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03/05/2019

Analysis: Target reaping rewards of investments in stores, digital and product

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Although Target’s overall revenue growth was flat on last year, this is because the 2018 trading period was 7 days shorter; as such, the comparison is a relatively unflattering one. The same cannot be said of comparable sales growth, which removes the time difference. Here, Target’s sales soared by an impressive 5.3%. In our view, this stellar performance has less to do with the trading environment and everything to do with Target’s investment in its ranges, stores and digital proposition.

Growth has come from all channels, with a particularly pleasing 2.9% increase in comparable store revenue. This completely justifies the extensive investment Target has been making in its shops, which are now more engaging and inspiring places to visit. Over the holiday season, this translated into higher footfall, better conversion rates, and higher satisfaction.

Digital sales also fared well, increasing by 31% on a comparable basis. The offer of free shipping over the holidays, along with improvements to the range of shipping options, helped to drive trade in this part of the business. Target marketed this heavily and reaped the reward of higher shopper numbers, including from new customer groups.

The free shipping offer had an impact on profitability, which is why gross margin rates were down 0.4 percentage points. However, this deterioration was nowhere near as bad as feared, mainly because Target’s stores fulfilled almost three-quarters of digital orders. In our opinion, the building of this strong omnichannel model gives Target a major strategic advantage over rivals.

Although both stores and online performed well thanks to improvements to the selling environment and trading strategy, neither would have prospered if the right products were not offered. On this front, Target has made enormous progress through the enhancement of its own brands. Categories like apparel are now more focused and relevant and, as a consequence, are attracting more shoppers. The same is true of home furnishings and even electricals where Target has an embryonic own-brand offering. Importantly, the growth of own-brand has made direct price comparisons with other players much harder and has helped Target to differentiate from its rivals.

Despite the sales uplifts, net income was down by 26.5%. Part of this is because of the shorter trading period, and part of it reflects a much higher income tax provision. While we believe increased costs in a number of areas, including wages, also took their toll they were offset by higher volumes and some good margin gains on own brand products. When all of this is considered, the bottom line outcome is respectable and should give Target the confidence to continue investing at pace.

Looking ahead, Target will start lapping some tougher comparatives. In our view this will crimp sales growth to a degree. However, the company has enough firepower in the form of new initiatives to engineer good growth, so comparable sales will remain firmly in positive territory. On those new initiatives, we are particularly encouraged by the ongoing store refurbishment program and the conversion of more stores to the new format, which has proven to improve sales. A number of new brand launches should also help Target gain share in key areas like household goods, lingerie and apparel.

Two years ago, Target was a retailer that stood at a fork in the road. It chose the difficult path of investment and modernization rather than short term profit maximization. It is now reaping the rewards and, in our opinion, will continue to do so over the year ahead.