Tuesday, March 15, 2016

Target Corporation: Will the Internet Power TGT Even Higher?

Target stock needs its e-commerce side to keep growing like a weed

Target Corporation (TGT) CEO Brian Cornell recently revealed some details about his plans to beef up the company’s online presence and spur increased e-commerce revenue.

And in the long run, this could help paint a more bullish picture for Target stock.

Last month, TGT reported fourth-quarter earnings, revealing 34% growth in e-commerce sales during the holiday shopping season. Investors were pleased with the results as a whole, sending Target stock more than 10% higher ever since.

Cornell’s decision to spend upward of $1.4 billion on improving the TGT website and mobile shopping experience clearly paid off, with full-year e-commerce revenue growing 31% over 2014. Sure, that’s not quite as well as he’d originally hoped, predicting 40% improvement. But Target’s 34% e-commerce growth in Q4 was more than quadruple the 8% increase reported by key retail rival Wal-Mart Stores, Inc. (WMT) and also ahead of the 26% increase reported by e-commerce big dog Amazon.com, Inc. (AMZN).

Cornell has said that TGT will spend approximately $2 billion in 2016 to further improve the company’s digital capabilities and make shopping online an easier, more pleasant experience for consumers.

Continued spending in this area could help TGT maintain steady e-commerce growth … but that doesn’t necessarily mean Target stock will benefit.

Where Will Target Spend the Money?

With the ramp in online sales, better systems are necessary for shipping, tracking and stocking goods, which is why TGT plans to invest in more RFID technology to better monitor inventory.

Additionally, location-sensitive beacons will push product details and sales promotions to customers in stores who have installed the TGT mobile app and opted into Target’s smartphone advertising network.

More potentially valuable, however, is Target’s most recent new hire, Arthur Valdez, as chief supply chain and logistics officer. Prior to being hired by TGT, Valdez worked in a similar capacity for Amazon, and before that he had worked for both Walmart and Sears Holdings Corp (SHLD). Cornell hopes that, with Valdez’s logistics experience and supply chain expertise, the revenue from Target’s digital sales will continue to rise.

Valdez will help TGT management improve the coordination of product shipment between fulfillment centers, stores and customer homes, as well as reduce the number of out-of-stock items on store shelves.

Increased E-Commerce Doesn’t Automatically Mean More Profit

The number of online transactions has been increasing exponentially, but while Target’s sales figures reflected more success in closing e-commerce transactions, their margins were smaller than in-store sales due to promotional discounts and free shipping.

Fourth-quarter segment operating margins fell 9 basis points, operating margins were down 10 basis points, and gross profit margins dropped 60 basis points to 27.9% due to the high costs of shipping and logistics, all of which was exacerbated by TGT’s holiday discounts and free shipping promotions. Management’s push to beat competitors on the e-commerce front worked, but the price for that success was less profit for the quarter.

Simply put, the boom in online sales was offset by the gross margin decline, which ultimately led to a Target stock earnings figure that was 2 cents per share below analyst estimates for the quarter.

E-commerce accounted for approximately 5% of total revenue for TGT in the fourth quarter of 2015, but it also accounted for two-thirds of Target’s 1.9% increase in comparable-store sales. So, while 5% may not seem like much, it’s actually quite significant when it comprises more than 60% of comp growth.

Despite a 1.3% increase in store traffic, Target’s fourth-quarter sales total decreased by 0.6%, which means that although more people visited TGT retail locations, those shoppers made fewer purchases.

In other words, it’s increasingly important that Target at least offset those in-store losses with e-commerce gains.

The E-Commerce Competition Won’t Be Easy

TGT isn’t the only retailer to acknowledge the importance of a stronger e-commerce position. In January, Walmart closed 269 stores and CFO Charles Holley revealed plans to invest more than $1.5 billion in improving WMT’s e-commerce technology.

Additionally, a push for a stronger online presence means more directly competing with industry goliath Amazon, which has historically reported razor-thin profit margins. Cornell described the planned upgrades to Target’s digital infrastructure as “building blocks” and admitted that TGT is “not even close” to declaring victory over AMZN.

The biggest challenges for TGT going forward will be finding a way to eke out more profit from the already-slim e-commerce margins and taking advantage of the increased in-store foot traffic.

However, the recent increases in both Amazon Prime’s annual cost and the free shipping minimum purchase requirement may ultimately benefit TGT e-commerce and Target stock. Casual shoppers who are not Prime members may be attracted to Target’s lower free shipping requirement and free “ship to store” options.

There’s much work to be done before Target could ever be considered a viable competitor to Amazon, but compared to the likes of Walmart, TGT is the clear frontrunner.

For Target stock, this won’t mean much in the near-term, but as management ramps up the quality of the company’s digital infrastructure and improves logistics, the long-term outlook definitely looks like a winner.

Article originally appeared on InvestorPlace (03/15/2016)

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