Please ensure Javascript is enabled for purposes of website accessibility
Free Article Join Over 1 Million Premium Members And Get More In-Depth Stock Guidance and Research

Target's Stores "Saved" Its Digital Business $3 Billion

By Adam Levy - Updated Apr 11, 2019 at 3:58PM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

The real savings are found elsewhere in its income statement.

In its fourth-quarter earnings report, Target ( TGT 2.13% ) management gave investors a lot of details about the progress of its digital business. Online sales increased 31% during the quarter compared to last year, and topped $5 billion for the year. Digitally originated sales accounted for over 10% of the retailers total in the fourth quarter.

On the earnings call, COO John Mulligan gave some additional information about how Target is leveraging its stores to fulfill online orders. "This year during our fourth quarter, stores fulfilled nearly three of every four orders, effectively doing the work of 14 fulfillment centers," he said. "That means we didn't have to spend nearly $3 billion on new warehouses over the past few years to accommodate that growth."

That's a substantial savings considering Target's operating cash flow totaled less than $6 billion last year. But the real cost savings are found in the company's gross margin.

Check out the latest earnings call transcript for Target.

A Target employee bringing an order to a customer's car curbside.

Image source: Target.

Where that $3 billion went

While Target might have saved $3 billion on warehouses and fulfillment centers thanks to its stores, that money isn't falling to the bottom of the cash flow statement. In fact, the company spent $3.5 billion on property and equipment last year. That's up from $2.5 billion in 2017.

The capital expenditures are part of Target's plans to invest $7 billion starting in 2017 to remodel stores, expand its small-store format, drive online sales growth, and lower its prices. Management expects another $3.5 billion in capital expenditures in 2019, putting its three-year stack closer to $10 billion.

While the store remodels are done to improve in-store sales by improving sight lines and customer flow, they're also mindful of the growing importance of Target's stores in fulfilling online orders. What's more, investments in its supply chain ensures Target stores inventory stays well stocked. Using capital expenditures to improve store formats and supply chains instead of building warehouses appears to be a smart move.

Keeping fulfillment costs in check

Over the last few years, brick-and-mortar retailers have seen their costs balloon as they push to grow sales through digital channels. Those costs are best reflected in declining gross margins, since online sales include fulfillment costs in their cost of goods sold.

Target's gross margin fell to 25.7% in the fourth quarter. The company had a gross margin of 29.3% for the full year of 2016. Likewise, Walmart ( WMT -1.22% ) has seen its gross margin fall as online sales become a bigger part of its business. Gross profit margin for Walmart's U.S. operations declined 27 basis points in the fourth quarter, slightly less than Target's year-over-year contraction.

Walmart is also making considerable investments to use its stores to fulfill online orders. With much of its online sales growth coming from grocery, store pickup is an essential part of its digital strategy.

Fulfilling digital orders from stores significantly reduces fulfillment expenses for Target. Items shipped from stores cost an average of 40% less to fulfill compared to orders shipped from warehouses upstream, according to Mulligan. Items picked up from stores, including Target's expanding curbside pickup program, cost 90% less to fulfill. Continued growth in store-fulfilled orders ought to reduce gross margin pressure.

Importantly, management notes store fulfillments aren't cutting into in-store sales growth. "In-store sales per square foot have grown at a 4% rate per year [since 2016], which means our Target stores can support incremental growth from Target.com without hurting in-store sales," Mulligan told analysts.

Target's decision to remodel its stores and invest in its supply chain instead of building out warehouses has enabled it to grow the business better than if it had invested in digital sales alone.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

Target Corporation Stock Quote
Target Corporation
TGT
$245.50 (2.13%) $5.11
Wal-Mart Stores, Inc. Stock Quote
Wal-Mart Stores, Inc.
WMT
$135.47 (-1.22%) $-1.67

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning service.

Stock Advisor Returns
634%
 
S&P 500 Returns
141%

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 12/03/2021.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Our Most Popular Articles

Premium Investing Services

Invest better with the Motley Fool. Get stock recommendations, portfolio guidance, and more from the Motley Fool's premium services.