One of the advantages of investing in a consumer-facing stock is that it's easy to see what the company is doing.
Curious about a new Starbucks beverage? Drop by one of their cafes. Wondering what kind of shape Macy's stores are in? Visit your local mall.
I've been a fan of Target (TGT 0.18%) as an investor for several years, but a recent visit, or multiple visits, to a Manhattan Target store has made me an even stronger believer in the company. I sampled several products from Target's new Good & Gather food brand and thought most of them were great, and they're often at considerably lower prices than similar name-brand products.
Image source: Target.
Target launched the label in 2019, and expanded it last year, a clear sign that the company is happy with the results. It now has nearly 2,000 products under the brand, which is already generating more than a billion dollars in annual revenue. I'm not the only one who seemed to like the brand as several blogs posted mostly rave reviews for Good & Gather.
My visits to Target also shed light on another one of the company's key strategies: its expansion of small-format stores, which pair well with its same-day fulfillment strategy that uses stores rather than distribution centers to service online orders, and allows it to penetrate dense neighborhoods. In fact, the small-format concept may be the most important component in Target's growth plan.
Target has blanketed Manhattan with the small-footprint stores in just a few years. It opened its first, in the Tribeca neighborhood, in 2016, and now has eight of the "flexible format" stores in Manhattan, as well as a larger store in Harlem. It's been accelerating store openings, a sign the strategy is paying off, with eight more on the way in Manhattan as well as several in New York's outer boroughs.
Why the small-format store is a winner
Target has long occupied something of a unique niche in retail. While its multi-category format is also shared by Walmart (WMT -0.08%) and Costco, Target is less dependent on the grocery category, and its "cheap chic" reputation distinguishes it from a competitor like Walmart, which is best known for everyday low prices.
That differentiated approach has helped make Target a winner, and the multi-category format has paid off during the pandemic as shoppers have consolidated trips. Target's small-format stores are even more unique. No other big-box chain has a similar concept, consolidating grocery, apparel, home goods, beauty, and other categories you'd find in a typical Target inside a store with less than 50,000 square feet.
The small footprint allows Target to penetrate neighborhoods that a typical Walmart or another big-box store couldn't touch, and Target can easily use the concept to move into a vacant location in a city neighborhood, while a store with 100,000 square feet or more has more limited options for expansion, requiring new construction, or a similarly sized retailer to move out.
In these neighborhoods, Target is generally competing only against independent stores, meaning it can easily undercut them on price, especially with brands like Good & Gather, and Target's omnichannel investments like order pickup also give at an advantage as the stores act as new e-commerce pickup points.
Over the long term, the small-format strategy should only gain strength. The U.S. population will grow and more multi-family housing will be built. The country will become denser, which means Target's small-format stores are ahead of the curve and will be a valuable asset in such neighborhoods. One study even showed that homes near a Target saw bigger gains in property value versus homes near a Walmart, potentially showing Target stores are more in demand than Walmart.
It's not surprising that the company is betting big on the strategy. Target had just 30 small-format stores in 2016. It now has 140 and it's planning to open 30 to 40 a year over the next several years. On the recent earnings call, CEO Brian Cornell said, "If these stores were a stand-alone chain, their revenue would rival that of fast-growing chains with many more locations." That shows they're one of the best ideas in retail today.
Image source: Target.
The big picture
I've outlined the bull case for Target several times before. The company's investments in omnichannel infrastructure and same-day fulfillment have resonated with customers and have led to Target generating operating margins that are significantly better than peers like Amazon, Costco, and Walmart. It gained $9 billion in market share last year, giving it significant momentum, and an increasing percentage of its sales are coming from owned brands like Good & Gather, which deliver higher margins than name brands. Finally, its small-format strategy has been a clear winner as a key source of growth and a way for the retailer to further differentiate itself.
Retail will never be a winner-take-all market, but it is increasingly shifting from a highly fragmented industry to one where a few winners, like Target, Costco, Amazon, and Walmart, take most. The impact of e-commerce, the effects of the pandemic and the decline of the mall ecosystem are all hastening this shift.
Despite Target's many attributes, the market still seems skeptical of the retail stock. Shares plunged after its recent earnings report when the company announced a new investment cycle with plans to spend $4 billion in capital expenditures a year over the next few years. Investors seem to be forgetting that the last time Target kicked off an investment cycle in 2017, investors initially balked, but the stock has more than tripled since then. Those investments, in higher wages and the omninchannel infrastructure that is so valuable to the business today, are directly connected to the stock's gains.
Consumer demand for Target products is at an all-time high following a year in which comparable sales grew 19.3%, and the stock is still cheap at a price-to-earnings ratio of 22.
The retailer has more momentum and a clearer growth strategy than possibly anyone else in the industry. With its small-format stores, omnichannel strength, and the emergence of its owned brands, the company's future looks as bright as ever.
