Target Delivers Another Big Earnings Beat

Adam Levine-Weinberg, The Motley Fool

After several years of sluggish sales and falling earnings, Target (NYSE: TGT) has gotten back on track in the past year and a half. On Wednesday, the discount retail giant reported that its strong growth continued in the first quarter -- even as many other big retailers suffered from a slowdown in consumer spending. This confirms that Target's growth strategy is working.

Target's best quarter yet?

In fiscal 2018, Target achieved a 5% increase in comparable sales, with strong growth in stores and a 36% surge in digital sales. Adjusted earnings per share (EPS) jumped 15.1% to a new record high of $5.39. Target's operating margin declined modestly last year, though, and tax reform was the main driver of the company's earnings growth.

Target's underlying earnings trajectory improved further last quarter. Comparable sales rose 4.8%, driven by a strong 4.3% increase in traffic. Comparable digital sales jumped 42%, while comp sales rose a solid 2.7% year over year in Target's stores. Management pointed to the toys and baby categories as particularly strong performers, indicating that the company is capitalizing on Toys R Us and Babies R Us having gone out of business last year.

Crucially, Target's operating margin improved to 6.4% from 6.2% a year earlier. Gross margin ticked down by 0.2 percentage points to 29.6%, due to rising fulfillment and supply chain costs. However, Target was able to more than offset this pressure through strong expense control, as selling, general, and administrative expenses fell to 20.8% of sales from 21.1% in Q1 2018.

The exterior of a Target store

Target managed to expand its operating margin last quarter. Image source: Target.

The net result was that operating income rose 9%, reaching $1.14 billion. Adjusted EPS jumped 15.9% to $1.53, getting an additional boost from Target's share buybacks. That exceeded the company's $1.32 to $1.52 EPS guidance range. Analysts had expected EPS of just $1.43.

Digital investments are paying off

The strong first-quarter results show that Target's digital-focused sales growth strategy is succeeding. The company is investing in three key initiatives to make ordering online more convenient: speedy order pickup (most orders are ready within an hour), drive-up service (Target staff bring pre-ordered items to customers in their cars within minutes), and same-day delivery through Target's Shipt subsidiary.

In the first quarter, these three convenience initiatives drove more than half of Target's digital sales growth and more than a quarter of its total comp sales gain.

Clearly, customers appreciate being able to order items online and receive them within hours, whether that be in a store, in the parking lot, or at home. Target is using its massive store base to quickly become competitive with e-commerce heavyweight Amazon.com from a convenience perspective. Crucially, Target is doing so without undermining its profitability.

The outlook is good, too

For the second quarter and fiscal 2019 as a whole, Target's guidance calls for low- to mid-single-digit comp sales growth and a slight operating margin improvement. Target expects adjusted EPS to rise to between $1.52 and $1.72 this quarter, compared to $1.47 a year ago. The analyst consensus currently sits at $1.59.

Despite its excellent first-quarter results, Target maintained its full-year EPS guidance of $5.75 to $6.05. That said, Target has been fairly conservative with its guidance recently. Considering the company's substantial sales and earnings momentum, there's a good chance that it will ultimately surpass this forecast.

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John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Adam Levine-Weinberg has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Amazon. The Motley Fool has a disclosure policy.