Target On-Target In The First Quarter

Target (NYSE:TGT) reported positive results for its Q1 fiscal 2015,  beating market expectations. Backed by strong growth in online sales, a good customer response to  its fashion categories, and arise in number of transactions, the retailer’s comparable sales increased 2.3% (ahead of its earlier guidance of 2%), while net revenues rose 2.8% to $17.1 billion. Excluding one time expenses, the company reported EPS of $1.10, solidly beating the consensus estimate of $1.02. Including certain charges, EPS settled at $0.98, reflecting a year over year improvement of almost 50%. Target’s gross margins improved a whole point to 30.5%, driven by a favorable shift in merchandise mix. Given this promising performance,  the company raised its full year EPS guidance slightly. It now expects its 2015 earnings per share to be around $4.50-$4.65 marginally up from its earlier outlook of $4.45-$4.65. ^[1]

After presevering for over two years in Canada and enduring relatively weak traffic in the U.S., Target is finally getting back on track. It is beginning to draw significant attention to its known-for-affordable fashion products, which is gradually bringing customers back. The traffic increase can also be attributed to a rebound from last year’s levels, when traffic fell off with the wake of the credit card security breach.  Now they are coming back to the retailer’s stores intrigued by the newness in its fashion merchandise. In addition to a rebound in its store traffic, Target saw a significant increase in its web traffic as well, that pushed its e-commerce sales up 38% year over year.

Our price estimate for Target stands at $78, which is inline with the current market price. However, we are in the process of updating our model in light of the recent earnings release.

See our complete analysis for Target

Steady Topline Growth

During the quarter, Target not only saw a rise in the number of customers, but it also witnessed customers spending more as compared to last year. While number of transactions were up 0.9%, average transaction value increased 1.4%. Higher spending can be attributable to two factors.  First, the customer response to Target’s limited edition and exclusive collections (such as Lily Pulitzer) and other key segments (such as apparel, home, beauty and digital) was extremely good.  This allowed it to operate with fewer special offers and discounts.  Second, REDcard penetration increased to 21.5%, up 110 basis points from last year, which prompted higher spending. ^[2] REDcard buyers have a tendency to spend more than regular customers, as they have an opportunity to earn discounts points. Interestingly, selling price per unit improved 5.1%, which again points to higher spending and fewer discounts. And, at the base of all these improvements was better product assortments.

Apart from an improvement in store performance, which is somewhat of a rare occurrence in the U.S. retail industry, Target’s web channel posted significant sales gain. The retailer’s e-commerce sales increased a massive 38% during the quarter, driven by a rise in web traffic and improvement in conversion rate. Interestingly, growth in online sales contributed 80 basis points to overall comparable sales growth, implying that web channel’s growth is finally contributing notably to the company’s overall growth.

Margins Go Up

Target’s gross margins went up during the quarter as it was able to replace its promotional activities on low margin products with higher sales of high margin products. More precisely, the retailer ushered increased sales of higher-margined apparel, home and beauty  products, reducing the proportion of less profitable electronics and groceries in the mix. Over the last couple of years, Target had deviated from its core strategy as it had tried to push its grocery business ahead of other categories in an attempt to make its business resilient to macro-economic factors. However, it had worked against the company as its brand image faltered due to this shift. Now with the new CEO, Target has resorted to its iconic strategy and has fortunately seen immediate positive results, both for topline and bottomline. Lily Pulitzer collection launched last month was indicative of the fact that Target still has its mojo intact. Also, with Canadian business out of the equation, Target no longer has that unwanted drag on its profits, which will make it easier for the company to grow its bottomline going forward. In fact, a bulk of the 50% increase in Target’s net earnings is attributable to a favorable comparable period, where higher losses from Canadian business had subdued bottomline growth. While the company accounted for $153 million in losses attributable to discontinued operations in Q1 fiscal 2014, it reported only $16 million this time around. ^[1]

A clear path has been set for Target to follow from here on. It needs to continue its push in its core fashion categories, while making well-directed investments in online and omni-channel. As far as international expansion in concerned, the retailer may not want to try its luck again any time soon. Hence, we cannot expect any substantial growth in revenues going forward. However, provided that Target remains proactive with its efforts on merchandise and e-commerce, it can sustain moderate growth in revenues and profits.

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1. Target Reports First Quarter 2015 Earnings, Target, May 20 2015 [↩] [↩]
2. Target’s Q1 fiscal 2015 earnings transcript, May 20 2015 [↩]