While primary competitors Wal-Mart (WMT) and Amazon (AMZN) have invested in big acquisitions of companies like Jet.com and Whole Foods (WFM) respectively, Target (NYSE:TGT) is going another route: investing in itself. The company announced a few months ago that it would be committing $7 billion over the next 3 years towards remodeling its stores, launching new labels, and attempting to increase traffic and improve comparable store sales. I think TGT is now a buy as this initiative looks promising and could re-vitalize Target's operating results.
Target's stock price has struggled over the past 12 months, and no, it has nothing to do with bathrooms. Fierce competition from brick-and-mortar Wal-Mart and online retailer Amazon has hurt revenue and comps and has led to a decrease in profits:
TGT Net Income (TTM) data by YCharts
With TGT down 25% over since June 2016 and trading just above multi-year lows, I think now might be the time to buy.
Target's new plan includes, over the next three years, remodeling 600 existing stores, rolling out 100 additional small-format stores, lowering prices across the board, investing in the supply chain to speed up sales through online and delivery, launching 12 new, exclusive brands, and investing in digital properties. Every one of these propositions is aimed at combating Wal-Mart and Amazon and the declining sales they have caused at Target, and so far I'm encouraged by the ideas and progress I've seen. Here are some of what I think to be the salient points, and I'll start out with the good.
First, accelerating the small-format stores is a smart move for three reasons: 1) it will allow Target to penetrate more markets and reach more people without finding the real estate for a sprawling superstore 2) it will create more distribution centers for delivering online orders to nearby customers and 3) CEO Brian Cornell has stated that these stores have double the sales efficiency as their larger counterparts. These small-format stores will play a key role in any future growth Target hopes to achieve and it's a good sign that management sees the upside in having more of them. An extra 100 stores is more than a 5% increase in total store count, demonstrating how significant of an investment this is by the company.
Second, investing in faster delivery of online orders and in initiatives like Target Restock, a next day delivery service being tested in Minneapolis, will be vital towards competing with Amazon and Wal-Mart in the years to come. While it's true that online orders carry lower gross margins than in-store orders, online sales are the only path to take. Any other path will likely lead to ruin quite soon. Investing in the supply chain for online orders can improve efficiency and give gross margins a boost even if they won't match the current margins on in-store sales. Target Restock specifically seems like it could be a legitimate boon if executed correctly as, if it succeeds, it will essentially section off Target customers from Amazon's influence. Of course this can't be done completely, but Target must aim to every customer it possibly can in its sphere of influence. Target Restock is a good first step.
Third, launching 12 new private label brands seems like a proposition with massive potential upside, though with some risks as well. For an example of the potential upside here, Target's Cat & Jack children's clothing line, which was launched back in July 2016, is expected by Cornell to reach $1 billion in sales in July 2017. 4 of these new brands are already slated to launch later in 2017. Combined, Target is aiming to rake in $10 billion in annual sales from these brands over the next two years. This is an ambitious target, but one I think is achievable should Target play its hand right. On the flip side, these brands are a risky proposition as it's tough to gauge consumer interest for a brand until it's already developed and on the shelves. On the whole though, I think investing in new brands is a smart proposition with high potential reward.
Now the bad. The first thing to discuss here is Target lowering prices across the board, especially in the grocery section. Most people would say getting into a price war with the likes of Wal-Mart and Amazon is futile and even delusional, but in this case I think it's a necessary evil. Yes, gross margin is being sacrificed, but this is an essential move to stem declining sales and loss of market share. In short, it needs to be done.
Another potentially negative aspect of this plan is that $1 billion in operating profit is being lost in order to follow through on these investments. While I would say investing in these areas is more important than retaining near-term profits, I could see the argument from the opposite perspective as well.
Lastly, remodeling 600 stores can be seen as a positive, as I do, because it will attract new shoppers, drive traffic, and make these store locations an overall better experience, but I can also see the potential downsides of the plan. For instance, the store experience could be the least of Target's issues, in which case overhauling current locations won't stop declining sales and comps. This is a worst case scenario and I don't think it will become reality, but in general, there is no guarantee the remodel will be worth the massive expenditures.
From a valuation standpoint, TGT is trading at a significant discount to its historical forward P/E ratio, which is likely indicative of the current sales slump.
TGT PE Ratio (Forward) data by YCharts
This also means that a sales recovery could boost the stock back to historical P/E levels.
Ultimately, I think Target's $7 billion, 3-year plan to invest in itself will provide long-term value and allow it to stem the sales decline due to competition from Wal-Mart and Amazon and perhaps even get back to growth. I should clarify that the current upside potential in shares is likely to be a medium-term to long-term proposition as Cornell has stated that 2017 and 2018 will be investment years while 2019 will be a growth year. This implies that, in the short-term, TGT may remain stagnant, but I think the company's strong capital commitment to its future will be a positive catalyst and value creator over the next few years.
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Disclosure: I am/we are long AMZN. 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.