Don’t Underestimate Target’s Lasting Allure

(Bloomberg Opinion) -- Like someone mistaking a Target dress for a designer frock, the stock market has misread the retailer.

Shares in the big-box store dubbed “Tarzhay” for its chic clothing outperformed strongly from 2017 until a few months ago. But since November they have underperformed both the market and shares of rival Walmart Inc. Investors have worried that Target Corp.'s profitability would be hurt by higher costs.

On Tuesday, Target proved such fears unfounded. The operating margin should be at least 8% this year, the company said, demonstrating its ability to hold onto the gains it's made over the past two years. Before the pandemic, its operating margin was 6%.

Target also upgraded its forecasts for revenue expansion and return on capital from fiscal 2023 onward.

Underlining the market's misreading, the shares rose as much as 14% on Tuesday, helped by a jump in fourth-quarter sales.

Undoubtedly some of this is due to the lingering effects of the past two years, for example more eating at home. Inflation is probably helping too; higher prices bolster the value of retailers' sales.

But much of Target's success is down to the blueprint it has been following for five years: In an increasingly digital world, it has put its almost 2,000 stores at the heart of its strategy.

When Brian Cornell, the chief executive officer, set out this plan in 2017, he “saw jaws drop,” he recalled at an investor event on Tuesday. But the approach is paying off. Target has overhauled more than half of its estate, making its stores inspiring places to browse. More recently, it has added shops in shops, including 100 Ulta Beauty units.

It has also used its stores as hubs for its online business. More than 95% of Target's fourth-quarter sales were fulfilled by its stores.

Many retailers now use their estates to support their digital business, through curbside pickup for example. But as Target started doing this in 2017, it is well ahead of the pack. On Tuesday, it set out plans to invest $5 billion this year to cement its advantage. It will open 30 stores and revamp a further 200.

The company is also investing in its operations behind the scenes. By spring, it will have six sortation centers to organize digital orders packed by local stores for fast neighborhood dispatch, and another five later this year. These will help free up capacity in shops to make them more efficient delivery hubs.

Target is seeking to improve in other ways, too. Later this year, its curbside delivery service will accept returns and also allow customers to pick up Starbucks products. 

Of course, Target isn't immune to pressures on the consumer and on its operations, including from labor costs. The company plans to invest $300 million in a labor package that will include raising starting hourly wages as high as $24. But the company should be able to withstand the pressures by building on its progress over the past five years.

Like Walmart, Target operates in the value segment. As consumers are squeezed, they become more price-conscious, and may trade down from more premium chains. Target's own brands, which account for almost a third of sales, tend to be cheaper and so appeal to consumers in more straightened times. The company said on Tuesday that its private-label foods and beverages are doing especially well.

Nevertheless, it pledged to maintain its focus on price. Its own costs are increasing faster than its retail prices as it seeks to maintain its value position. And it left its long-term forecast for operating profit unchanged at a mid-single-digit expansion. That leaves plenty of room for investment, including in price.

This is essential. Like Walmart, Target must be on watch for Aldi and Lidl, the German discounters that are expanding across America. These no-frills supermarkets are also adept at adjusting their stores and product ranges to appeal, for example, to the cash-strapped middle classes.

As long as Target recognizes the threat, it can keep delivering that “Tarzhay magic” for investors as well as shoppers.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Andrea Felsted is a Bloomberg Opinion columnist covering the consumer and retail industries. She previously worked at the Financial Times.

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