The year 2015 was kind for Target Corporation (TGT). Target had been able to outperform its bigger rival Wal-Mart Stores, Inc. (WMT) with 1.9% growth in comparable sales against Walmart’s 1%, and a solid operating margin of 6.7% compared to 5% of WMT Stock.
Of course, the cherry on top is the sale of Target’s convenient pharmacies to CVS Health Corp (CVS) for $1.9 billion.
And yet coming into the earnings release for the first quarter, Target stock is vulnerable, because all the factors that played in favor of TGT in 2015 will now play against it.
Target Stock: Sweet Turns to Sour
Target’s main strategy to achieve growth and high margins is simple. Target emphasizes more of a premium buying experience, with a focus on more expensive categories such as apparel, home furnishing & decor, and hardlines. These allow Target to charge more and maintain a higher margin.
Moreover, in good times, when consumers are in spending mode, demand for premium products grows faster than staples and other consumable goods (because people don’t eat twice as much just because times are good).
But when times are tough, this model falls short. For example, Walmart gains 55% of its revenue from groceries, pet supplies and sundries. Sure, the operating margin is narrow for WMT Stock, but what WMT Stock loses in margins it gains in volume. Demand for groceries and pet supplies is rather resilient and keeps traffic in Walmart stores high.
In Target stock, however, with merely 21% coming from consumable goods, traffic in stores can fall sharply when times are tough. And times have been tough. Moreover, now that the pharmacy business is owned by CVS Health Corp, sales could be hit even harder.
Throughout Q1, consumers were not in the mood for spending. Retail sales fell lower month-over-month, both in January and in March.
On a separate note, Target has hired both a new chief merchandising officer and its first ever chief digital officer.
Down to the Numbers
Target stock earnings are due on Wednesday before market opens. According to Target’s own guidance, the company expects Q1 EPS from continuing operations to range between $1.15 and $1.25 per share. That is roughly 14% higher than the $1.01 EPS for Q1 of 2015.
According to the median estimate by a Reuters survey, adjusted EPS is expected to hit $1.20, compared with $1.10 in Q1 of 2015, 9% higher.
Considering the weakness in retail sales, it’s hard to see Target stock delivering both on Target’s own guidelines and on analysts’ expectations, leaving us with no choice but to hope for a beat and prepare for a miss.
As of this writing, Lior Alkalay did not hold a position in any of the aforementioned securities.
