Target can finally share some good news with investors.
Goal (TGT 1.07%) was one of the best performing retail stocks during the pandemic.
The combination of selling necessities like food and groceries, as well as consumer goods like electronics, clothing and beauty products, paid off as the company was able to keep its doors open and experienced rapid growth through its Drive Up curbside pickup program.
But since then, Target’s business has been a flop. Sales of consumer goods have declined as consumers have suffered from inflation and higher interest rates. Like many of its competitors, Target has also suffered from a rise in theft.
Investors who have been waiting for a turnaround seem to have finally found what they were expecting with the company’s second-quarter earnings report, as Target’s share price rose by double digits following the news.
Comparable sales rose 2% in the quarter, a modest pace but driven by 3% customer growth, showing that customers are returning to the retailer. In addition, the company saw customer growth in all six major merchandise categories. Sales in the everyday categories, which make up the majority of Target’s sales, are improving, and the company reported 3% growth in the key apparel category.
Revenue for the quarter rose 2.7% to $25.5 billion, beating estimates of $25.2 billion. The most impressive part of the report, however, was Target’s earnings improvements. Gross margin increased from 27% to 28.9% due to cost improvements and favorable category mix, which drove operating margin up 160 basis points to 6.4%. As a result, earnings per share for the quarter rose 42% to $2.57, well above the consensus of $2.18. Gross margin could continue to expand, boosting operating margin in the second half of the year.
Looking ahead, Target also raised its earnings per share forecast to $9.00-9.70 from $8.60-9.60, or a midpoint of $9.10 to $9.35, compared to the consensus forecast of $9.28.
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What is fueling Target’s comeback
Target is still digging its way out of a deep hole but is seeing promising signs in its business as digital comparable sales rose 8.7% in the quarter, driven by low double-digit growth in same-day fulfillment services such as Drive Up and Target Circle 360.
Target also continues to expand its store base with 10 new stores, 60 ongoing store renovations and three new distribution facilities.
The company recorded strong growth in the roundel advertising business, following in the footsteps of competitors such as Amazon And Walmartand is targeting high double-digit growth this year, in addition to 20% growth in 2023. Roundel is also helping to increase Target’s margins.
Target has also improved its anti-theft measures, saying gross margin increased 90 basis points due to lower “inventory shrink,” which mostly refers to theft.
Is Target a buy?
Following the jump, Target is trading at a price-to-earnings ratio of 17. That seems like a good price assuming the momentum continues.
For comparison, Walmart trades at a P/E ratio of 34, although the retailer has earned a premium after strong results over several quarters.
However, Target has similar potential to Walmart as it also enjoys a number of competitive advantages, including a multi-category retail model that few other retailers such as Walmart, Amazon and Costco The model is also highly adaptable, with a presence in urban, suburban and rural environments, and its same-day fulfillment services also help differentiate the company from the competition.
It may be too early to call Target’s improvement a comeback, especially since the company is only targeting nearly flat comparable sales growth for the year. But it’s clear that its business model has plenty of room to run if it can increase its gross margin. Plus, the company should benefit from interest rate cuts that should boost consumer spending in the coming quarters.
Given the valuation, Target shares still have great upside potential if the trend continues.
John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Jeremy Bowman holds positions in Amazon and Target. The Motley Fool holds positions in and recommends Amazon, Costco Wholesale, Target, and Walmart. The Motley Fool has a disclosure policy.
