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Why Investors Shouldn't Worry About Target's Earnings

By Jennifer Saibil - Mar 31, 2020 at 1:14PM

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Target withdrew guidance due to unexpected high sales but affected margins. But even if earnings come in lower than expected, the sales surge is still a win for the retailer.

Target (TGT -2.69%) is the neighborhood superstore for many in the U.S., and that's where they are turning to get their essentials during the COVID-19 shut-in.

But while sales of necessities are soaring, sales of higher-margin merchandise are slowing down, which is already putting some pressure on the cheap but chic retail king's first-quarter gross margin. 

Not to worry. The overall sales hike and commitment to its customers and employees should pull the company ahead longer-term. 

Target at Herald Square in New York.

Image source: Target.

A typical quarter at Target

Target has seen steady growth over the past few quarters as it's ramped up its omnichannel program and continues to bring out customer-focused products. It has also set the bar for how to do digital right, widening its margins as competitors trying to develop digital have been trying to figure out where to cut costs.

Here are the company's comparable sales growth rates, digital growth rates, and margins over the last five quarters.

 

Q4 2019

Q3 2019

Q2 2019

Q1 2019

Q4 2018

Comps growth

1.5%

4.5%

3.4%

4.8%

5.3%

Digital growth

20%

31%

34%

42%

31%

Gross margin

26.3%

29.8%

30.6%

29.6%

25.7%

Data source: Target quarterly reports.

Although overall momentum seems to have slowed in the 2019 fourth quarter, gross margin was better year over year. 

Staying focused

Target has been a leader throughout the current COVID-19 situation, making crucial adjustments to its regular protocols to meet changing consumer dynamics. These are some of the actions the company has taken in light of current events:

  • Having a team member at the entrance to the store to ensure the availability of clean carts.
  • Setting up floor decals at the checkout lanes to show proper distancing.
  • Disinfecting checkout counters between customers.
  • Rotating checkout lanes for interval deep cleaning.
  • Dedicating hours for the elderly and the immunocompromised to shop.
  • Raising hourly wages for team members.
  • Hiring extra workers to meet sales and delivery demand.

Many of these changes obviously incur major costs to the retailer, in addition to the $300 million Target has committed to directing toward employee benefits that include increased wages, bonuses, paid sick leave, and relief fund contributions.

Changing expectations

With Target now one of the only open operators in town as store doors have been shuttered, it's no wonder sales have shot up. Comps for the month of March are already up 20% year over year, driven by food and beverage as well as essentials, which are up 50%.

While high sales can't be a bad thing, in this case, they're not a signal of real growth. When reality goes back to normal, this unique expansion will cease and normal sales will ensue. In February, when there was already elevated activity, sales were at 3.8% growth.

To confuse things, most of those sales are coming from lower-margin goods, as people are putting the higher-margin non-essentials on hold. Combined with the costs associated with Target's store and benefit adjustments, margins may be severely pressured even as sales increase. 

Why uncertainty won't undo Target

All of these developments make Target's previous guidance a moot point, and the company has withdrawn it.

But regardless of the fact that sales are artificially inflated, what we're seeing now says so much about the company -- about what it means to customers and where it falls on their radar. Target is rising to the occasion by showing commitment to its customers and employees, but also by demonstrating its ability to carry out a huge operation under duress and unexpected conditions. This indicates it has a winning, flexible model that won't change when everything else goes back to normal.

So while Target's first-quarter earnings might show a squeeze, it doesn't tell us much about the company itself, just the short-term situation. In the meantime, the company is winning over its customers for greater long-term success. 

Jennifer Saibil has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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