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Target Pays a Steep Price for More Customer Traffic

Demitrios Kalogeropoulos, The Motley Fool

Target (NYSE: TGT) has made it clear to investors that they should brace for lower profitability in the business as the retailer invests in the digital sales channel and cuts prices at its physical locations. The good news is that those initiatives yielded solid sales growth to kick of Target's fiscal 2018. However, the company had to sacrifice a chunk of its earnings power to achieve that top-line expansion.

Let's take a closer look at the first-quarter results.

 Metric

Q1 2018

Q1 2017

Growth (YOY)

Revenue

$16.6 billion

$16 billion

3.5%

Net income

$718 million

$678 million

5.9%

Earnings per share

$1.34

$1.23

8.9%

Data source: Target's financial filings. YOY = year over year.

What happened with Target this quarter?

Sales growth held up well and nearly matched Target's strong holiday-quarter results thanks to solid customer traffic numbers. Yet the company's profitability fell at a quicker pace than management had projected

Two women next to a clothing rack, examining a shirt

Image source: Getty Images.

The key highlights of the quarter included:

  • Comparable-store sales rose 3% thanks to a 3.7% spike in customer traffic that marked Target's best performance on that metric in a decade. Target outpaced rival Walmart, which only lifted customer traffic by 0.8% in the period as comps rose 2.1%.
  • E-commerce sales jumped 28% and now make up 5.2% of total revenue, up from 4.2% a year ago.
  • Average spending per shopper declined, in part because of lower prices that pushed Target's gross profit margin down to 29.8% of sales from 30% a year ago. Operating costs jumped, too, due to increased investments in the digital business. As a result, operating income declined 10% to $1 billion.
  • A sharply reduced tax liability lifted net profits even though operating income dropped. 
  • Target spent $827 million on capital investments while returning about the same amount to shareholders through dividends and stock buybacks.

What management had to say

Management highlighted its customer traffic wins, which came despite unfavorable weather in April. "We're very pleased that our business continued to generate strong traffic and sales growth in the first quarter," CEO Brian Cornell said in a press release.

"Our performance," he continued, "reflects the benefit of our unique multi-category portfolio. Strong sales growth in our home, essentials and food & beverage categories offset the impact of delayed sales in temperature-sensitive categories." The gains resulted in "broad market share gains across its core merchandise categories," according to the press release

Looking forward

Cornell and his team said they've seen that positive traffic momentum accelerate into the start of the second quarter, just as other retailers like Walmart and Home Depot have noticed. That means comps could reach into the mid-single-digit range for the current quarter. However, Target left its full-year outlook in place, which calls for only modestly higher sales in 2018.

The profit outlook isn't as bright. Target posted a 13% drop in operating earnings in 2017 and, while executives warned that this year will also be an investing year, they are hoping to slow that slide before eventually expanding profitability again. Time will tell where the retailer's profit power lands after it completes its transformation into an omnichannel seller. But this quarter's weakening metrics point to more declines ahead, especially as Target rolls out its same-day online delivery services nationwide.

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Demitrios Kalogeropoulos has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.