The first quarter of fiscal 2020 was a period of extreme volatility for Target (TGT -2.19%). Sales surged in March as people stocked up in the early days of the COVID-19 pandemic, slowed dramatically later that month as most of the country went into shutdown mode, and then sales reaccelerated as states began to reopen in the second half of April.
The U.S. battle against COVID-19 has continued to have ups and downs over the past few months. As a result, most investors expected Target's second-quarter performance to be similar in many respects to what it reported three months ago. Instead, the retail giant posted blowout sales and earnings results on Wednesday, sending Target stock up 13% to a new record high.
A phenomenal quarter
During Target's Q1 earnings call, CEO Brian Cornell shared that "over the last couple of weeks of April, we saw some of the strongest comparable sales growth we've experienced in our history." That momentum continued during the second fiscal quarter, which ran from early May to early August.
Comparable sales surged 24.3% last quarter: a record. Digital sales nearly tripled, driving more than half of this stellar comp sales growth, with even faster growth for curbside pickup and same-day delivery from Shipt. In-store sales also rose 10.9% year over year. Total revenue reached $23 billion, up 25% from $18.4 billion in the prior-year period.
Target noted that all of its major merchandise categories grew and gained market share. Whereas high-margin apparel sales plunged 20% in the first quarter, the cheap-chic retailer posted double-digit growth in that category in the second quarter. Home sales surged more than 30%, electronics sales jumped more than 70%, and most other categories posted growth of at least 20%.
This incredible sales performance enabled equally impressive margin expansion. Gross margin ticked up to 30.9% from 30.6% a year earlier, because of lower markdowns. Meanwhile, operating expenses declined as a percentage of revenue, as the benefit of higher sales more than offset wage increases and other coronavirus-related costs. As a result, Target's operating margin climbed to 10%, compared with 7.2% in Q2 2019. For comparison, operating margin had plunged by 4 percentage points year over year to just 2.4% in the first quarter.
The combination of high revenue growth and margin expansion caused Target's Q2 earnings per share to nearly double year over year, rising 84% to $3.35 under generally accepted accounting principles (GAAP). Adjusted EPS skyrocketed 86% to $3.38, more than double the average analyst estimate of $1.62.
What is temporary and what is permanent?
Clearly, Target has been a big-time winner from the COVID-19 pandemic. People are shopping at Target more frequently (traffic was up 4.6% last quarter). More importantly, they have been buying more on each Target run, as "basket" size surged 18.8%.
Target's combination of everyday essentials and discretionary items like apparel and home goods has made it a one-stop shopping mecca for many consumers during the pandemic. The retailer is acquiring new customers and getting more business from occasional customers. Target's private-label RedCard credit and debit cards accounted for 20.5% of sales last quarter, down from 23.2% a year earlier. This suggests that the recent sales surge was driven by customers who haven't historically been Target loyalists.
That raises the question of whether Target's recent gains are sustainable. Management acknowledged that growth has already moderated somewhat in August, with sales up at a low- to mid-teens pace. Once the cloud of the pandemic lifts, consumers may no longer feel the need to consolidate shopping trips, causing Target to cede some of the market share gains it has achieved in 2020.
Target stock is a bit pricey
In the early days of the pandemic, Target stock plunged below the $100 mark as investors worried about the potential impact on its business. By contrast, the stock closed above $154 on Wednesday. That's equivalent to 24 times the company's fiscal 2019 adjusted EPS of $6.39.
That's a reasonable premium to pay, considering that the retailer posted double-digit EPS growth in the first half of fiscal 2020 (with its stellar Q2 results more than offsetting weak Q1 earnings) while demonstrating its long-term staying power. Still, Target stock is no bargain after its surge on Wednesday -- unless the big uptick in sales last quarter reflects a permanent change in buying habits.
The key question is whether people who have suddenly begun spending large amounts at Target this year are poised to become the next generation of loyal Target shoppers or if they will return to their pre-pandemic buying habits over the next few years. I suspect the truth lies somewhere between those two extremes. If so, Target stock is a solid pick for long-term investors, but there may be better opportunities in the market today.