Target (TGT 1.55%) recently announced results from its final quarter of fiscal 2020 in line with the update management provided a few months ago. Revenue increased 21% year over year to $28.0 billion, and net income surged 66% to $1.4 billion as the big-box store's investments in e-commerce and same-day order fulfillment paid off during the pandemic.  

The really big news, though, was Target's new outlay for annual capital expenditures: $4 billion. It's a sharp uptick in what Target was spending the last time it made a strategic announcement like this, but the timing couldn't be better. Coming off a huge year of profitable gains, the company will be investing more in the areas of its business that made it a success in a new e-commerce-driven world.

Target dialing up its spending

During the fiscal 2020 fourth-quarter earnings call, Target management took some extra time to discuss its plans in the coming years. And after growing sales $15 billion in 2020 -- more new revenue than the prior 11 years combined -- the priority will shift to holding onto those gains and building on the successes.  

In dollar terms, the company is going to dedicate up to $4 billion to capital expenditures in fiscal 2021 (spending on long-lived assets like real estate, equipment, and technology). For the sake of comparison, capital expenditures were $2.6 billion in 2020 and $3.0 billion in 2019. This was part of the aggressive spending outlay the company launched at the end of 2016, which included the acquisition of personal shopper and delivery service Shipt in 2017.  

Target's aggressive spending wasn't exactly greeted with investor enthusiasm in 2016, but it paid off big time during the pandemic. Now, it's a much larger business than it was, and it's time for some more upgrades to support the expansion. And this time around, Target's $4 billion or so per-year capital expenditure guidance is nothing to worry about since its strategy has a proven track record. 

A small grocery cart and shipping boxes sitting on a laptop

Image source: Getty Images.

The Target store experience is a differentiator

Where exactly will that $4 billion be spent? First, on its stores -- the brick-and-mortar locations. In an era of e-commerce? Yes, because for Target, its entire digital business hinges on its real estate.

You see, Target actually posted a 7.2% increase in same-store sales at its physical locations (the rest of the 19.3% full-year comparable-sales increase came from online). A big reason for this was the widespread rollout of same-day curbside pickup. Target reported many of its customers are saying they'll continue using this feature even after the pandemic, so some remodeling will be needed to better accommodate shoppers.

The company also plans to open 30 to 40 small-format stores every year for the foreseeable future. Expanding its footprint makes sense. The majority of Americans live within 10 miles of a Target store, and the company wants to reach many more in urban centers with these new smaller locations.

And since 95% of all orders are fulfilled directly from a Target store these days (versus from a distribution center like most e-commerce companies), increasing this reach makes sense as the company tries to build on its differentiated digital commerce model that allows for direct shipping, pickup, or same-day delivery via Shipt. 

In addition to remodels and new openings, Target is a much larger business than it was a few years ago. In spite of this growth, it was able to funnel all of its new activity to its existing real estate, thus the big increase in net income last year.

But the time has come to increase its supply chain capacity, and some of the $4 billion of spending will go to two new distribution centers this year and another two in 2022. In addition to back-end supply chain, Target says it will up its game in last-mile delivery, presumably with more investment in Shipt to expand the service to more markets.

And a final point of emphasis will be on further differentiating its merchandise. Target inked new deals with Levi Strauss, Ulta Beauty, and Apple, but the steady expansion of its own in-house brands has been the real standout winner. Since 2016, Target has launched over 30 of its own brands across all store categories, several of which (like its All In Motion brand of workout clothes and in-home gym equipment) quickly turned into $1 billion businesses.

With the department store industry in steady decline, Target continues to win market share with its convenient one-stop shopping experience for everything from groceries to household basics to apparel. Thus, it plans to continue launching its own brands to build on this success.  

A temporary hit for the bottom line

Higher spending means profitability will take a hit, but management said it sees operating margins holding above the 6% rate posted in fiscal 2019 but below the 7% recorded in 2020 during the worst of the pandemic. If the company can hold onto its new customer sales and keep growing at a steady clip, earnings will rise over time too -- supporting another expected dividend increase later this year (which the company has been paying now for decades).

This may not be the fastest-growing e-commerce company around, but there's still plenty to like about Target. Rather than worry about the new $4 billion annual outlay, this looks like it will be money well spent, given the success the big-box store has had to date getting itself set up as a leader in digital and physical retail.