A Look at Target, Lowe's, and Krispy Kreme

Despite a great second-quarter report (and a $15 million stock buyback plan), Target (TGT -0.36%) failed to impress Wall Street. Lowe's (LOW 1.49%) popped 10% after posting strong second-quarter profits and raising full-year guidance. In this episode of MarketFoolery, Motley Fool analyst Alicia Alfiere analyzes those stories and Krispy Kreme's (KKD) first report as a public company.

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This video was recorded on Aug. 18, 2021.

Chris Hill: It's Wednesday, Aug. 18th. Welcome to MarketFoolery. I'm Chris Hill. With me today, Alicia Alfiere. Thanks for being here.

Alicia Alfiere: So glad to be here, Chris.

Hill: We've got one restaurant and two retailers to talk about today, we're going to start with Target. Second-quarter profits and revenue came in higher than expected. Same-store sales were up nearly 9% and they raised full-year guidance. You would think all of those together would be pushing the stock up, but the stock earlier this month hit an all-time high. It's not falling precipitously, it's down 1% or so. But this seemed like, I don't want to say anything but good things, but it seemed almost entirely good things for Target.

Alfiere: Yeah, agreed. There were a lot of good things from Target's report. As you said, second-quarter comparable sales were up 8.9% year over year, and that's on top of their record growth of over 24% in the second quarter of 2020. This means that the second-quarter total sales have expanded over 36% over the last two years. Pretty incredible here. The No. 1 interesting trend I want to talk about is that people are coming back to the stores. As COVID restrictions eased, Target saw customers returning to their store, they said in droves, and the majority of their second-quarter growth was driven by their stores channel. This segment grew 8.9% on top of 10.9% growth from last year. Also proving that people are headed back to the store, the digital channel's share of total sales fell a bit from 17.2% last year to about 17% this year, so it saw a bit of a change there. But it's still massively larger than the 7.3% from 2019. But as I said, customers coming back to the store, increasing their traffic. Traffic was up 12.7% in the second quarter. But at the same time, as we are going to Target more, average spending per trip was down a little bit. It's about a 3.4% decline in average ticket, but don't fret. The company reports that they've seen double-digit increases in their traffic and tickets from 2019. They're doing pretty well here.

Hill: They really are. I mentioned the stock was recently at an all-time high. It doesn't appear to be an expensive stock and certainly, management doesn't think so because part of the report was the announcement of a $15 billion share buyback plan. Just like yesterday, what we've heard out of Walmart with regards to back-to-school shopping, we heard similar things today out of Brian Cornell and his team. It sounds like back-to-school is off to a strong start. He was even talking about Halloween, which is one of those things that as a shareholder I'm happy about as someone who doesn't like holidays, getting ahead of themselves, it bothers me a little bit, but I'm going to put that aside. It's smart for their business to do that. It really seems like they are doing all the right things. The buyback plan, I found a little interesting, just because part of what Cornell and his team have done over the last five years is they've made a lot of their own investments. It's rare that the headline is, oh, they're spending $15 billion on stock. It's more often that we get they're investing in their apparel brands and that sort of thing. I don't want to second guess Cornell because his track record is amazing, but it was just one of those things that struck me.

Alfiere: I'm excited to see where it goes from here. I think there are other things to look forward to with Target. I think specifically they are going to be launching, or actually they launched this month, their partnership with Ulta (ULTA 0.31%), which is supposed to take the beauty part of their store to the next chapter, to the next level. So it's another thing to be aware of. Also, in terms of conscious capitalism, I saw that in the fall, Target is starting their debt-free education assistance programs for full-time and part-time U.S.-based employees. A lot of really interesting programs that they are starting and things to look forward to.

Hill: Like Home Depot (HD 0.86%) yesterday, Lowe's second-quarter profits came in higher than expected. Same-store sales were down slightly, but just like we talked about with Target, that's off a huge increase in comps a year ago. It wasn't even as bad as feared. There was the expectation of a drop, but it wasn't as big a drop as Wall Street was expecting. Shares are up 10% today. I will point out that they were down about 5% yesterday in sympathy with what was happening with Home Depot's stock. But, yeah, a good day for Lowe's.

Alfiere: Yeah. Maybe it's about beating those expectations. We know that 2020 results, especially in this sector, were buoyed by COVID. Last year in the second quarter, Lowe's saw sales growth of about 34% year over year. This means that businesses like Lowe's, Home Depot, they had these really difficult year-over-year comps. As you said, for Lowe's, comparable sales were down 1.6% year over year from that mega growth. When that's the case, I would invite investors to take a broader look at the time horizon. If we look at sales growth against second quarter 2019, we could see second-quarter 2021 comparable sales are up about 32%. Again, we did see that year-over-year decline and big trend driving this decline was a shift in the do-it-yourself trends. 

The company reported that after Memorial Day, they saw a pivot in those really high customer behaviors during the pandemic, but they've been doing really well with their pro segment, which is their small and medium business owner who frequently shops at Lowe's. This group has been increasing their spend with the company, reporting a 21% growth in their pro segment year over year and a 49% growth since 2019, which easily outpaces the growth in 2019. Some other really interesting trends that we saw in the Lowe's report are that the installation services grew 10% year over year. Lowe's is expecting this area is going to continue to play an important role for them as customers continue to look to them as an end-to-end service. That will be important to look at going forward. Also, they have their omnichannel offering, so customers can shop, however, wherever, whenever they want, and it's been working. Sales on lowes.com grew 7% year over year, that's on top of 135% growth in 2020. Pretty impressive.

Hill: This is the case for retail in general, but it certainly seems to be the case for businesses like Home Depot and Lowe's. A lot of this comes down to logistics. A Lot of these items are huge and so it's interesting to me that Lowe's and Home Depot have taken this approach of basically saying, we're not going to stock everything in this store. Yes, we have really big stores, we're not stocking everything here. There are things that you can look to buy from Lowe's and you can be in a Lowe's. I've had the experience of being in a Lowe's, looking for a particular item, they're like, oh, you can get that on our website. It's one of those things where the omnichannel investments might not be the sexiest thing in the world. But those are the types of investments that can really pay off if you do them right. I have to say, it's great to see that Lowe's is taking what has worked for so many years for Home Depot and really making that work for them in everything you were saying about the way that they serve professional contractors and increasing that business.

Alfiere: Yes, definitely and I just want to make a point to the omnichannel. I think it is sexy, I think a lot of companies are doing it and they're benefiting from it. I dispute your claim. But also, to your point that Lowe's doesn't necessarily have those things in stock, they made a point of mentioning in their earnings call that they're transforming and modernizing their supply chain, which aims to replace their legacy store model, where they had a lot of those big-ticket items in stock and instead transitioning to what they're calling a more customer-focused model, where you could order those things online and the bypass the store completely and go right to your house.

Hill: Really smart. It was great to see and not surprising with Ellison and the job he's done as CEO in the past few years. Krispy Kreme issued its first quarterly report as a newly public company. I think it's fair to say the results were mixed, the revenue was a little higher than expected, the adjusted profits were a little lower. Anything in particular stands out to you in Krispy Kreme's — this is the stock that since it went public in July, has steadily gone down. There was nothing so good in this report that is pushing the stock up today.

Alfiere: I found some interesting trends in the report. It's their first earnings report since the return to the public market. According to the company, it was actually one of the strongest quarters in their 84-year history, so well done to you Krispy Kreme. What have they been doing since 2016? They've invested in that omnichannel strategy. That's so sexy, Chris. Their omnichannel strategy to reach customers where they are, through what they're calling a hub-and-spoke distribution, which has what they call their hot light theater shops and their doughnut factories acting as a centralized hub. Then their spokes are these smaller doughnut shops and kiosks and they deliver fresh daily products which you find in grocery stores and convenience stores. They've also expanded internationally and they've seen some significant growth in the U.S. The company reports that they now control 48 of the 50 top markets. 

According to the report, the net revenues grew 43% year over year. Now, when we take away the impact of a lot of franchisee acquisitions Krispy Kreme has made over the last year, we get down to their organic revenues. Organic revenues increased about 23% year over year, which as I said before, represents one of their best quarters on record. This again, driven by omnichannel strategy and their ability to reach their customers. By the way, this marks an improvement from the 6.7% decline that they saw in the second quarter of 2020. This was largely driven by a lot of the impacts from COVID. I think about 30% of their shops were closed globally as a result of COVID. As you said, they're still reporting losses. Net losses were about $15 million in the quarter, while net losses last year were about $11.7 million. They did say that these quarterly losses were driven by IPO costs, related party interest expenses, and incremental tax expenses. But they are expecting to see adjusted net income growth over the full year. I think they're estimating about $62 to $68 million for the full-year guidance. We'll see how it goes, how this omnichannel approach works.

Hill: I'm a little more skeptical on omnichannel doughnuts than I am about building supplies and that sort of thing. Also, I may have misread this, but I thought I read somewhere that they're paying a quarterly dividend. If that's true, that's insane to me. While I raised an eyebrow at Target with their $15 billion buyback plan, I give Brian Cornell a pass because of everything he has done running that company. When we talk about capital allocation strategies, Krispy Kreme comes out of the gates and says, here's a tiny little quarterly dividend we're going to pay. That makes no sense to me.

Alfiere: Good eyes. They had said that in accordance with their dividend policy, they are expecting a cash dividend of about $0.03 per share in the quarter ending October so it's an interesting strategy. We'll see how it works.

Hill: You're being really nice to call that strategy interesting. For all of the headwinds that Krispy Kreme is facing, that seems like a really odd choice in terms of capital allocation.

Alfiere: Agreed, they should probably look more toward that omnichannel approach, reaching customers, trying to increase frequency. I don't know if I would appreciate an increased frequency in my own doughnut consumption, but it would definitely help their results.

Hill: They make great doughnuts, but then you have to deal with the aftermath of wolfing down several doughnuts in my case. Alicia Alfiere, great talking to as always, thanks for being here.

Alfiere: Wonderful to be here, Chris.

Hill: As always, people on the program may have interest in the stocks they talk about and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. That's going to do it for this edition of MarketFoolery. The show is mixed by Dan Boyd. I'm Chris Hill, thanks for listening and see you tomorrow.