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3 Reasons Target Is a Buy

By Adria Cimino – May 16, 2020 at 1:45PM

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Though sales in some categories have suffered recently, the retailer holds several keys to growth once the coronavirus crisis is over.

As the coronavirus outbreak spread throughout the U.S., shoppers flocked to Target (TGT -2.24%) to stock up on essentials. That sounds good, but at the same time, they bought fewer high-margin items too. Target said that will weigh on the company's profits for the recent quarter.

A shopping cart filled with toilet paper, sanitizer, and a mask

Image source: Getty Images.

Still, I won't be discouraged by weakness when Target reports first-quarter earnings on May 20.

1. Digital and delivery

Earlier this month, Target said it would acquire Deliv, a start-up focused on last-mile delivery technology. Target has been boosting its delivery services over the past few years in an effort to compete with larger rival Amazon. In 2017, Target acquired same-day delivery platform Shipt. The strategy has been a winning one. Last year, Target's order pickup, drive up, and Shipt initiatives grew more than 90% and made up about three-quarters of the retailer's same-store digital sales growth. We can expect the addition of Deliv to further streamline Target's delivery capabilities.

More recently, the coronavirus crisis sent delivery and pickup services soaring as shoppers avoided leaving their homes to stop the virus from spreading. Last month, Target said digital sales had climbed more than 100% quarter to date, and demand for same-day fulfillment remained strong. This trend can be seen well beyond Target. "Buy online, pickup in store" orders surged more than 200% year over year last month, according to the Adobe Digital Economy Index.

It's clear that once the pandemic has passed, investors cannot expect such gains month after month. But it is likely the trend, which was already gaining momentum pre-crisis, will continue picking up speed. Many consumers have learned to appreciate the convenience of online shopping and same-day services. And some, still concerned about the spread of the coronavirus, may continue to favor social distancing when possible.

2. Loyal customers

The important thing to note is that Target didn't lose customers during the lockdowns. Instead, customers' shopping lists changed.

In Target's quarter-to-date report in late April, the company said sales of apparel and accessories declined more than 20%, while sales of essentials and food and beverage climbed by the same percentage. Total same-store sales rose more than 7%, Target said. The problem for the company is that apparel and accessories is a higher-margin category.

The company already warned that this trend will weigh on profitability in the fiscal first quarter. Investors should be prepared for weakness in nonessential categories to extend beyond the first quarter too. With record unemployment claims in the U.S., it's likely many Americans who have lost their jobs will cut back on spending. However, this should only be a temporary headwind, and Target's overall sales gains throughout the crisis are a positive sign for the future.

3. Owned-brand potential

Target has been successful with its owned brands, generating billions in revenue from children's clothing label Cat & Jack, for example. In January, Target launched activewear brand All in Motion, but the label didn't have much of a chance to take off before the outbreak hit.

The line, focusing on comfort and fit, may have the opportunity to take flight in the coming months if a current trend persists. As consumers telecommuted in April, online pajama sales climbed more than 140%, according to the Adobe Digital Economy Index.

Through the crisis, many employers discovered the cost savings and productivity gains that often come with allowing employees to work from home. Some say telecommuting will become the new norm. Even if it simply gains a bit of ground, telecommuting could boost sales of comfort clothing as workers opt for yoga pants and T-shirts instead of suits.

And finally, last year, Target said its new grocery brand, Good & Gather, would include more than 2,000 products by the end of this year. This ramp-up in selection should help Target gain market share in the growing online grocery market. Though on hold at the moment, Target aims to add fresh groceries and adult beverages to its drive-up and order pickup offerings.

Target shares lost as much as 29% this year, but they've rebounded and are only down about 6% year to date as of this writing. Share performance may be rocky around the earnings report, but for the long-term investor, any weakness in this retail stock is a great buying opportunity.

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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