Target (NYSE:TGT) is one of the few retailers seeing their businesses boom amid the coronavirus pandemic. In an update to investors, management said same-store sales increased more than 7% quarter to date. That's driven by over 100% growth in online sales while in-store sales have dropped slightly. Online sales have picked up momentum in April, up over 275% so far this month.
But while sales are booming for Target, management says it's seeing pressure on its profitability, claiming various factors will weigh on its operating margin to the tune of over five percentage points. Management declined to provide any specific earnings estimates for the quarter ending this month, but investors shouldn't expect the surging sales to translate into huge profit growth for the company.
Here are four factors weighing down Target's profits amid the coronavirus pandemic, and how investors in Target as well as competitors Amazon (NASDAQ:AMZN) and Walmart (NYSE:WMT) should think about them.
1. Increased pay and benefits
Target temporarily increased its workers' wages by $2 per hour, and it announced this week it's extending that pay bump through May 30. Amazon and Walmart have made similar moves and have also substantially increased hiring. All three will see big impacts on their operating costs this quarter.
Target previously estimated that its heightened wages combined with efforts to protect its workers and shoppers would cost it about $300 million for the six weeks of heightened pay. Extending the additional wages for another four weeks could cost it around $200 million more.
By comparison, Amazon expects to spend $500 million on wage increases, but it's also hiring 175,000 additional workers. At $19 per hour, those workers will cost hundreds of millions of dollars for Amazon.
Meanwhile, Walmart paid out special bonuses to its employees totaling $370 million and accelerated payment on about $180 million worth of bonuses. It also increased wages for warehouse workers by $2 per hour, and it hired 150,000 new temporary employees.
That said, the relative scale of Walmart and Amazon means the impact of their wage increases won't be as drastic as for Target, despite their larger increases in employee compensation.
2. A mix shift toward lower-margin categories
Target says sales of groceries and essentials grew nearly 40% in March and 12% in April. Meanwhile, apparel sales have fallen substantially, down 30% in March and 40% in April.
The shift toward lower-margin categories means that despite increased revenue, gross margin dollars won't actually increase very much. Amazon may see a similar impact from increased demand for its grocery business (although Whole Foods generally produces higher margins than other grocers) and reduced inventory for items it deems non-essentials.
Meanwhile, Walmart may see less of an impact on its gross margin since a high percentage of its sales already come from grocery items.
3. Inventory writedowns in Apparel & Accessories
With the rapid downturn in apparel sales, Target is writing down the value of some of its inventory. Management didn't say how severe the writedown could be, but it was substantial enough to note in its business update.
Apparel & Accessories accounted for 18.5% of Target's total revenue in 2019. Walmart and Amazon don't break out their percentage of sales from the category, but it's likely lower for both. Walmart, as mentioned, already draws substantially more of its revenue than its competitors from grocery sales. Meanwhile, apparel sales have been slow to move online to marketplaces like Amazon.
4. The shift to digital orders
Many people are opting to use one of Target's digital fulfillment options instead of going into its stores and shopping themselves. But digital orders are more expensive for Target than in-store purchases. It has to pick items, package them, and ship them. Same-day delivery requires a contractor to deliver individual orders to customers' doors. And even curbside pickup requires someone to pick items off of shelves and bring them out to the car.
Walmart has also likely seen increased online order fulfillment. It's been one of the biggest winners of new online grocery shoppers. That may be a drag on its gross margin dollars, but Walmart has been pushing to get shoppers to use its online grocery platform for years, and it's winning market share despite its already massive lead in food & beverage sales.
Meanwhile, Amazon is practically all digital. That said, there's certainly been a surge in Prime Now deliveries, which will likely increase its fulfillment expenses.
Brace for impact
Target usually reports its first-quarter earnings results in the second half of May, so it'll probably be another month before the retail company shares its next update. Investors should brace for the impact of the current environment on Target's earnings, but note that Target's willingness to dispense information means a lot has already been priced into the stock.
Amazon's earnings at the end of April may provide a glimpse of what's to come for Target, but the two have considerably different businesses. Drawing concrete conclusions about Target's results from Amazon's earnings may prove difficult. For now, investors will just have to wait and see how badly Target's earnings were affected.