Sometimes, the strongest and most courageous thing you can do is to quit. It's a difficult pill to swallow. You must rationally evaluate your current business conditions, future conditions, and potential. It takes great faith, courage, and conviction to quit. It is an acknowledgement that things have changed and bold action should be taken.
It's time for Target to exit grocery
Over the past 20 years, grocery has become the Big Box retailer's drug of choice for rapid expansion of revenue. It is mesmerizing and tantalizing. "But just look at that in-store traffic! Wait, look at the repeat business! Oh, and all those billions in additional revenue!" All derailed by stiff competition, razor-thin margins, and costly logistical investments.
So, with Amazon's (NASDAQ:AMZN) shake-up of the grocery world (anyone living under a rock, click here), the dynamics of the grocery business are clearly about to change. Below is a graph of market share by retailer for US grocery in 2016.
Wal-Mart (NYSE:WMT), which was one of the first Big Box department stores to really jump into grocery, has a commanding lead. Target (NYSE:TGT), you are way down there at no. 12 (no. 11 if you combine Sam's and Wal-Mart). With the purchase of Whole Foods (WFM), that little spec down on the chart called Amazon just leapfrogged you. Now, I don't know exactly what Amazon has planned, but I think we can reasonably deduce that it will expand grocery and delivery to dramatically increase its market share and put even more pressure on prices. This market share loss will be distributed across other grocery retailers.
Already a relatively small player, in a hyper-competitive and crowded market, what competitive advantage does Target have in grocery? With same-store sales declining already, largely due to grocery, how can this be turned around anytime soon? Below is an excerpt from the company's 1st-quarter 2017 conference call:
For our less discretionary essentials and food beverage businesses, first quarter market share trends were more challenging. For the quarter, we saw low single digit comp declines in both of these businesses and we are taking steps to regain our value and every day price perception in both of these.
Its solution? Compete on price and price perception. That sounds like a race to the bottom with Target at a very competitive disadvantage to Wal-Mart, Kroger (NYSE:KR), and Amazon.
More proof the company really has no idea how to fix this? Here's more from the conference call:
I want to stress that this work is very detailed and surgical. There isn’t a single solution across items and categories so that our team will be testing and iterating at a very granule level and they will be expanding the scope of their work as the year progresses.
Testing and iterating means no solution yet. Target acknowledges it also has a perception problem in grocery pricing:
More value in everyday price perception are a challenge in our food and beverage category.
Target is a trend-forward department store and will always be "Tar-ZHAY" in the minds of consumers.
After the rebranding of the Dayton Hudson stores, Target positioned itself as a trend-forward department store. As a result, Target stores tend to attract younger customers than Wal-Mart. The medium Target shopper is 41, the youngest of all major discount retailers that the company competes directly against. The median household income of Target's customer base is roughly $63,000. Roughly 76% of its customers are female, and more than 45% have children at home. About 80% have attended college, and 48% have completed college. (Source: Target Corporate Fact Card)
It will be difficult for Target to shake the perception that it is a higher-priced/-quality alternative to Wal-Mart. So why compete on price in grocery? There is nothing "trend-forward" about a dozen eggs and a gallon of milk. Get back to being the store that people who are too good to shop at Wal-Mart frequent. Be a destination store for "trend-forward" with reasonable and value pricing. Competing on price with Wal-Mart/Kroger/Amazon in grocery is a losing strategy.
How much is grocery really adding to the bottom line?
Grocery always looks good on the top line, but let's take Kroger as an example. The company's gross margin for Q1 2018 is 22.1% and its operating margin is 2.7%. Kroger's core competency is dedicated to food and food distribution. Target breaks out neither its grocery margins nor operating margins separately, but we can reasonably expect them to be comparable or slightly worse (as this is not the company's core competency) to Kroger's. That means for all the effort, Target is adding at best $300 million to its bottom line in grocery? Keep in mind, this is still all pre-Amazon and Whole Foods ramp-up. Net income for 2016 for Target was $3.63 billion. Grocery is a low-margin business for the company, with declining comps.
What about the "It drives traffic to our stores" argument?
Is it really driving the type of customer Target is looking for? With this argument, Lowe's (NYSE:LOW) and The Home Depot (NYSE:HD) would be dialing up Sanderson Farms (NASDAQ:SAFM) and looking to buy some chicken - "Come get your eggs, poultry and 4"x 8" plywood sheets!"
So what to do with the retail space? How to transition?
Target can do a few things. It should use its brand image and "trend-forward”"positioning to feed off the carcasses of Sears (NASDAQ:SHLD), J.C. Penny (NYSE:JCP), Bed Bath & Beyond (NASDAQ:BBBY) and other retailers. The company can fill this void better and more efficiently than a pure online retailer, and it has already identified this as an opportunity. From the conference call:
And I'll let Mark talk about some of the successes we saw in categories like apparel. But I'd highlight the efforts that we put behind our swim business where we start at number one share position, but we saw changes the marketplace competitive closures, competitive exits.
So where we're already had a strong number one unit market positioning in swim, we didn't rest on our laurels, similarly to action in Kids. And we looked at this market with declining players and saw an opportunity to win even further.
Pick a business with better margins and more in line with your core customer, like home décor. Look at how Big Box home décor retailer At Home (NASDAQ:HOME) is performing. At Home has a great strategy to counter Amazon with 50,000 unique designs and solid product positioning. I recently wrote a strong buy article on them here, called "At Home - Positioned For Years Of Solid Growth".
Do more of what is working in food and beverage. The company already has all the answers it needs right from its own conference call.
"Another great bright spot is our adult beverage business, which saw a mid single digit comp increase this quarter."
Adult beverage - great, do more of that. Challenge Costco (NASDAQ:COST) as the leading wine retailer in the country. Try offering more great whiskeys, high-end tequilas, mixers, and specialty local brews. Target can find the space after it stops selling eggs and milk. As evidenced by the same-store comp sales, adult beverage is more aligned with its core customer.
Summary
Same-store sales is the most compelling data point for a retailer. It proves whether the concept is working or in trouble. By staying in grocery, Target will be hard-pressed to raise same-store sales without a huge compromise on margin.
By exiting the highly competitive and crowded business of grocery, Target can better utilize its retail space for more "trend-forward" designs in home decor, adult beverage, swim, apparel, and other home brands. These can all be captured from competitors closing their doors. The company can build market share into that void, increasing gross margins and driving both same-store sales (after a transition period) and earnings for years to come. Sometimes doing the hard thing - quitting - is the correct strategy. Target has shown an ability to pivot before by shutting down Target Canada. I hope the company can see its way out of grocery.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
