment report.
Target is planning to do the exact opposite.
A $7 billion bet on consumer experience
In the company's recently reported third-quarter conference call, Target CEO Brian Cornell reaffirmed the company's earlier $7 billion commitment to improve the consumer experience. The broad initiatives include:
- Better aligning of the digital and physical channels.
- Remodeling more than 1,000 locations.
- Opening smaller-footprint stores in urban areas.
As reported in Business Insider, the planned remodels are designed with the consumer experience in mind. The first major change from the next-generation store is a two-entrance scheme whereby one entrance is designed for time-crunched consumers with quick access to the essentials: grab-and-go food, online order pickup, and self-checkout lines. The second entrance is for traditional shoppers who want the full shopping experience.
The company's redesign is not simply within its stores; Target plans to introduce parking spaces near the entrance for online pickup orders to better align the digital and physical experience.
Is Target's plan too late to compete with Wal-Mart?
In many of these initiatives, Target finds itself playing catch-up to larger rival Wal-Mart. After years of being the trendier retailer, Target failed to see Wal-Mart's aggressive moves and now finds itself a laggard after years of being the leader in the traditional retail space.
Digital shopping and fulfillment were vastly improved by Wal-Mart CEO Doug McMillon's decision to buy Jet.com and allow its founder, Marc Lore, to head both Jet.com and Wal-Mart's eponymous website. In Wal-Mart's recently reported third quarter, digital sales increased 50% on a year-on-year basis. By comparison, Target produced a digital sales increase of only 24%.
Even with a resurgent Wal-Mart and the continued threat from Amazon.com, the U.S retail market is, and will continue to be, large enough for a third general-merchandise retailer. Target may be losing ground to Walmart, but it's not a winner-take-all market.
Target is cheap, but is it a value trap?
For value-oriented income investors, Target deserves a serious look for inclusion in your portfolio. Currently, the stock trades at 12.5 times forward earnings, much lower than the 21 multiple of the greater S&P 500. Target's dividend yield is 4.4%, much higher than the overall yield of the S&P 500 and the 10-year U.S. Treasury bond.
It is for this reason that Target doesn't have to significantly improve its operations for investors to benefit. If management can merely convince Wall Street it's moving in the right direction, the stock should experience a relief rally. But while it appears the risk/reward for Target is favorable at these valuations, management needs to continue to show improvement. Target's third-quarter results were encouraging, but the fourth quarter will be heavily watched.
