Apparel Plays Key Role in Target’s Strong Q3 Performance

 

Published November 20, 2019

The Minneapolis-based retailer was able to drive up traffic in its stores and online.

Target Corp.’s third-quarter results Wednesday showed strength across the business, from the top line to the bottom. The retailer smashed analysts’ expectations for several metrics and raised its profit outlook for the full year. The performance was attributed to the optimized brand assortment, store remodels, rollout of shipping capabilities and rapid expansion of small-format stores.

The news bodes well for Target’s performance during the cutthroat holiday season and is further evidence of the strength of the discount channel following equally strong results from Walmart Inc. and TJX Cos. Inc., while department stores including J.C. Penney Co Inc. and Kohl’s Corp. had weak quarterly results. The Minneapolis-based retailer said last month it will spend $50 million on additional payroll to staff its stores during the season.

Net earnings in the third quarter rose 14.8 percent to $714 million, from $622 million in the 2018 third quarter, on sales of $18.4 billion, a 4.7 percent increase over the prior year’s $17.6 billion. Target beat analysts’ consensus estimates for earnings per share of $1.19, posting $1.36 a share in the 2019 third quarter, 24.9 percent higher than last year’s period.

Third-quarter comp-store sales grew 4.5 percent, on top of a 5.1 percent gain last year. Over the last two years, Target’s comps have risen nearly 10 percent. The comparable sales growth reflects a 2.8 percent increase in stores and a 1.7 percentage point contribution from digital sales. Third-quarter comparable traffic increased 3.1 percent, driven by gains in stores and digital channels.

“We focus first on driving traffic in our business because it indicates the continued relevance of our brands and growing engagement among our guests,” said Brian Cornell, Target’s chairman and chief executive officer. “The real health we’re seeing in overall traffic growth will translate into a guest who’s shopping more categories.”

Target has been modernizing its supply chain and instituted a new inventory planning and control system. It’s testing and rolling out distribution center automation. 

Target has a deal with Toys ‘R’ Us to run the toy retailer’s web site. Its Disney partnership for shop-in-shops at 25 stores is expanding to 40 more locations, with 450 items available on Disney’s store on target.com. Cornell said during a conference call with analysts that Target will open a store at Disney World next year. Six small-format stores are opening this month and 30 are planned for 2020.

Cornell touted unique holiday items from Target’s 40 owned and exclusive brands, 2,000 new home décor items and 10,000 new and exclusive toys. The ceo noted that Target Circle, the loyalty program that launched in October to complement its popular Red Card, has already signed 35 million members.

The retailer’s comparable digital channel sales grew 31 percent in the period, on top of last year’s 49 percent rise. Same-day fulfillment services, including order pickup, drive-up, now at 1,750 stores in 50 states, and Shipt, at 1,500 stores in 48 states, accounted for 80 percent of Target’s digital comparable sales growth.

“This reflects really strong performance, well ahead of our expectations going into 2019, and it demonstrates the power of the durable operational and financial model we’ve been developing over the last few years,” said Cornell. “The team designed and implemented meaningful changes, from the store service and operating model to our unmatched digital fulfillment capabilities and our inventory replenishment system. While there’s much more to do, it’s gratifying to see how these efforts are already driving outstanding operational and financial performance.”

Cornell said Target continues to gain broad market share. “Apparel saw the most dramatic share gains in the quarter, with comp sales growth of more than 10 percent,” he said. “This was driven by even stronger trends in jewelry, accessories and shoes, intimates and sleepwear, young contemporary and women’s ready-to-wear. Home, which was annualizing really strong growth a year ago, had low-single-digit comp strength. There was amazing strength in beauty and cosmetics, which delivered high-single-digit comp growth in the quarter.”

Investment research firm Jane Hali & Associates estimated that Target’s beauty and cosmetics segment in 2018 accounted for 24 percent of the retailer’s total sales, or nearly $18 billion. “It’s the largest category, bringing in more than the fashion and accessories categories or food and beverage,” Hali said. “Clean beauty and clean essentials are a huge differentiating factor.”

“Target continues to operate in rarified air, with third-quarter results that are outstanding across the board, especially the 80-basis-point improvement in operating margin,“ said Charlie O’Shea, retail analyst at Moody’s. “With inventory levels down by around $1 billion year-over-year, Target is well-positioned for holiday, and will be able to avoid excessive promotions this season.”

Target shares on Wednesday rose $15.56, or 14.03 percent, to $126.43 in after-hours trading on the New York Stock Exchange.

The retailer’s gross margin rate was 29.8 percent, compared with 28.7 percent in 2018, reflecting the benefit of merchandising efforts to optimize costs, pricing, promotions and assortment, combined with favorable category sales mix.

Operating income rose by 80 basis points. “It was way ahead of our expectations,” Cornell said. “The metric reflected beneficial factors such as category mix, which contributed about 30 basis points of gross margin improvement as a result of exceptional sales trends in apparel. On top of the mix benefits from stronger-than-expected apparel sales, we saw a rate benefit with a higher than expected mix of full-price sales.”

A new operating model where dedicated store teams take business ownership in key categories such as apparel, beauty, home electronics “will allow our teams to provide an elevated experience throughout the holidays.”

For the fourth quarter, Target expects comp-store sales growth of 3 to 4 percent, and earnings per share of $1.54 to $1.74. The retailer raised its full-year earnings guidance to $6.25 to $6.45 a share, compared with its previous estimate of $5.90 to $6.20. The analyst estimate was $6.18 a share.

© 2020 JHA Jane Hali & Associates, Investment Research

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