Why Target Stock Was Down

In this episode of Market Foolery, Chris Hill and Motley Fool analyst Jason Moser go through the latest business headlines, including how Target (TGT -0.70%) is responding to the current environment and preparing for long-term sustainable growth. There is news on the financial side. On the restaurants front, a popular pizza chain announced its results with all-around growth, but the stock was still down.

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This video was recorded on April 23, 2020.

Chris Hill: It's Thursday, April 23. Welcome to Market Foolery. I'm Chris Hill. With me, back by popular demand, it's Jason Moser. Good to see you again.

Jason Moser: Back at it, baby.

Hill: Earnings season is rolling on. We've got some financials, we've got restaurants, but we're going to start with some retail news, because Brian Cornell, the CEO of Target, came out this morning in an interview on CNBC talking about how digital sales at Target are up more than 100% quarter to date. They don't report their first quarter until, I think, late May, but what they're seeing right now is -- you know, Cornell came out and said, "We're basically doing Cyber Monday every day", which is fantastic, until you start to factor in the higher costs that are at play here, and he talked about that as well. And you know, shares of Target went down a little bit today as a result of that, but, I mean, you just got to be encouraged by those digital sales, right?

Moser: I certainly would be if I were an investor in Target, and I'm not, though, I could see a world where I would want to own shares in a business like this for a number of different reasons. But to your point about the digital sales, what's even more astounding, honestly, I mean, if you look at month-to-date in April, their total comp sales increased more than 5%, in the face of store comps that have declined in the mid-teens. And so that translates into digital comp sales, month-to-date in April, are up more than 275%.

And so this goes to show you, we've talked a lot about businesses that are out here in this challenging time, figuring out ways to adapt and to do things differently. And Target is certainly a business that is succeeding on this front. I mean, I think the way the business is being done, generally speaking, is changing. It was changing before the coronavirus outbreak, it's changing during it, I think this is going to accelerate that change as time goes on.

And I think that really is a sign of strength, companies that are able to adapt on the fly like this. And so, the market may be selling off the shares based on this first-quarter performances, I mean, no, duh! Right, I mean, everybody is feeling the pain here. The performance isn't going to be what we had hoped; tell me something I don't know.

But to put it into context, management sees their operating margin for the quarter taking a hit of at least 5%. Now, it's important to understand why that operating margin hit is occurring. I mean, clearly business is going to be down in some capacity, though they're making up for a lot of it on the digital side. But costs are going to go up for the foreseeable future. They make efforts to look after employees, they're writing down inventory, they're trying to right-size the business and become as lean and efficient as possible. So it costs money to do that in the short run, but ultimately, in the long run, it's the right thing to do. I think it creates something that's far more sustainable in the long run.

And you have to believe that as we get through this, you know, management is going to have a revised playbook once all is said and done. They're going to incorporate a lot of the policies and practices they're putting into play now that ultimately, I think, is going to make their business even stronger in the long run. As an investor, you have to love that, right? That's all you can really hope for these days.

Hill: Well, and we've talked before about retailers, not major retailers like Target or Walmart or Costco. I'm thinking more of a business like Williams-Sonoma, which for years succeeded because they had this omnichannel approach. And it really seems like, in part, because they're forced to, but it really seems like Target, Brian Cornell and his team, are turning that business into an omnichannel approach, where they just want as many customers as possible, and they're going to serve them however they can, whether it's curbside pickup, delivery to your home, in-store. They're building the omnichannel right now. And yeah, it's not without some cost, but you look at the digital sales numbers, and it's impressive.

Moser: Yeah, I agree. I mean, there are examples out there, there are blueprints out there that exists today of companies that have done this successfully. They started this process a little bit further back. And so, you know, what they've been saying, better late than never, right? But definitely, Target is recognizing the value in that omnichannel presence, the value in that bricks-and-mortar footprint. I mean, I think it's somewhere in the neighborhood of 1,900 stores that they have. And leveraging that store base, to be able to maximize sales, whether it's in person or digital or that in-store pickup. I mean, same-day online services are gaining a lot of popularity.

So there are blueprints out there that exist that sort of lead them to these decisions, saying, "Well, if these companies are doing it and it's working, let's try it." And trying it and it's working; at least it's showing signs of working.

And you know, in a time right now where everybody is trying to figure out exactly how to exist and how to just keep their heads above water, I think you look at Target, and this is a business that's not only doing well by its customers, it looks like they're doing well by their employees, or at least as well as they can. I mean, I would imagine that everybody wants them to do a little bit more, right? Regardless of the company you work for, you probably want them to do a little bit more.

But in the face of an unprecedented time right here, I mean, Target strikes me as a company that's responding in a number of different ways, and Brian Cornell strikes me as an empathetic leader who really is trying to look out for the culture of this business and build something that is long-term sustainable and that's going to succeed in this retail environment of the 21^st century.

And so, again, I think they're going to take a lot of lessons from this. I think they're going to put some of these practices into their playbook of the future, and I think it's going to work out for them, because certainly they have that physical footprint already in place. And being able to incorporate more of the e-commerce digital side, the omnichannel presence, as you said, that I think is going to lead them to longer-term success.

It's going to come with a little bit of pain in the short term. Even if we weren't going through this coronavirus crisis right now, there would be costs in implementing this strategy. But if you're a longer-term investor, if you can see that forest for the trees, I think you have to be optimistic about the stuff that they're doing today.

Hill: Discover Financial Services (DFS -0.17%) reported a loss in the first quarter. The stock has been cut-in-half in the past couple of months. And I'm not saying Discover Financial should be in the war on cash basket, but they are part of the war on cash. I mean, how are they struggling to this degree?

Moser: Well, to a degree, they are a part of the war on cash. I mean, you know, Discover has two segments of the business that they report in. They have a direct banking business and they have the payment service business. And so, ultimately, at the end of the day, I think you have to look at Discover as more of a bank than anything else. They're on the hook for all of this credit card spending. I mean, they actually are responsible for that debt that exists out there.

You look at something like a Visa or a MasterCard, where they're just that tollbooth, Discover is a bank holding company. So we talked about, last week, the big banks and the theme of the calls all being about reserves, right? And Discover was no exception here. Discover has to deal with this as well. And they had to boost their provision for credit losses significantly this quarter. Those provisions increased almost $1 billion from the prior year. And so, for a business like this, it's smaller, it doesn't have the same reach as some of its stronger competitors in the space. I mean, that's a very significant chunk of change, and they're always going to be on the hook for that debt.

Now, that's not a bad thing, right? I mean, banks are wonderful investments in some cases. And I think that, as the interest rate environment normalizes over time, there's going to be more opportunity for Discover, perhaps, to wring a little bit more profitability out of the business. But for now, we do have to recognize that they're on the hook for a lot of this debt out there. And there's going to be a lot of bad debt coming, there are going to be a lot of write-offs, and they're going to have to deal with that.

Now, the good news is they're accounting for that, they're preparing for that. But when you look at where the stock trades today, I mean, this thing is trading at less than book value. So from the value investor side, this actually does look like it could be a compelling idea, because, I mean, it's not the biggest card out there, it's not the most popular card out there, but it's got a strong cardholder base. And they also have that Pulse network where, you know, if you go to a store and swipe your card, if you go to an ATM, if you see that Pulse symbol, that's Discover. So I mean, they do have that payment services side of the business which is really strong.

And the business, I think, performed fairly well. Credit card loans ended the quarter up 4% from a year ago, personal loans up 3%, private student loans up 4%. What I found really impressive was that the share count for this business is down 30% since 2014. Now, the flip side of that is the stock hasn't performed very well. But I mean, it's understandable why it might not be performing well right now, and I think it's understandable the pessimism that would exist for a company like this today. I don't know that I would have it at the top of my list, but I actually do see, based on the valuation of the stock and given what they do, there could be a value-style investment here.

Hill: Do you think there could also be an acquisition? Because this is not a big company. All things considered, when you consider the financial space, this is basically an $11 billion company.

Moser: Yeah, I mean, I could, on the one hand, see an acquisition, I could see them as being a target. Now, on the other hand, given the depressed level of the business today, I don't know that they would be all that excited about selling for less than maybe what they think the company is really worth. And so, you got to take those two hand in hand. But it's a business that's similar to what something like an American Express does. It's a business that -- shoot! I mean, we've been talking about consolidation of the banking sector over the last year, year and a half and, I mean, I could see a bank out there being interested in buying this network and bringing it in-house. Again, though, I don't know that Discover will be all that excited about selling at depressed levels today, but I got to believe the name is thrown around in board rooms.

Hill: Domino's Pizza (DPZ 1.36%) came out with their first quarter report and the stock is down about 5% today, but, look, this was a report where everything was up. Profits were up, revenue, same-store sales were in positive territory, not crushing it, but they were still positive. Do you think the drop in the stock that we're seeing today is a function of the guidance being withdrawn for the next couple of years? Or is it the fact that -- look, this was a good quarter but the stock is still, even with the drop today, the stock is still up about 15% for the year, so maybe it's a valuation thing.

Moser: I think it's probably more a valuation thing than anything. The business today trades at around 35X earnings, which is in line with the range it's traded over the past several years. I mean, it's traded in that range of 30X to 40X, even 45X earnings. And I think the main reason why it garners that premium multiple is because this really is a good business. If you dig into Domino's and you actually look at how this business is structured and how they've performed over the past several years, you come away feeling like, wow!

I mean, this is one of those investments that it's right under your nose. I mean, probably a lot of people wouldn't even think about it, but this really is, it's a phenomenal business. And I say that from the perspective of having done a lot of research into this business for one of our services.

I mean, the first quarter marked the 105^th consecutive quarter of international same-store sales growth. It was the 36^th consecutive quarter of U.S. same-store sales growth. I mean, that's impressive.

Now, we talk about businesses that should hold their own in a time like this. I think Domino's is clearly one of them. But it's not just because of the delivery aspect. I mean, we talk about that omnichannel presence, and Domino's has done a really good job of taking the +17,000-store base and utilizing it from a delivery and a carryout perspective.

And, you know, I've talked about this before where the numbers, how they deliver, how they get their product to consumers. I think most people think it's just a delivery company, but delivery makes up 55% of transactions and 67% of sales; carryout makes up 45% of transactions and 33% of sales. And so, again, they do a great job of leveraging that store base.

And ultimately, management has these goals of hitting 25,000 stores and $25 billion in global retail sales by 2025. Now, they're at just a little bit more than 17,000 stores today and around $14.6 billion in global retail sales. So that would give you an idea of how much farther they feel like they have to go to really hit those goals, but I mean, it's a franchise model, it means they can grow quickly, they can grow efficiently. They've done a great job of incorporating technology, and it's not like they just started doing that; they've been working on that for a long time.

So my suspicion is that the selling today is based more on valuation than anything else, because it's still not a cheap stock today. But it's a high-quality business, and I definitely think it's one that is worth keeping on the radar.

Hill: Well, and they also provided a little bit of insight into what same-store sales for Q2 are looking like. And so far, it's early in the quarter, but they're up 7% so far. So they're getting it done.

Moser: Yeah, I mean, this is a business that should thrive in a time like this. And I'll just speak from a personal perspective, having used Domino's a few times here since everything went into shutdown mode, they've just made it so easy. I mean, we talked for many years about how they, sort of, came to the realization that their product wasn't the best it could be, and so they said, "Well, let's get back down to business here and make our food better."

And you know, it's interesting: When you make good food and you make it easy to get to people and you sell it at an affordable price, it turns out people are going to buy it a lot of times. [laughs]

Hill: It's shocking.

Moser: I know. And I mean, it's pizza, right? I mean, what is it that Jay Leno said? Even bad pizza is still pizza. Now, I'm not saying Domino's is bad pizza, I think it's actually pretty good pizza. But, yeah, Domino's is the No. 1 delivery pizza company in the U.S. It has 35% share of this market. It's the No. 2 pizza carryout company in the U.S. with 16% share.

And again, you got a business here, the majority, more of its stores are international than domestic, but they have just such a strong franchisee family with such a proven track record of success, that for me, I mean, this is the type of business that's going to perform well in good times and in bad. They pay a little bit of a dividend there, so that's nice as well, but I really do think, given the goals that management has set out for that 2025 target, I think it gives you an idea of their aspirations. I think it gives you an idea as an investor, this is still very much a growth opportunity, assuming that management continues to execute. To this point, I don't see any reason why they shouldn't. So yeah, I look at Domino's today, and I think it's a high-quality business that belongs on every investor's radar.

Hill: Do you have anything that you add to pizza? I'm not talking about the toppings that you order, I'm saying is there anything you're like, "Whatever pizza I'm getting, I'm going to add a little crushed red pepper, a little Parmesan cheese," that sort of thing?

Moser: Yeah, you know what, it's funny, so actually I do. And I think for me, the go-to is the crushed red pepper, like you said. I also like getting that oregano shaker out, you know? Throw a little oregano on top. I don't think people recognize the significance that oregano plays when it comes to Italian food, and not only the aroma, but the flavor. Yeah, I get those. And, of course, you know, the McCormick spices, Chris. So I mean, I get the shakers out of the spice cabinet every time we get -- whether I make it or whether I order it, the crushed red pepper and the oregano is right there on the counter ready to go.

Hill: See, I always do the crushed red pepper, but tomorrow night, I guess, Friday night, going to go for some pizza, yeah, I'm going to take your advice, do the oregano as well.

Moser: Give it a shot.

Hill: Jason Moser, thanks for being here.

Moser: Thank you.

Hill: As always, people on the program may have interests in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear.

That's going to do it for this edition of Market Foolery. The show is mixed by Dan Boyd. I'm Chris Hill. Thanks for listening. We'll see you next week.