- TGT is expected to deliver strong earnings on the strength of the holiday season.
- Digital sales are expected to be ebullient, but they could come with lower margins and higher SG&A expense to retain customers.
- The key is what type of guidance management gives for next quarter.
- TGT is a hold into earnings.
Target (NYSE:TGT) reports quarterly earnings Tuesday. Analysts expect revenue of $22.53 billion and EPS of $1.38. I expect this to be an important earnings report as management continues to lay out its digital growth strategy. Investors should focus on the following key items.
Will Q4 Become The Equivalent Of "Crop Season?"
When I first saw the $22.53 billion estimate, I thought it was a misprint. Apparently, Target's holiday sales were so strong that the company had to increase its Q4 guidance:
Target Corporation [NYSE: TGT] today announced that its comparable sales in the combined November/December period grew 3.4 percent, compared with the expected range of 0 to 2 percent. Comparable sales across all of the Company's core merchandise categories – Home, Apparel, Food & Beverage, Hardlines and Essentials – were positive and accelerated from the third quarter, reflecting strong traffic growth, positive store comps and continued strength in digital sales. Target now expects 2017 will be the fourth consecutive year in which its digital sales grow more than 25 percent.
Expected same-store sales of 3.4 percent in November/December is downright gaudy compared to the 0.8% figure reported last quarter. Management expects the strong shopping season to push total full-year comparable sales above 1 percent. First of all, it could be a dangerous trend for Target to have to rely on holiday sales or "crop season" to drive an uptick in same-store sales. Secondly, while management should be commended for a strong holiday season, the question remains, "What happens below the revenue line?"
As more retail sales occur online, that implies lower operating margins for traditional bricks-and-mortar stores. Target is no different. Last quarter the company's gross margin ticked down slightly to 29.7% from 29.8% in the year earlier period. Its EBIT margin fell to 5.2% from 6.5% on higher SG&A expense and higher depreciation costs. I would expect more of the same this quarter. Despite the top line growth, shrinking margins imply Target could be running in quicksand for several quarters until it finds the right balance between digital and in-store sales.
Digital Sales Remain Strong
Target's digital sales growth has been a silver lining. Last quarter digital sales were up 24% versus 26% growth in the year earlier period. Reports suggest digit sales were robust during the holiday season as well. This is important as 100 percent of Target's 0.8% same-store sales growth last quarter came from digital sales; store channel comparable store sales growth was nil. It also suggests the customer experience at Target.com is strong enough to generate repeat business and compete with the likes of Amazon (AMZN). I view Amazon as a technology company and other retailers' technology has to be on par in order to compete. It appears Target is meeting the challenge.
The company has also taken major steps to enhance digital customers' experience, which could lead to stickier customer retention. Target has tested and rolled out same-day delivery in four locations in New York. Its recent $550 million acquisition of Shipt - a same-day delivery platform - should allow it to expand same day service and keep pace with Walmart (WMT) and Amazon. It has also rolled out ship-from-store capabilities, which will also allow customers to pick up shipments in-store. This will allow Target to keep pace with other leading retailers, but it could also drive up SG&A costs and/or entice customers to buy more online. Ultimately, these moves should help digital sales remain strong.
After gushing over holiday sales, investors and analysts will need to turn their focus to the next quarter. Analysts anticipate sales of $16.51 billion for the quarter-ended April 2018, which implies about 3% growth Y/Y. Even if the company hits its revenue bogey, can it meet bottom line results? Target needs to pedal harder to keep its top line from falling. As more of its revenue is generated via digital, it implies lower gross margins and higher selling costs to entice and retain customers.
Tomorrow's earnings results should be strong, but weak guidance could stymie TGT. I rate the stock a hold into earnings.
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