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Is Target’s Focus on Store Remodels Misguided?

$22 billion versus $1 billion.

That’s how much Amazon and Walmart have spent building out their next-day delivery supply chains over the past two years relative to Target, the No. 3 player in the holy trinity of American retail.

And Brian McGough, retail sector head for Hedgeye Risk Management, thinks that’s a big problem.

Demand for super-fast shipping and delivery is on the rise, thanks largely to Amazon “priming” customers to expect their online orders not in a matter of days but as little as a few hours. In 2017, NRF predicted that 65 percent of retailers will offer next-day fulfillment by 2019 to keep pace with shoppers’ need for speed.

And though Amazon has long been the pacesetter in retail logistics and fulfillment, Walmart has scrambled to stay apace—with its $10 billion next-day investment just $2 billion off from the tech giant’s. With its smaller next-day investment, Target can get 17,500 products to customers by the next day, a mere drop in the bucket versus Walmart’s 200,000 (“going on 500,000,” McGough noted) and Amazon’s 3 million “going on 100 million,” the analyst added.

Target, meanwhile, has been busy funneling funds toward sprucing up its stores—and its budgetary priorities have flip flopped over the past few years as a result. Whereas IT/supply chain spending outpaced investments in new stores and remodels back in 2014 and 2015, investments in existing stores overtook those other areas starting in 2016—dwarfing them altogether by 2018, per Hedgeye’s analysis.

“It’s trying to make stores look better, and that’s fine,” McGough said during a Hedgeye TV segment, adding, “I give them a golf clap on that one.”

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But where it all breaks down, according to McGough, is when you look at the return on capital spent.

Target remodels generated a 2.2 percent return in 2017, which grew to 3.6 percent last year, McGough noted. “This all ties back into putting a lot of money into the wrong part of the P&L, wrong part of the balance sheet,” he said, “which is taking operating asset turns down [and] margins down…[and] going to be an earnings hit and a multiple depressor in that context.”

Is spending to make stores attractive, inviting and worthwhile really a bad investment, though?

Target operates 1,853 stores across the U.S., lower than Walmart’s 5,000 locations inclusive of Puerto Rico. Amazon, of course, operates far fewer, including 17 “just walk out” Go convenience stores, a handful of book stores, and 500 Whole Foods supermarkets.

Target’s store-first strategy seems to be a conscious doubling down on a focus on driving shoppers into its physical locations. The most recent holiday season, example indicates that Target’s BOPIS push is succeeding at persuading shoppers to visit a store to collect a purchase initiated online. Stores fulfilled about 25 percent of all online orders in November and December, according to Target’s data.

And RSR Research managing partner Paula Rosenblum agrees.

“I feel like Target’s numbers speak for themselves,” she said. “Sales are rising, omnichannel sales are rising, fulfilling from stores is working well for them.”

While it’s easy to focus on the hot topic of next-day delivery at the exclusion of all else, that blinders-on approach often ignores the full, complicated picture of what’s happening in retail today. “Anyone who thinks store remodels are an ‘unwise investment’ doesn’t understand the fundamentals of retail, which will include brick-and-mortar for the foreseeable future, and which require those stores to look good,” Rosenblum explained.

Eighty-eight percent of retailers surveyed for RSR’s latest store benchmark report would love their stores to be cleaner, which they think would boost with relevance with consumers. “A remodel is a step beyond that,” Rosenblum added.

And so Target seems to be making omnichannel the priority while the same-day war rages on between Amazon and perennial rival Walmart.

“Amazon and Walmart are duking it out now and it’ll be a fight,” McGough said. “This is not just Amazon running away with the show here.”