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1 Big Way Target's Business Is Getting More Valuable

By Demitri Kalogeropoulos – May 20, 2020 at 10:31AM

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Demand changes around COVID-19 are hurting profit margins but giving the retailer a chance to win more loyal customers.

Target (TGT -0.35%) shareholders had been expecting to see significant first-quarter sales growth, especially after rival Walmart (WMT -0.99%) announced a record expansion pace during the early phase of the COVID-19 pandemic.

Target followed up that report with some records of its own, including an 11% spike in comparable-store sales. And, while the retailer's profitability took a big hit as shoppers shifted spending toward essentials, that trade-off looks like a long-term win for the business.

A delivery person holding several boxes rings the doorbell at a home.

Image source: Getty Images.

Sales growth is all digital

Target's growth in the first quarter looked a lot like Walmart's in that it overcame falling customer traffic by posting soaring average spending and robust gains in the digital channel. Its physical stores saw shopper volume fall 1.5% compared to Walmart's 6% drop. Average spending jumped 13%, while Walmart's shot higher by 17%. 

Target achieved faster digital sales gains, though, with e-commerce rising a blistering 282% in April and jumping 141% for the full quarter. Walmart's comparable quarterly figure was 74%.

The big difference was Target's same-day fulfillment services, which include in-store pickups and home deliveries and accounted for just under half of the chain's growth. Management said the chain's ability to deliver these products safely helped lift the brand during a tough time. "In the face of [COVID-19] challenges," CEO Brian Cornell said in a press release, "our team showed extraordinary resilience as guests relied on Target as a trusted resource for their families." Executives said Target won market share across each of its five core product categories.

Changing profit profile

Target reported some extra costs associated with COVID-19, including higher wages, which pulled profitability lower. That happened with Walmart, too, but the chain also noted a significant shift away from its consumer discretionary products, especially apparel, toward lower-margin essentials like food. That move combined with the tilt toward digital fulfillment to push gross profit margin down to 25% of sales from 30% a year ago.

Several of Target's other financial metrics worsened in the quarter, including return on invested capital, cash flow, and operating margin, in part because the chain took impairment charges on seasonal merchandise in its apparel and accessories divisions.

Yet the surging sales figure still gave management ample flexibility to boost shareholder returns. Stock buyback spending was $609 million, and dividend payments landed at $332 million. That $1 billion total return was about even with what investors saw last quarter.

Looking ahead

The uncertainty around the virus hasn't declined enough to allow management to reinstate the short-term outlook it withdrew in late March. However, executives said Target's performance through the initial phase of the pandemic puts it in a good position to keep gaining market share once the industry returns to more normal conditions.

Cornell said:

With the dedication of our team, the benefit of a sustainable business model, and a strong balance sheet, we are confident Target will emerge from this crisis an even stronger retailer, with higher affinity and trust from our guests.

Right now, the company is taking a financial hit from its transition into a quick fulfillment point for consumer staple products. But high customer satisfaction around these services should keep them popular once the COVID-19 threat has faded.

Demitrios Kalogeropoulos 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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