I recently wrote about what I needed to hear from Target's (NYSE:TGT) management on the Q2 conference call for me to continue being a shareholder. I want to briefly recap the items that were positives for me and in-line with what I needed to hear.
Unlike previous calls, I did not walk away with the feeling that management was using the data breach as a scapegoat for all of the problems facing Target. They did advise that any additional expenses from the data breach should not be anything meaningfully damaging to their bottom line.
The other point that Target sufficiently addressed was same store traffic. While down year-over-year, same store traffic was improved versus the first quarter and the average basket was increased enough to offset any traffic that was lost year-over-year. Considering the environment around retail at the moment, this was a positive for the company. I specifically wanted to see Target perform better than its nearest competitor, Wal-Mart (NYSE:WMT), which I believe it did.
Finally, the Target confirmed that they remain committed to their ever increasing dividend which currently stands at 3.4% after its 33rd consecutive increase since 1971. While I had hoped to hear that Target may begin investing in itself with share buybacks while it goes through the rebuilding process - CFO John Mulligan advised it was not plausible in the immediate future but is something they plan to return to as performance increases. It is fair enough to give Target a pass on that as a full turnaround may take a while and the funds could potentially be better served elsewhere.
Canada Remains Foggy
When it comes to Target and Canada I feel like I am still being left wanting more. While I did not expect to see much positive news come out of the Canadian division, I was hoping management would elaborate on their 3 point plan for a Canadian turnaround. We heard a lot about the Canadian segments "comprehensive review of strategy and operations" and the previously outlined strategy - new supply chain, new items, better pricing - but nothing new still.
On that same note however, Target did advise that sales accelerated in Q2 - while still falling short of expectations - and that was before this new turnaround strategy has had time to really take hold. New CEO Brian Cornell did stress the importance of urgency and moving quickly so I would again be willing to give the company a pass on this for the time being while I await more information as I anticipate it will be soon.
Online Sales: Target's New Vision?
I touched briefly on my previous article that Target was seeing large increases in mobile and online sales and while they were still a small portion - I wanted to see that growth continue. What I heard on the call was much more than I had expected to hear about the subject and depending on how you feel about Target's ability to execute, could be a potentially huge source of growth. To take an unscientific approach to quantify just how much this was discussed, looking at a transcript of the conference call, the words '.com', mobile, online, and digital were used a combined 83 times while the words traffic(generally used referring to in-store traffic), basket, conventional, and in-store were used a combined 29 times. Again, this is not the best indicator, it doesn't factor in how many times the words were used together in a sentence and its 8 words out of hundreds but it does paint a vague picture of just how much it was discussed.
With this new focus on online and mobile sales - my and many other shareholder's first thoughts probably go straight to the same few concerns; what will happen to the stores if most of the shopping is done online? Why would Target want to compete with Amazon (NASDAQ:AMZN)? What will happen to the margins?
Going forward, this part of the article may be speculative as online & mobile sales are still not a huge driver of revenue but are clearly a focus going forward. Pulling from the information given on the conference call, I want to attempt to answer the concerns around Target's omni-channel approach and push deeper into the online world.
What would happen to the stores?
This was the first thought for me. If shoppers are buying everything online, what value do the stores possess, would they not just become a drain on the bottom line? There are a couple things to consider when it comes to this and a lot of them will answer the question of whether or not Target can truly compete with Amazon.
First, Target tested their ship-from-store capabilities in the Boston, Miami, and Minneapolis markets and saw some great results. They intend on rolling it out to another 35 markets shortly. The major benefit of this service is same day delivery - something not yet widely offered through Amazon. Target can achieve this because the shipments are coming from items already in their local stores instead of regional warehouses. Thinking of Target stores as fulfillment centers for a moment, this would give Target 1,797 fulfillment centers in the United States compared to Amazon's 61. While these Target 'fulfillment centers' would have far fewer items, they would allow those select items to be more relevant to the immediate area and allow for that same day shipping. Also in this line of thinking, Target advised they have the current capability to be able to offer 1 or 2 day shipping to 91% of the country. This shows that Target stores - even with decreased traffic - may still have some unused value to the company.
Another thing to consider with the stores is that they could easily be tailored towards items that are not generally easily sold or shipped online or items that typically are bought in person. The first of this type that comes to mind would be fresh food - which is coincidentally something that Target saw positive comparable sales in. Other items to consider would be clothing, hard lines, and home goods. Until technology develops further to allow customers to trust that clothes they buy online will fit just like they would if they tried them on in store, this will continue to be something that struggles online. It was difficult to find updated numbers but this article by Slate.com shows the struggles that online retailers have even citing that at that time, Zappos.com was seeing 35% of their merchandise returned and this article in the Wall Street Journal that shows multiple clothing retailers seeing over 10 to almost 20% of their sales returned. With many expensive hard lines items, think iPads, TVs, etc., many customers may not want those types of items shipped to their house and left to sit on their porch for hours to deal with potential theft and weather concerns and would instead opt for in-store pickup. In-store pickup being another feature that Amazon cannot offer and with Target reporting that 1 out of 5 in-store pickup customers also made other purchases while in the store. This again shows that the omni-channel approach may be better in the long run versus only an online retailer - if it's done right.
How could Target compete with Amazon and those margins?
I outlined above that Target's advantage may actually come from having the physical locations. All of those store locations could provide advantages in ship-from-store, store pickup, and allowing Target to sell items not easily sold online. Another potential benefit would be the ability for customers to make returns in store instead of having to ship them back.
I think the benefits of retaining brick and mortar stores can be seen but the next question is always - what would that do to margins? Especially considering one of the positives of having physical retail locations - food - is already a small margin business. I think the key to keeping margins up would be efficient management of the space and private line items. The good thing is that Target spent a lot of time talking about the new private line items that they are rolling out. Those items are also focused in the segments that would still be beneficial in having physical stores. The new S-Sport line by Sketchers (which has been a very popular brand as of late), the Honest Company, the Made to Matter collection, and the CHEFs catalog all sound to be promising brands that will offer higher margins.
Do I think Target will see growth in its online sales and its omni-channel approach? Yes I do. I could see Target being an Amazon alternative that offers many of the same benefits with the option to use the stores as a showroom and fulfillment center. Do I think that will meaningfully drive overall revenue growth in the immediate future? I do not believe so. I like how Target's vision is shaping up but with such little trust in the current management, I need to see more results before I believe they can execute that vision - especially considering it would mean the shrinking margins they've shown recently - 18% this quarter - would become permanent and thus allow for fewer mistakes.
With the stock trading at 20 times earnings, this stock is priced to grow now and it's my belief that said growth will take a while. I will take my small profit from Target and walk away for now. As I stated though, I like the vision and if Target shows that they are on the right track and they can execute their new plan to be a true omni-channel retailer and be successful in Canada, I would be willing to buy back into the company for the outstanding dividend growth and potential but I just imagine there will be more speed bumps than I can tolerate along the way without having more faith in the current management team.
Disclosure: The author is long TGT.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.