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Should You Panic About Target’s Next Earnings Report?

By Adria Cimino – Apr 29, 2020 at 8:00AM

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Target has warned investors that first-quarter profit will be lower -- even as digital sales soared.

I often refer to Target (TGT -2.19%) as the "good student" of retail, with annual revenue gains since 2017, strong owned brands, and growth in key areas like digital sales and grocery. But these days our good student hasn't been at the top of the class.

Most recently, Target said declines in sales of high-margin items like clothing, as well as costs in pay and benefits during the coronavirus crisis, will lower profit in the first quarter. Not great news, but this doesn't mean we should give our good student a failing grade.

Let's take a closer look at the current situation at Target.

A shopping cart is pictured on a cell phone, with a mini shopping cart filled with packages in the background behind the phone.

Image source: Getty Images.

Target, like peers Walmart and Amazon.com, has seen demand surge in recent weeks. Amid the coronavirus outbreak, consumers are stocking up on basics, and Target has benefited. The company said March comparable sales in essentials and food and beverage have climbed 40%. That's the good news. The bad news is that the higher-margin area of apparel and accessories saw sales drop more than 30%.

In April, gains in essentials and food and beverage slowed to about 12%, while apparel and accessories sales extended declines to 40%. Still, overall comparable sales increased 5% in the month, while digital sales soared by more than 275%.

Pay increases, protective gear

Costs associated with the crisis -- such as $2 an hour temporary pay increases, protective gear for employees, and rigorous cleaning of stores -- may add to the headwinds. Target, which withdrew guidance in late March, now expects its first-quarter operating margin rate to drop by more than 5 percentage points.

So ... should we panic? No. Though we shouldn't expect a great quarter from Target, the coronavirus effect is temporary. It's too early to say whether "temporary" means one quarter or more, but that doesn't change my positive outlook on Target as a long-term investment.

The latest update from the retailer supports my argument. It shows consumers are still flocking to Target, but in a different way and for different items. These days, shoppers are visiting Target online and filling their carts with essentials rather than clothing. This is positive, meaning customers are staying with Target but adapting their shopping to what they need right now.

Once the coronavirus outbreak has passed, it is likely consumers will reduce pantry stockpiling and return to Target with their usual shopping lists. What may remain is the shift to online shopping, and Target is fully prepared.

Digital sales rose more than 25%

For the sixth consecutive year, Target in 2019 increased digital sales more than 25%. (Last year's gain was 29%.) And order pick-up, drive-up, and Target's shipping service grew more than 90% in 2019. The company's plan to make fresh grocery and adult beverages available through drive-up and order pickup services is on hold due to the outbreak, but once back on track, this should further lift sales.

I also like Target's product mix -- five product areas each generating 17% to 24% of the company's revenue -- and strong owned brands. Target last year said its new "Good & Gather" high-quality, affordable food brand would offer 2,000 products by the end of 2020. That may help Target carve out a bigger niche in the grocery market.

Target's shares have lost 13% since the start of the year. Though the retailer has prepared us for the next earnings report, any slight disappointment still may weigh on the shares. But once the crisis is over, Target's future remains bright, making this a stock to buy and hold on to for the long term.

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Adria Cimino has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Amazon and recommends the following options: short January 2022 $1940 calls on Amazon and long January 2022 $1920 calls on Amazon. The Motley Fool has a disclosure policy.

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