Investors have some big questions heading into Target's (TGT +7.43%) first-quarter earnings report on Wednesday, May 23. On the bright side, the retailer has had mostly good news to report on the operating front lately. Case in point: It beat management's upgraded sales growth guidance in the holiday quarter.
However, that expansion pace likely slowed at the start of 2018, as it has for other major retailers that have reported earnings recently, including Walmart (WMT +0.08%) and Home Depot. Furthermore, executives have warned that this fiscal year will show another decline in profitability as Target shifts toward a more digitally focused business.
With that bigger picture in mind, let's take a look at what investors can expect from Target's upcoming quarterly announcement.
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Shopper habits
Target's holiday quarter marked a dramatic turnaround from the year-ago period, as comparable-store sales sped up to a 4% increase, compared to a 3% slump at the end of 2016. That result put the company solidly ahead of Walmart, which expanded comps by 2.6% over the holidays. Target benefited from a 3% surge in customer traffic that lifted its full-year results into positive territory and reversed a painful decline in the prior year.
Growth might be harder to come by in the first quarter. Walmart recently announced that its comps decelerated to a 2.1% pace as customer traffic gains slowed to 0.8% from 1.6% in the prior quarter. Home Depot saw a much more pronounced swing, with shopper traffic turning negative due to a delayed start of the spring selling period. Target's business isn't as seasonal as Home Depot's, but the retailer still likely had a sluggish start to the year. But the key question will be whether the latest trends will shift management from its initial 2018 target of between 1% and 3% comps gains.
Spending money
Target is saving money right now by making its network of stores double as online fulfillment centers. But the digital sales channel is still soaking up resources, and that challenge is being compounded by the need for aggressive price cuts aimed at keeping sales growth humming along in the stores.
CEO Brian Cornell and his team have warned investors to expect operating earnings to decline again in 2018, but at a slower pace than last year's 8% slump. This will be a "transition year," they said in a recent conference call, as the company spends heavily on initiatives like store remodels, increased wages, and fulfillment upgrades aimed at speeding delivery from its physical locations.
Walmart's profitability dipped slightly during the period, with operating income falling 3% to $3.9 billion. If Target sees a similarly modest drop, it should be considered a win for the business, given the tough selling environment.
WMT Operating Margin (TTM) data by YCharts.
Executives believe Target's shift toward a multichannel selling approach will hurt the business in the short term but yield positive results over time. The move will result in "somewhat lower operating margins than we've seen historically," Cornell explained in early March. In exchange, the retailer expects to generate healthy cash flow and higher returns on invested capital.
Target's profit performance this week, and management's updated earnings forecast, should tell investors a lot about just how far profitability might decline before it stabilizes in 2019 before beginning a rebound.
