Target (NYSE:TGT) investors expressed their booming enthusiasm for the company by sending shares 20% higher following the retailer's second-quarter earnings report. That announcement was highlighted by slight surprises on sales and profits, along with a stable outlook for the second half of 2019. Yet the bigger story was that the chain's shift into multichannel selling appears to be making it more profitable rather than less so, as investors feared might happen.
CEO Brian Cornell and his team explained in a conference call with Wall Street analysts why that change is helping lift the business to new heights when it comes to overall growth and earnings power.
It's all about digital speed
Our same-day options are growing much faster than our digital sales, specifically combined sales for in-store pickup, drive-up, and Shipt have more than doubled over the last year, accounting for nearly three-quarters of Target's 34% digital comp in the second quarter. That means that nearly 1.5 percentage points of the company's overall comp[arable-store sales] growth was driven by our same-day services.
-- COO John Mulligan
Three months ago, management called the same-day portion of the e-commerce channel a "game changer," and this week executives revealed more data supporting this contention. The 36% spike in digital sales accounted for most of the retailer's 5% comparable-store sales gain, but the real growth driver shows up when you look beneath that top-line figure.
In fact, same-day fulfillment orders expanded by over 100% this quarter to account for about 75% of all digital sales. Put another way, these quick-delivery and pickup services represented about one-third of Target's comp growth this quarter, up from roughly one-quarter just three months ago.
Getting more profitable
What's even better is that these services also make sense for our business because they leverage existing store assets and our store teams in new ways. As a result, our same-day options are also the most profitable within our digital offering.
The main worry with Target's shift toward multichannel selling from its prior physical shopping focus was that overall profitability would decline. However, the consumer demand for instant gratification has changed that calculus since the retailer's national network of stores allows it to deliver products within hours of a shopper's order.
The profitability on those quick orders is improving, too. Executives estimated that costs fell by about 30% in the past year in areas like in-store pickup as volumes rose and as the company learned how to make better use of labor time. That success helped push overall profit margin up to 30.6% of sales from 30.3% a year ago. That marked the first time in almost three years that Target boosted that critical profit figure.
Elevated spending for years
We continue to expect to invest about $3.5 billion in [capital expenditures], driven by our remodel program, other investments in store assets, new store openings, and in our supply chain and technology capabilities.
-- CFO Cathy Smith
Target affirmed its full-year sales outlook and predicted a strong profit margin performance over the final half of 2019. Looking further out, executives said that its elevated capital investment pace will continue through 2020 and into 2021, at which point its store remodels into fulfillment centers will be complete and spending will level off.
Given that the chain started its investing strategy in 2017, that's five years of unusually heavy spending for the retailer. Yet the focus has allowed digital selling to power the consumer products stock's fastest growth in over a decade. Combine that trend with the fact that same-day sales are growing even faster and becoming more profitable, and it's clear why investors see a much brighter future ahead.