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Optimist or Pessimist: Don't Miss Your Target in 2018

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Brick and mortar retailers have been hit hard by the Amazon (AMZN - Free Report) effect and many stores have as a result bitten the dust. Target (TGT - Free Report) may have shut a few itself, but that isn’t a good enough reason to think that the retailer has bowed out. The following analysis shows that not only will the company continue fighting, but like Walmart (WMT - Free Report) , it will also become a force to reckon with in the increasingly omnichannel retail market.

The Turnaround Plan

Weak sales, weak gross margins (an indication that the company is heavily discounting goods to move stock, or high procurement cost related to new brands, or both) and relatively steady EPS despite a steadily declining share count aren’t things that inspire confidence. But CEO Brian Cornell has outlined a turnaround plan, and execution appears to be on track.

“We’re investing in our business with a long-term view of years and decades, not months and quarters,” Cornell said in a nutshell. “We’re putting digital first and evolving our stores, digital channels and supply chain to work together as a smart network that delivers on everything guests love about Target, including more than a dozen new brands we’ll introduce over the next two years.”

For the purpose, he’s earmarked $7 billion for capital expenses over the next three years and a billion more in operating profits, beginning in 2017. So let’s see how he’s doing-

Putting Digital First

There are two aspects to this, the first being increased digitization of the stores to improve the in-store shopping experience and the second being the building of the online shopping channel to improve that shopping experience.  Target has been working on both.

On the store front, it has added RFID (radio frequency identification) tags to apparel to quickly locate in-store inventory and beacons through which location-based information can be transmitted to shoppers while in the store. Now, it’s doing more to remodel the stores so they are to support delivery of orders taken online (more on that later).

This year, it’s rolling out new technology in stores that will allow store employees to check inventory, take orders, process payments through a mobile point-of-sale system and arrange delivery. The capability will be expanded to all stores by year-end.

On the online shopping front, it has invested in its digital infrastructure to increase its speed, stability, performance and capacity. So today it has a much more functional website and app. This year, it is also integrating its savings app Cartwheel with the main Target shopping app to streamline the shopping experience. It also has a deal with Pinterest that could attract more users.

As a result, Target’s digital sales have grown strongly every quarter, doubling between 2013 and 2016.

Google Alliance

Although part of its digital focus, the alliance with Alphabet’s (GOOGL - Free Report) Google is big enough to warrant separate discussion.

Target has expanded and deepened the relationship this year. After testing Google Express (an ecommerce shipping service with no subscription charges and free shipping depending on order size) in select markets across New York and California, it has now announced that Target products can be purchased via Google Express across the country.

Come 2018, devices like Google Home, Android and iOS smartphones and smart TVs that come with Google Assistant, can also be used to shop Target using voice commands. Also in 2018, Google Express will integrate Target REDcard, so holders can grab their related special discounts and offers.

The Google agreement is particularly significant because the tech giant already has a ton of data on individuals that it will use to personalize offers and discounts. It’s also building augmented reality apps that can greatly improve the shopping experience. Target, with its focus on stylish home, apparel and beauty products at reasonable prices, can benefit hugely.

Additionally, with Google Express and Assistant, customers have more choice than Amazon Prime and Alexa, because they can choose products from a number of retailers like Walmart, Target, Costco (COST - Free Report) , Walgreens (WBA - Free Report) and PetSmart depending on price, availability, convenience (whether they want to pick up at the nearest store or get it delivered) and other criteria. So the deal allows Target to become part of a larger basket.

Evolving Stores

Of the 1,800 stores Target is operating today, it plans to remodel more than a 1,000 by 2020 (600 by 2019). It also plans to operate 130 additional small-format stores by 2019. The target for this year is to remodel 110 stores and open 30 small-format stores.

The remodeling entails reorganization of the backroom so it can double as a hyper-local delivery hub. Now, this space is being optimized to build a ship-from-store capability (shipping from the nearest store when a customer orders online to minimize delivery time and cost). Target has said that 1,400 stores already offer this capability and by 2019, all stores will have it.

All stores already support the order pickup facility (where a customer chooses to pick up the item at the store after ordering it online). Ship-from-store and order pickup are already taking care of more than half the digital sales volume today although it’s expected to peak during the holidays.

The smaller format stores are being opened in densely populated urban areas and college campuses and they are open for long hours (7AM to midnight). The goal is to allow customers to make quick purchases of every day essentials-type of things. On college campuses, the goal is to lure young consumers to the Target brand. They also operate as pickup centers for online orders.

Creating a Smart Network

The revamped stores and online channels are increasingly woven into a smart network that allows Target to offer many fulfillment options. So customers can now opt for in-store pickup; drive-up (where a store employee takes the order out to the customer’s car); same-day delivery in select locations and for select items including fresh groceries; next-day delivery; Target Restock, where the company takes orders for essentials up to 7PM every day for delivery on the following day; and Google Express. As the supply chain gets smarter, the in-stock position improves so it is also able to expand the number of products eligible for next-day delivery.

Focus on Employees

Retail has forever been about having the right products in the right place and at the right time. But now, it isn’t just about products anymore because people are increasingly also looking for a good experience. Therefore, it is important to retain good employees with the requisite knowledge and experience. It therefore started investing in its people. The company recently raised the minimum wage to $11 an hour as part of an initiative to raise it to $15 an hour by the end of 2020. It is also investing in training employees for better guest satisfaction.

More Than a Dozen New Brands

The private label market is exploding with supermarkets, drug chains and mass-merchandise stores like Amazon all jumping in. The concept is also a very big deal in Europe where it was used effectively by German chains Aldi and Lidl.

To tap this opportunity, Target has said that it plans to launch 12 new store brands. The advantage of these brands is that customers can’t get them anywhere except from Target, so once brand loyalty is built, it results in repeat customers. Other advantages include a greater control over product creation, time to market and pricing, translating into stronger profitability.  The fact that millennial shoppers are less attached to the brands their parents swore by makes this that much easier to do.

Target’s private labels focus on its most profitable apparel and home categories and include the kids clothing line Cat & Jack, the kids bedding and home collection line of more than 1,200 pieces of furniture (including 12 themes) Pillowfort, the baby brand Cloud Island, women's apparel brand A New Day, menswear line Goodfellow & Co., homewares brand Project 62, athleisure brand Joy Lab and home and lifestyle brand Hearthand Hand with Magnolia. Cat & Jack, which has been around the longest, racked up $2 billion in sales in its very first year since launch. With eight of the twelve already launched, Target will see the effect in the holidays and through 2018, when we’ll know more about how they did.

There are also four more to go, and according to recent trademarks, they could reportedly be "Universal Thread" or "Universal Thread Goods Co.," United Thread and an Obvious Foods rebranding. The company generally focuses on style, wellness, baby and kids products, so its private labels are unlikely to venture too far from these.

Conclusion

All of the above point to the fact that Target is poised for some big changes in 2018. It has most of the pieces in its turnaround plan on the board, now it just needs to tie it all together. Two metrics are particularly interesting in this respect: digital sales, which continue to grow at strong double digits despite tougher comps and two straight quarters of traffic growth, indicating that customers are returning to Target.

As far as the Amazon effect is concerned, it’s worth knowing that ecommerce is still just 8.1% of total retail sales, according to the commerce department. Yes, it’s causing disruption, but Target has finally jumped on the bandwagon and the changes it has embraced (along with suitable advertising) should help the company get back on track. Add to that the fact that not all retailers will be able to weather the storm so Target has scope to grab share.

Note that the company also returns cash to investors both as share repurchases and dividends. So the fact that it is catching up with leading trends increases confidence that there is no risk to the income.

The way things stand now, it does appear that Target is entering buy territory.

 

You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here

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