General merchandise retailer Target (NYSE:TGT) reported results in line with analysts' expectations in Q3 FY2023, with revenue down 4.2% year on year to $25.4 billion. Turning to EPS, Target made a non-GAAP profit of $2.10 per share, improving from its profit of $1.54 per share in the same quarter last year.
Target (TGT) Q3 FY2023 Highlights:
- Revenue: $25.4 billion vs analyst estimates of $25.24 billion (small beat)
- EPS (non-GAAP): $2.10 vs analyst estimates of $1.48 (41.8% beat)
- EPS (non-GAAP) Guidance for Q4 2023 is $2.25 at the midpoint, above analyst estimates of $2.24
- Free Cash Flow of $807 million is up from -$1.20 billion in the same quarter last year
- Gross Margin (GAAP): 28.5%, up from 25.8% in the same quarter last year
- Same-Store Sales were down 4.9% year on year (better than expectations of down 5.2% year on year)
- Store Locations: 1,956 at quarter end, increasing by 15 over the last 12 months
With a higher focus on style and aesthetics compared to other large general merchandise retailers, Target (NYSE:TGT) serves the suburban consumer who is looking for a wide range of products under one roof.
Founded in 1902 as the Dayton Dry Goods Company, Target now positions itself as both a one-stop shop but also a trendier alternative to competitors. The company serves the customer who is both value and trend-focused, and this customer is usually a middle-aged female shopping for herself and her family. While that shopper can find everything from clothing to home decor to toys to groceries at Target, the company differentiates itself through collaborations with designers to create exclusive clothing lines or partnerships with popular brands. The aim is to bring affordable luxury within reach of its customers.
A traditional Target store is large and averages over 100,000 square feet. These stores are located mostly in suburban areas, often as an anchor tenant in a shopping center and in close proximity to residential neighborhoods. The store layout is straightforward and organized, with sections for grocery, apparel, electronics, and home goods. Target has also introduced smaller, more localized store formats to serve urban and densely populated areas such as college campuses. In addition to physical stores, Target has an e-commerce presence that was launched in 2000. Customers can shop online and choose home delivery or store pickup, even with grocery offerings.
Large-format Grocery & General Merchandise Retailer
Big-box retailers operate large stores that sell groceries and general merchandise at highly competitive prices. Because of their scale and resulting purchasing power, these big-box retailers–with annual sales in the tens to hundreds of billions of dollars–are able to get attractive volume discounts and sell at often the lowest prices. While e-commerce is a threat, these retailers have been able to weather the storm by either providing a unique in-store shopping experience or by reinvesting their hefty profits into omnichannel investments.Scaled competitors that sell general merchandise and/or groceries to US consumers include Walmart (NYSE:WMT), Amazon.com (NASDAQ:AMZN)–which as a reminder owns Whole Foods market, and Costco (NYSE:COST).
Target is a behemoth in the consumer retail sector and benefits from economies of scale, an important advantage giving the business an edge in distribution and more negotiating power with suppliers.
As you can see below, the company's annualized revenue growth rate of 8.3% over the last four years (we compare to 2019 to normalize for COVID-19 impacts) was decent despite not opening many new stores, implying that growth was driven by higher sales at existing, established stores.
This quarter, Target reported a rather uninspiring 4.2% year-on-year revenue decline, in line with Wall Street's estimates.Looking ahead, analysts expect sales to grow 1.4% over the next 12 months.
Number of Stores
When a retailer like Target keeps its store footprint steady, it usually means that demand is stable and it's focused on improving operational efficiency to increase profitability. At the end of this quarter, Target operated 1,956 total retail locations, in line with its store count 12 months ago.
Taking a step back, the company has kept its physical footprint more or less flat over the last two years while other consumer retail businesses have opted for growth. A flat store base means that revenue growth must come from increased e-commerce sales or higher foot traffic and sales per customer at existing stores.
Target's demand within its existing stores has been relatively stable over the last eight quarters but fallen behind the broader consumer retail sector. On average, the company's same-store sales have grown by 1.2% year on year. Given its flat store count over the same period, this performance stems from increased foot traffic at existing stores or higher e-commerce sales as the company shifts demand from in-store to online.
In the latest quarter, Target's same-store sales fell 4.9% year on year. This decline was a reversal from the 2.7% year-on-year increase it posted 12 months ago. We'll be keeping a close eye on the company to see if this turns into a longer-term trend.
Gross Margin & Pricing Power
Target has poor unit economics for a retailer, leaving it with little room for error if things go awry. As you can see below, it's averaged a 26.2% gross margin over the last two years. However, when comparing its margin specifically to other non-discretionary retailers, it's actually pretty decent. That's because non-discretionary retailers have structurally lower gross margins as they compete to provide the lowest possible price, sell products easily found elsewhere, and have high transportation costs to move their goods. We believe the best metrics to assess these types of companies are free cash flow margin, operating leverage, and profit volatility, which take their scale advantages and non-cyclical demand characteristics into account.
Target produced a 28.5% gross profit margin in Q3, marking a 2.8 percentage point increase from 25.8% in the same quarter last year. This margin expansion was particularly strong for a retailer like Target, which is structurally less profitable than the typical retail business for the reasons mentioned above, as it signals a less competitive environment with more stable input costs (such as freight expenses to transport goods) and less pressure to discount products.
Operating margin is an important measure of profitability for retailers as it accounts for all expenses keeping the lights on, including wages, rent, advertising, and other administrative costs.
This quarter, Target generated an operating profit margin of 5.2%, up 1.3 percentage points year on year. This increase was encouraging and driven by stronger pricing power, as indicated by the company's larger rise in gross margin.Zooming out, Target was profitable over the last eight quarters but held back by its large expense base. It's demonstrated subpar profitability for a consumer retail business, producing an average operating margin of 4.6%. Its margin has also seen few fluctuations, meaning it will take a big change to improve profitability.
These days, some companies issue new shares like there's no tomorrow. That's why we like to track earnings per share (EPS) because it accounts for shareholder dilution and share buybacks.
In Q3, Target reported EPS at $2.10, up from $1.54 in the same quarter a year ago. This print beat Wall Street's estimates by 41.8%.
Between FY2019 and FY2023, Target's adjusted diluted EPS dropped 55.1%, translating into 13.8% average annual declines. In a mature sector such as consumer retail, we tend to steer our readers away from companies with multiple years of falling EPS. If there's no earnings growth, it's difficult to build confidence in a business's underlying fundamentals, leaving a low margin of safety around the company's valuation (making the stock susceptible to large downward swings).
On the bright side, Wall Street expects the company's earnings to grow over the next 12 months, with analysts projecting an average 13.5% year-on-year increase in EPS.
Cash Is King
If you've followed StockStory for a while, you know that we emphasize free cash flow. Why, you ask? We believe in the end, cash is king, and you can't use accounting profits to pay the bills.
Target's free cash flow came in at $807 million in Q3, representing a 3.2% margin and flipping from negative in the same quarter last year to positive this quarter. Seasonal factors aside, this was great for the business.
Over the last eight quarters, Target has shown mediocre cash profitability, putting it in a pinch as it gives the company limited opportunities to reinvest, pay down debt, or return capital to shareholders. Its free cash flow margin has averaged 0.5%, subpar for a consumer retail business. However, its margin has averaged year-on-year increases of 5.3 percentage points, a great result that should improve its prospects.
Return on Invested Capital (ROIC)
We like to track a company's long-term return on invested capital (ROIC) in addition to its recent results because it gives a big-picture view of a business's past performance. It also sheds light on its management team's decision-making prowess and is a helpful tool for benchmarking against peers.
Target has a solid track record of investing in profitable projects and is more likely to get better terms with financiers if it wants to raise or borrow capital. Its five-year average ROIC is 19.1%, higher than most retailers.
Key Takeaways from Target's Q3 Results
With a market capitalization of $51.14 billion, a $1.91 billion cash balance, and positive free cash flow over the last 12 months, we're confident that Target has the resources needed to pursue a high-growth business strategy.
While same-store sales declined, it exceeded analysts' expectations. We were impressed by how significantly Target blew past analysts' EPS expectations this quarter, driven by a small beat on revenue, better profitability, and a lower-than-expected tax rate. The company also generated healthy operating cash flows and reduced its inventory. Next quarter's EPS guidance was slightly ahead of Consensus. Zooming out, we think this was an impressive quarter that should please shareholders, especially in light of some troubling consumer commentary from other companies. The stock is up 9.9% after reporting and currently trades at $121.7 per share.
Is Now The Time?
Target may have had a good quarter, but investors should also consider its valuation and business qualities when assessing the investment opportunity.
We cheer for all companies serving consumers, but in the case of Target, we'll be cheering from the sidelines. Its revenue growth has been a little slower over the last four years, and analysts expect growth to deteriorate from here. And while its solid ROIC suggests it has grown profitably in the past, the downside is that its gross margins make it more challenging to reach positive operating profits compared to other consumer retail businesses. On top of that, its mediocre same-store sales performance has been a headwind.
Target's price-to-earnings ratio based on the next 12 months is 12.5x. While we think the price is reasonable and there are some things to like about Target, we think there are better opportunities elsewhere in the market right now.
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