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Target Shows Some Promise in a Competitive Retail Environment

Target (NYSE: TGT) is one of the biggest retailers in the U.S., but that doesn't mean it's immune to the rapid growth of Amazon.com (NASDAQ: AMZN). Target has reported several consecutive quarters of comparable-store-sales declines. However, comp sales probably returned to growth in the second quarter, according to updated guidance that Target provided last month.

In this episode of Industry Focus: Consumer Goods, the team digs into Target's recent business trends and its plans to get sales growing again. Target is in the early stages of a multiyear program to invest in its store base and its e-commerce capabilities, but it seems to be on the right track.

A full transcript follows the video.

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This video was recorded on Aug. 1, 2017.

Vincest Shen: We have another brick-and-mortar retailer that is finding its footing, and that's Target. It's still one of the top 10 retailers in the U.S. The company was actually recently surpassed by Amazon. The stock has underperformed in the past year as foot traffic declined. Holiday sales fell short, and comps turned negative. Target is in the early stages of executing a turnaround strategy. The latest guidance from management has taken a more positive tone. Do you think these are the first signs of progress for the company?

Adam Levine-Weinberg: Yeah. I think Target has a ways to come, but they're definitely on the right track. In a lot of ways, I see Target as going in the opposite direction of Sears. What I mean by that is, if you look back at 2001 or thereabouts, Target made this really terrible decision that they were going to outsource their e-commerce to Amazon.com, and basically Amazon would get a commission and run the site, and Target would sell its products through there. The result was that Amazon was getting all this data about Target's sales, and they were getting people accustomed to an Amazon kind of layout, and Target didn't have any control over what should have been a key part of its growth. The result is that Target has much less online sales as a percentage of its revenue than a lot of its competitors. It's still under 5%, and that's after doubling its online sales in the past three years or so. So you can imagine how bad they were back in 2012, right after they had taken control of their website back from Amazon.

So Target was behind, especially in e-commerce. They are trying to fix that now. E-commerce, of course, has been the biggest growth driver for them. The problem was, recently, you did see these comp sales declines. And since they include the online sales in their comp sales numbers, that meant that if comp sales were declining, their retail in store sales were declining at an even faster rate. So that definitely puts pressure on profitability because there's a lot of overhead expense associated with having this massive store footprint throughout the United States. 

In the fourth quarter, they had a pretty significant comp sales decline. Back in February, when they were providing their guidance for the first quarter, Target's management thought it was going to get even worse with a low to mid-single digit comps sales decline for the first quarter. Now, comps sales did decline in the first quarter of the year, but only by 1.3%, which was a lot better than the original guidance. And EPS came in way ahead of their initial forecast at $1.21, whereas they had been expecting $0.80 to $1.00. So much better profitability than expected, still not quite as good as the previous year. And now you're seeing that same trend play out again in the second quarter. Comp sales have now turned positive again, which is definitely a good sign. Profitability is probably going to be down a little bit year over year, but maybe not, because once again, they raised their EPS guidance for the quarter. They announced a couple weeks ago that, instead of having EPS between $0.95to $1.15, it's going to be somewhere above $1.15 for the second quarter, they just haven't specified yet. So we'll find out when they report earnings in a few weeks just how well they managed to do. 

So you're definitely seeing that Target is not having a great year in 2017, but it's a lot better than what they expected, and that's a pretty good sign, considering that the company is making some significant investments and long-term bets right now in order to drive its competitiveness in the long-term against rivals, especially Amazon.com. 

Shen: Sure. With the impressive but small scale of the online growth that you talked about so far, still a single-digit percentage of their overall revenue, the company obviously has a long way to go. That's a big investment for them, obviously. A few other key parts of the turnaround effort, I feel like they've mentioned things like new small format store locations, updating the aesthetics of some of their stores, also a lot of investments on the e-commerce side in terms of a better online experience, faster fulfillment. Where is the money going? What do you think is going to be really important for them going forward? 

Levine-Weinberg: One thing that they are doing is, they're renovating a lot of their stores. They're not opening as many stores as they did a few years ago, but they're still opening some. But they're renovating a lot of stores, and they're trying out a new store format, which definitely sounds promising. Instead of having a single main entrance, they're trying in these new stores to have two entrances with a different focus. There's a grocery entrance, that's for quick trips where you're just picking up some essentials, and it's supposed to get you in and out. Then, another main entrance, which is for discretionary purchases and things that Target is more known for in their home and style. That's definitely the entrance they're hoping you go into, but they're trying to give you an opportunity if you don't have time for that to get in and get out and go to Target more frequently, rather than, oftentimes, in a Target store, they literally put the grocery at the other end of the store from where you go in, and it definitely takes you a lot longer, so that might drive some customers to go to a regular supermarket instead of going to Target, because it's just more convenient. So that will be an interesting experiment, to see how that works for Target.

As you mentioned, they're also opening a lot of these small format stores. I think one of the most interesting things they're doing is they're making a big push into Manhattan, where 10 years ago they didn't have anything in Manhattan. They opened one full-sized store back in 2010 in Harlem in a big box center there. But now, they're getting more into downtown, midtown and lower Manhattan areas with these smaller stores. They have one opening later this year across the street from Macy's, on 34th Street. They have other stores coming within the next couple of years. I think they'll have six stores in Manhattan by the end of 2019. So we'll see if they keep growing from there. But, this is going to allow them to do more same-day fulfillment, which is really necessary now to keep up with Amazon as it rolls out Prime Now to more and more products to offer same day delivery. You just have to keep up if you want to stay competitive with Amazon.com.

Adam Levine-Weinberg owns shares of Macy's. Vincent Shen has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Amazon. The Motley Fool has a disclosure policy.