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How Do Brick-and-Mortar Naysayers Explain Target?

- By John Kinsellagh

For those ambivalent investors who may have sold off Macy's (NYSE:M) and Kohl's (KSS) indiscriminately on earnings reports that exceeded expectations, a question on many people's minds was what would be the verdict for Target (TGT)? The company reported its results on Tuesday, reflecting an extraordinary quarter for one of the biggest players in the department store business.


Target's striking results are indicative of the fact that department stores aren't going away anytime soon. They may operate on a somewhat reduced scale in an industry that has been upended, but the contours of change for the brick-and-mortar retail sector are beginning to take shape and, in terms of future viability, it is clear those stores that respond effectively to the inexorability of economic Darwinism will succeed. The stores that don't adapt will fail.

Here is a synopsis of some of Target's key second-quarter results: increase in traffic at its retail stores; fastest increase in same-store sales in more than a decade; accelerating its remodeling plan at its stores has resulted in an increase in sales at an average of 2% to 4% per store and a 40% increase in comparable digital sales for the second quarter. That last figure is significant and bodes well for Target successfully competing directly with Amazon (AMZN), the current king of online retail.

For the period ending Aug. 4, Target's profit rose 19% to $799 million, or $1.22 per share, an increase from $671 million, or $1.22 per share, in the comparable quarter last year.

On an adjusted basis, earnings were $1.47 per share, up from $1.22 per share. The consensus estimate was for $1.40 per share. For the full year, Target estimates earnings in the $5.30 to $5.50 range, exceeding its guided earnings of $5.15 to $5.45 a share.

The results this quarter represent Target's fifth straight quarter of increasing same-store sales. The company expects same-store sales in the third quarter will be in line with year-to-date comparable sales growth of 4.8%.

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Target expects margins to improve in the second half of the year as its previous investments in revamping its business model to incorporate a more robust digital sales component and store redesigns were responsible for keeping margins lower than investors would have liked. The company is now reaping the rewards from the costs it incurred over the past year to achieve its strategic alteration in order to compete with its nemesis, Amazon.

The alteration in the company's strategic business plan to effectively compete with Amazon indicates Target intends to take the online retail Goliath head on. Its plan is to leverage its 18,000 stores so that those who order online can pick up the merchandise the same day.

This strategy is what separates Target from some other department store chains and will put it in a strong position to take on Amazon directly. The retailer is being aggressive in its approach; it is not adopting a passive or Maginot Line mentality to ward off the march of the online colossus.

Many analysts seem to forget that although Amazon was a pioneer in creating the online retail business, it does not necessarily mean brick-and-mortar stores cannot emulate the online shopping experience. Despite inventing the now-ubiquitous revolutionary device, is Apple (AAPL) the only company today that manufactures and sells smartphones?

Amazon doesn't have a monopoly in online shopping; the internet doesn't play favorites between companies who seek to avail themselves of its utility and power.

In addition, in the wake of strong quarterly results, many analysts have been quick to insert the caveat that a strong economy has boosted department store sales, the implication being that a downturn in consumer spending will have a deleterious effect on earnings. Perhaps, but these same conditions apply equally to Amazon; the company is not immune from economic downturns simply because its stock is selling for $1,916.

Target is perhaps the perfect exemplar of the proposition that shopping in-store and ordering online aren't consumer behaviors that are mutually exclusive. Far too many analysts suffer from "Amazon is taking over the world" syndrome.

There is no question a booming economy has helped all retailers, including Target, but that shouldn't obscure the radical changes that have occurred since Amazon began to take a bite out of department stores' sales.

For investors, perhaps the most important question is how many retailers reporting better-than-expected results will it take to convince naysayers that department stores are not going away anytime soon?

The present undue pessimism concerning the future of department store retailers is unwarranted and the stocks of select companies may provide opportunities for astute value investors.

Disclosure: I have no positions in any of the securities referenced in this article.

This article first appeared on GuruFocus.