Target (TGT +0.50%) posted yet another strong quarter of revenue and earnings growth on Wednesday, defying the malaise of the retail industry. Revenue rose 4.7%, with digital sales leading the way, up 31% year over year. Adjusted earnings per share climbed 24.9% on the back of a 22.3% increase in operating income.
Target's numbers compare favorably to its biggest rivals, Walmart (WMT +0.63%) and Amazon (AMZN +0.38%). While Walmart's online sales outpaced Target's by 10 percentage points, Target saw its overall sales grow faster thanks to strong store traffic growth. Meanwhile, Target's digital growth outpaced Amazon's 24% increase in North American sales.
Most importantly, Target is growing its sales in an extremely cost-efficient manner, which has led to its excellent bottom-line results.
Image source: Target.
It all starts with product mix
Target saw exceptional growth in the apparel category. Management said comparable sales of apparel grew 10% year over year last quarter, by far its strongest category.
Target's success stands in stark contrast to general apparel retailers' results this quarter. Walmart's management notably said it saw "softness in apparel" last quarter due to unseasonably warm weather.
That growth is being driven by Target's private-label brands, as well as some national brands the company added last quarter. Target's home-grown brands have been a staple of its success over the last few years. Amazon has also had notable success with its own private-label brands. Walmart's finally following in Target's footsteps, building its own brands in-house, after a couple of years of trying to acquire brands and shoehorn them into its business.
Not only are Target's private brands driving increased sales in key product categories, but they also produce better margins for the company. Target launched a new private grocery brand last quarter, Good & Gather, which management expects to become its largest brand over the next year. That could improve its margin on its grocery business to supplement its other departments.
Target's sales have lower overhead than the competition
Target's increased foot traffic in the third quarter translated into lower fulfillment costs as a percentage of revenue for the company. When a customer goes into a Target store, picks an item off a shelf themselves, takes it to the register, and checks out, the marginal operating expense for that sale is practically nothing. So the 3.1% increase in store traffic last quarter and the 2.8% increase in comparable in-store sales mean lower average fulfillment costs for Target.
Meanwhile, Target's online sales growth is driven primarily by its same-day fulfillment options: pickup, Drive Up, and Shipt. Management says 80% of digital sales growth came from same-day fulfillment. These options have much lower fulfillment costs than shipping items longer distances to customers' doors.
Meanwhile, Amazon is competing by offering Prime members one-day shipping on over 10 million items. And while the benefit is compelling enough to drive incremental sales, it comes at a huge cost to Amazon's bottom line in the near term.
Management still sees room to scale its higher-margin same-day fulfillment options. Productivity on "pick, prep, pack, and ship" from its stores has increased 60% this year. And there's still a wide gap in sales from its average stores to its most productive stores.
The combination of lower operating expenses and higher gross-margin sales resulted in significantly better-than-expected earnings results for Target. Management expects that trend to continue in the fourth quarter and next year as Target's private-label brands and same-day fulfillment options continue to drive growth while it brings greater traffic into its physical stores.
