Target Earnings are Not a Fluke

Target NYSE: TGT shares are surging as investors and analysts are cheering the release of the company’s third-quarter earnings. In addition to delivering earnings per share (EPS) and revenue that beat expectations, the company also raised its full-year profit guidance. Whereas analysts were predicting an EPS range between $6.05-$6.40, TGT management issued guidance between $6.25-$6.45. This was above their prior estimate for an EPS between $5.90-$6.20.

The stock market can be predictable during the earning season. When a company beats expectations, as Target did, the stock is rewarded. And when a company misses, the stock is generally punished. What matters in both cases is why the company’s earnings came out the way it did.

For example, Home Depot NYSE: HD and Kohl Co. NYSE: KSS missed on earnings, but I think the outlook for the two stocks is completely different.

So why did Target come in with such a good earnings report? You can really say it’s just a continuation of a trend.

Target is embracing the “new retail” model

In the last year, I’ve been keeping an eye on Target. While social media is not a perfect predictor of human behavior, I’ve noticed that Target is getting a lot of positive mentions. Then it started to beat analysts’ expectations. And the stock started to go up. Only it hasn’t simply gone up, TGT stock is up 82% in 2019.

I realized the company must be doing something right. That something is blurring the line between its brick-and-mortar stores and the digital shopping experience for its customers. Some people call it “omnichannel”. Retailers that are flourishing are giving consumers what they want, delivering it where they want and when they want it.

If that sounds familiar it should. That’s essentially the Amazon NASDAQ: AMZN model.

In the past year, Amazon has spent and continues to spend, a lot of money to deliver on the promise of next-day shipping on select Amazon Prime orders. If you put your mind in the mind of Jeff Bezos for a second, it makes sense.

The one “weakness” to Amazon’s model was its distribution network. Whereas Target can have a customer buy something online at work and pick it up at the store on the way home, or deliver it to their home or office. Amazon didn’t have a brick-and-mortar location. So Amazon is aggressively investing in their “last three feet” in an effort to remove the need for customers to shop anywhere else.

Granted, for retailers to embrace this new model would require a new way of thinking about retail. However, in the last few years, the choice has been clearly made. Survival requires that retailers make this paradigm shift. The only question for retailers was when they would attempt to take advantage of this weakness.

Target has clearly decided to embrace the strategy. Walmart NYSE: WMT has as well. And both TGT and WMT are examples of retailers that are profiting in a retail environment that is still very choppy.

Target is also enhancing the store experience inside its existing stores. A much-ballyhooed example of this was the company’s announced partnership with Disney NYSE: DIS. In October, Target introduced Disney stores within the existing footprint of 25 Target locations. The “store in store” concept has delivered mixed results for retailers, but the pairing of Disney and Target particularly with Disney’s launch of their streaming service, Disney+, would appear to be a home run for the retailer.

Target also introduced an in-store brand of grocery items under the label Good & Gather. Products under this private label feature no artificial flavors, synthetic colors, artificial sweeteners, or high fructose corn syrup. This should create an appeal for more health-minded consumers. It is also designed to increase brand preference for Target in the grocery niche, an area where they are still lagging behind Walmart.  

Is Target becoming a forever stock?

Lost in the midst of Target’s exceptional earnings report is that the company continues to offer a dividend that is well above the sector average. The company will issue its next dividend of 66 cents in December. This comes out to a $2.64 annual yield. In June, the company increased its dividend by two cents per share. Target’s current dividend yield is 2.12%.

Target’s dividend yield is higher than the sector average. However, income investors are far more concerned with the amount of, and the security of, the dividend. The fact that Target continues to increase its dividend is a good sign. And with a payout ratio of 48.98% the dividend would seem to be very secure.