Back in March of 2017, I authored an article that focused on all that has been ailing Target Corp. (TGT) and probably, more importantly, the man at the helm of the ship during the last couple of years, CEO Brian Cornell. The article titled Brian Cornell's Aim Has Been Way Off Target found a great readership and chronicled my concerns for the business and brand dating back to 2012.  Within the article I contextualized and articulated the various initiatives Target has put forth over this time period and how little they had impacted the business…but that is all in the past, right? Well, we’ll have to wait and see of course. In this update on the Target business, I will review Target’s Q1 2017 results as well as deliver my thoughts on the quarter that was and the potential for investor/trader opportunity going forward.

Target shareholders had a rough Q1 2017 period and since the company released its FY17 guidance earlier in the year.  Shares fell to a 52-week low trading price of $52.70 per share during the 1^st quarter and are hovering slightly above the 52-week low in the face of beating both top and bottom line expectations in the 1^st quarter of 2017. Target reported EPS of  $1.21 a share against expectations of $.90 a share. With regards to revenue, the company reported $16.02Bn, a decrease of 1.1% YOY, but above the average analyst estimate of $15.6Bn for the quarter. Despite strong beats, shares of TGT have given up all of their earnings day gains and them some. Such price depreciation validates the thesis regarding valuation of brick & mortar retailers facing sales declines. With Target’s historic multiple of 14.5 X EPS, it would be somewhat negligent for investors to believe that not only could TGT shares achieve the historic multiple, but exhibit multiple expansion.  It has proven extremely difficult to exhibit multiple expansion while major operating metrics are in decline. And that is exactly the situation surrounding Target with sales, earnings and gross profit margins all declining in 2017, despite beating analysts’ expectations. 

For the 1st quarter, comparable sales fell 1.3% with a little over half of this decline being driven by traffic (down 1%), combined with a small decrease in average ticket. First quarter gross margin rate was down about 40 basis points YOY, driven by increased fulfillment cost resulting from the growth in digital sales. In the digital channel, sales increased 22% in the 1^st quarter, much faster than the growth rate of the industry and a continued bright spot for the retailer. After seeing the growth rate decelerate during periods of 2016, digital sales growth has reaccelerated into 2017.  

First quarter ship-from-store volume was more than double last year’s amount, accounting for 27% of digital sales. This growth was partially driven by approximately 600 shipped from store locations that were added since last year. However, the increase was also driven by additional volume running through stores that had this capability for more than a year. Specifically, for the 460 stores that were shipping directly to guests in the 1^st quarter last year, YOY growth in ship-from-store volume was 32% this quarter.

While Target presents to investors that ship-from-store is a positive for the retailer, it has its puts and takes. Ship-from-store is nothing new, retailers have been doing it for well over a decade. Bed Bath & Beyond (BBBY) has been doing it since 2005 in fact. While the notion and implementation of ship-from-store has grown significantly in the last several years, investors should understand this is a practice that has been forced upon retailers from the shift to digital consumption as opposed to brick & mortar consumption. It is more costly for the retailer to operate this application of consumption and facilitates a further shift away from stores in favor of digital consumption. The shipping cost from such a retail operation is a net negative for all the retailers and on every good shipped. Additionally, the ship-from-store operation also forces retailers to refine supply lines, logistic operations as well as in-stocks and store inventory levels. So when a retailer touts their increased levels of ship-from-store sales volumes, understand these sales volumes come at a cost and validate the direction of retail consumption. 

As noted, Target is still experiencing traffic declines even though on a month-to-month basis sales improved for the retailer during the 1^st quarter. Target faults itself for declining foot traffic in part because of its shortcomings in demonstrating value to the consumer. 

As we've mentioned in previous calls, we believe that consumer perception of value at Target have not reflected how well or out-the-door prices really are. As a result, we’re in the early stages of implementing merchandising and marketing efforts to improve Target's value perception with guests and reestablish everyday price credibility on key items. 

During the 1^st quarter of 2017, Target invested nearly $500 million of capital in the 1^st quarter and is on track to invest more than $2 billion this year.  The retailer completed 21 existing store remodels and opened four new small format locations. For the year, Target is on track to complete 100 remodels and add 30 small format stores. Small format stores are currently expressing double-digit comp sales. Now let’s take a look at some of the categorical results for Target during the 1^st quarter.

As Target has mentioned in several previous reporting periods, essentials and grocery have been and continue to be a headwind for the company with YOY sales falling. There was, unfortunately, no relief found for Target in these categories during the 1^st quarter although adult beverage was a growing sub-category of sales. Having said that, apparel sales have also continued to fall for Target, albeit more modestly than in previous quarters. Within apparel, there were some bright spots in certain sub-categories and classes of product. 

In the first quarter, we were pleased with the results from our limited time partnership with Victoria Beckham, which proved to be one of the single biggest partnerships in our history.

The guest response to Cat & Jack, in particular, has been amazing. Among guest who purchased kids apparel for Target in the months leading up to the launch of this new brand, spending on kids' apparel increased more than 50% in the months following the launch.

The Cat & Jack brand is forecasted to become a billion dollar brand for the retailer and only one of many private brands that Target aims to launch through 2017. Target is capturing market share in apparel, especially active wear, ready-to-wear, swim and kids apparel. However and as noted earlier, some of these market share gains are being offset by the declines in essentials and grocery losses.

Target also experienced a strong sales period in electronics and entertainment during the 1^st quarter. Beyond video games, electronics benefited from healthy growth in Apple Watch and iPhone sales during the quarter. As a result, for the first quarter in total, electronics delivered a mid-single-digit comp sales increase, the strongest in three years. This result may carry through the back half of the year with Apple’s (AAPL) iPhone 8 coming this fall as well as new video game releases slated for the summer months. 

Despite the numerous initiatives in place at Target, the market share gains in select categories and improvements to select category sales, Target is still expecting both EPS and sales declines for 2017 as it invests for its future and return to growth.  By its own admission, while consumer spending continues to rise, the retailer is not yet where it needs to be in order to capture the growth in consumer spending.

As we look ahead to the second quarter, we’re committed to maintaining the cautious posture that service well in the first quarter. While consumer spending growth remains strong, we’re seeing a continued shift towards experience, which is absorbing a meaningful portion of that growth. 

If we harken back to the company’s significant beat on the bottom line, Target committed to supply line and inventory efficiencies, where it focuses to cut costs. In fact, Target finished the quarter with inventory down 5% YOY, that’s somewhat eye-opening and discouraging to some investors. I offer as such, in part, due to the large nominal drop that is rare for department store retailers as well as with respect to the company’s continued problems regarding in-stocks over the years. Moreover, the true test of inventory and supply line improvements will likely be measured during the busiest season of the year, the Holiday shopping season of the 4^th quarter. Until then, many investors may not believe in the initiatives in place or exude a high level of comfort from a 5% inventory reduction. Also harkening back to Target’s growth in ship-from-store volumes, where do you think the product is being removed to fill these online orders? That’s right, sometimes it is coming right off of the store shelves, on the selling floor and if that merchandise is not in the backroom (Backstock).  It’s extremely difficult to measure the necessary in-stock levels and supply lines during this seismic shift from online/digital sales and it becomes increasingly relevant for investors to analyze the shift in total for all its puts and takes. 

Given a difficult retailing landscape that is not expected to change anytime soon and despite a significant bottom line beat during the Q1 2017 period, Target is maintaining its initial FY17 guidance. I think this is a smart move on behalf of the management team as it sustains a prudently cautious outlook  and level sets investor expectations. Moreover, the guidance also reflects some one-time anomalies that occurred during the 1^st quarter with respect to expenses that will show up in the 2^nd quarter.

Target’s balance sheet remains one of the strongest in the retail sector, achieving over $1bn in net income in the 1^st quarter. It is for this reason among others that the company is able to maintain its dividend growth and share repurchase program, which has been moderated on a YOY basis. The company purchased only $300mm in stock during the 1^st quarter and remains cautious on the pace of share repurchases.  

On the EPS line, Target expects a range of $0.95 to $1.15 for both GAAP and adjusted EPS in the second quarter. For the full year, and as a reminder, Target anticipates a low-single digit decline in comparable sales for the year and adjusted EPS of $3.80 to $4.20.

The Final Word

Target may be in the early stages of turning a very elongated corner for which 2018 may find shares of TGT appreciably higher for long-term investors. I’m not a long-term investor in Target’s business model, which has proven to be a wise position to take for greater than a decade and with respect to the benchmark rate of return. Shares of TGT are being reasonably valued presently and in the range of $52-$58 a share. The valuation expresses concerns over the seismic shift in the retail industry as well as how Target is approaching the shift. With EPS and net revenues expected to decline in 2017, shares of TGT are likely to remain range bound and below $60 a share over the next 90-day period, leading up to Q2 2017 earnings release date. Under this assumption, shares of TGT are better suited for trading w/the possibility of collecting a quarterly dividend if held through ex-dividend date.