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Target’s Store-Based Fulfillment Services Grew 50, 100 and 500 Percent in Q3

Despite a $60 million third-quarter tariff impact, Target Corp. still bested Wall Street’s expectations, powered by strength in apparel sales and same-day delivery.

In a Nutshell: Target chairman and CEO Brian Cornell said, “Our third-quarter results are further proof of the durability of our strategy, as we’re seeing industry-leading strength across multiple metrics, from the top line to the bottom line.”

In its quarterly earnings call to Wall Street investors and analysts, Cornell described the third-quarter report as “well ahead of our expectations on nearly every measure.”

Target’s work diversifying its sourcing matrix puts it in a good position to deal with tariff challenges still ahead. “We’ll see what happens as we go into the next couple of weeks and into the start of 2020,” Cornell said. “But I think we’re well prepared to react and, obviously, we’re all facing the same tariff issues together. I think our size, scale, the sophistication of our team and our vendor partners positions us well [to] navigate this unchartered water.”

Tariff pressure in the second quarter amounted to about $50 million and grew by $10 million in the third quarter, Cornell said.

Target benefited from a “balanced multi-category assortment,” which gave the retailer flexibility to lean into different seasons, such as back-to-school and weather-sensitive categories when colder temperatures chilled the country.

“Apparel saw the most dramatic share gains in the quarter, with comp sales growth of more than 10 percent,” Cornell said. “This was driven by even strong trends in jewelry, accessories and shoes, intimates and sleepwear, young contemporary and women’s ready-to-wear.”

Beauty and cosmetics delivered high-single-digit comp growth in the quarter.

Cornell said the quarter’s profitability came in stronger than anticipated, “driven by a much larger-than-expected increase in our gross margin rate.”

Operating income in the period grew 22.3 percent to $1.0 billion from $819 million. In addition, merchandising efforts to optimize costs, pricing, promotions and assortment all contributed to a gross margin rate in the quarter of 29.8 percent, up from 28.7 percent in the year-ago period.

The fourth quarter stands to benefit from Target Circle, the retailer’s new loyalty program that went live nationwide last month and already has more than 35 million members, Cornell said. “During an 18-month test period, guests enrolled in Target Cirlce save more, shop more frequently and spend 2 percent to 5 percent more than guests who weren’t in the program.”

For holiday, Cornell said Target rolled out free shipping on “hundreds of thousands of items” and has begun delivering “compelling promotions” as well as the two-day Black Friday preview sale earlier this month.

Store-based fulfillment services were bright spot in the quarter. Drive-Up is available in all 50 U.S. states in over 1,750 locations, and same-day delivery with Shipt can get purchases from target.com or the Target app to customers in as little as one hour, Cornell said. Shipt is already available in more than 1,500 stores across 48 states. Target also offers free Order Pick Up in all stores.

John J. Mulligan, executive vice president and chief operating officer, told investors that the “growth rate of all three of [the] services in 2019 has been nothing short of remarkable. In the third quarter, the slowest growing of these services was Order Pick Up, which grew more than 50 percent. Target sales volume fulfilled by Shipt grew more than 100 percent and Drive Up, our highest-rated service, saw astounding growth of more than 500 percent.”

While a portion of Drive Up’s growth was buoyed by the addition of more than 800 locations, compared with a year ago, more than half of the growth occurred in mature locations, he noted. Because of the rapid growth in the services, Target is planning for them to “play a really important role in the fourth quarter” and has made investments in training, tools and fixtures to prepare its stores to accommodate a “meaningful spike in volume of these same-day options during the holidays,” Mulligan said.

Net Sales: Total revenues for the three months ended Nov. 2 rose 4.7 percent to $18.7 billion from $17.8 billion, which also included a 4.7 percent gain in net sales to $18.4 billion from $17.6 billion.

Comparable sales rose 4.5 percent–2.8 percent growth in stores and a 1.7 percent contribution from digital sales–on top of the 5.1 comp gain in the same year-ago quarter, which the company noted reflected a comp sales gain of nearly 10 percent over the past two years. The 1.7 percent contribution from digital sales included a comparable digital sales growth of 31 percent in the quarter, on top of 49 percent last year. Target saw a 3.1 percent increase in comparable traffic growth in the quarter, driven by increases in both stores and digital channels.

Apparel sales “running at a 10 percent comp [is] really healthy on the margin line,” Michael Fiddelke, executive vice president and chief financial officer, said. That helps to boost the gross margin rate when more products sell at full price during the quarter versus taking a markdown at the season’s end.

While apparel sales saw growth, Target also saw soft sales trends in the electronics and entertainment categories.

Inventory levels in the quarter were down by nearly $1 billion, or about 8 percent, compared with last year. “However, given that this inventory position was about 8 percent higher than two years ago, the year-over-year decline is largely a reflection of the specific inventory investments we made in advance of the fourth quarter last year,” Fiddelke said.

“As we approach this year’s peak season,,” he added, “we feel very good about both the level and make-up of our inventory, which should position us to extend the strong sales and earnings performance we’ve seen so far this year.”

Many retail analysts believe that one reason retailers have not raised prices despite the high cost of tariffs is because the companies had invested in buying goods ahead of time in preparation for the fourth quarter and holiday season.

Earnings: Net income for the quarter jumped 14.8 percent to $714 million, or $1.39 a diluted share, from $622 million, or $1.17, in the year-ago period. On adjusted basis, EPS was $1.36.

Wall Street was expecting adjusted diluted earnings per share at $1.19 on revenues of $18.49 billion.

Target said it expects comparable sales growth for the fourth quarter of between 3 percent to 4 percent, and adjusted EPS of between $1.54 to $1.74.

For the full year, Target guided adjusted EPS to between $6.25 to $6.45, up from prior guidance of $5.90 to $6.20.

The company said it plans to issue a post-holiday financial update on Jan. 15, 2020.

CEO’s Take: Cornell said, “Looking ahead, we have ushered in the holiday season with an unwavering commitment to guest service that complements our highly differentiated, value-driven assortment, our exceptional in-store shopping experience as well as an unmatched suite of easy and convenient fulfillment options.”

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