Target Talks Surging Customer Traffic and Profit Shortfalls

Target (NYSE: TGT) announced mixed earnings results last week that paired robust customer traffic gains with a discouraging drop in operating profits. But management isn’t worried about the earnings shortfall. In fact, executives took the opportunity to affirm their broader goals for 2018, a fiscal year they’ve said will establish Target as a truly multichannel retailer.

Below are a few highlights from the conference call that CEO Brian Cornell and his management team held with analysts in which they put those results into context for investors.

Growth strategies are working

We are seeing multiple drivers of the recent acceleration in our performance, from our investments in stores, supply chain, new brands, and our team, even our ongoing partnership with CVS, everything is contributing to our success and our guests are responding.
— Cornell

Target’s customer traffic spiked higher by 3.7% to set its fastest growth pace in more than a decade. That win was particularly good news considering Walmart‘s traffic slowed to a 1.3% increase in the period. And retailers with heavier seasonal businesses, like Home Depot and Lowe‘s, posted falling traffic.

Image source: Getty Images.

As a result, Target’s sales growth met management’s goal this quarter, with same-store sales rising 3% while Walmart’s comparable figure was 2.1%. The growth wasn’t quite as strong as it might seem, since a calendar shift pushed some early back-to-school sales into this quarter when they usually lift fiscal second-quarter results. Thus, Target is simply on track to reach executives’ revenue prediction for the year.

An e-commerce future

Store shopping remains very important and will continue to be so in the future, but it’s no longer the only way people choose to shop.
— Chief Operations Officer John Mulligan

Executives believe they have to adjust to the new reality of multichannel retailing. And, just as Walmart refers to its “digital transformation,” Target says it aims to be “America’s easiest place to shop.”

Online sales jumped 28% and were responsible for 1.1 percentage points, or about one-third, of overall growth. The company is leaning heavily on its physical footprint to support this surge, with two-thirds of digital sales volume being fulfilled by its stores, up from 50% a year ago. Target plans to aggressively expand in this area, with faster delivery options, lower shipping fees, and additional shipping capacity all in the works for the coming quarters.

Slipping profit margins

Our gross margin rate of 29.8% was down about 20 basis points from last year. This was a bit below our expectations, as the mix impact of late spring weather caused a later than usual surge in higher-margin, temperature-sensitive categories.
— CFO Cathy Smith

Target’s slight drop in gross profit margin was blamed on the fact that an unusually cold winter depressed demand for higher-priced seasonal products. The decline combined with rising costs as the company paid more in wages and spent aggressively to support its digital sales channel.

Image source: Getty Images.

Altogether, operating income fell 10% as profitability worsened to 6.2% from 7.2% a year ago. Executives had predicted that its margin challenges would moderate this year, and that didn’t happen this quarter. However, Cornell and his team believe the shortfall was mainly tied to weather challenges that will be recovered in future quarters.

As a result, Target affirmed its 2018 sales and profit forecasts in part because the retailer believes revenue gains will accelerate over the coming quarters. Profitability should drop again after falling last year, but executives are hopeful that they’ll moderate the pace of earnings declines. From there, Target expects to begin boosting its core earnings starting in 2019 even as the business shifts more toward online selling and fulfillment.

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Demitrios Kalogeropoulos owns shares of HD. The Motley Fool has the following options: short September 2018 $180 calls on HD and long January 2020 $110 calls on HD. The Motley Fool recommends CVS and HD. The Motley Fool has a disclosure policy.

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