Target Corp. (TGT, Financial) is an incredible business and one of the top big-box retailers in the United States. However, when I first wrote about the company back in January of 2017, it was in a much different position.
At the time, Warren Buffett (Trades, Portfolio)’s Berkshire Hathaway (BKR.A) (BRK.B, Financial) owned 12.9 million shares of Walmart (WMT, Financial) and my argument was that Target was the better buy, or at least a better-run business at the time.
Comparing Target with other retailers
Today, both companies are essentially on par in terms of certain metrics, namely gross profit margins and net income per employee. However, Target's $6,184.09 is considerably lower than Charlie Munger (Trades, Portfolio)’s favorite, Costco Wholesale Corp. (COST, Financial), where revenue per employee exceeds $19,000 annually.
Walmart continues to generate a lot more in terms of cash from operations, and while Target does significantly better on the return on equity, the company lags in terms of asset turnover and return on total capital.
History and operations
Founded in 1902 by George Dayton as the Dayton Dry Goods Company in Minneapolis, the company was later renamed. The first Target store opened in Roseville, Minnesota in 1962. Since then, it has grown into the eighth-largest retailer in the U.S. with 1,932 stores in all 50 states and the District of Columbia.
These stores are supported by 51 distribution centers, which is one of the biggest problems Target can solve in customer experience. It already has an incredible return policy, comparable to Amazon (AMZN, Financial) (if not better), but Amazon and Walmart have 250 and 163 domestic fulfillment centers, respectively. Considering how easy Target has made online buying and in-person returns, the challenge is getting packages to doorsteps the next day.
Product range and marketing
Target sells a variety of products, including clothing, household essentials, electronics, toys, beauty products, groceries and more. The company focuses on providing affordable prices and an optimized in-store shopping experience.
The typical full-size Target store is around 130,000 square feet and averages around $30 million in annual sales, while high-volume locations can generate over $60 million in yearly sales. The company consistently allocates over $1 billion a year on advertising, which represents about 1% to 1.5% of its total sales, and it has a quality following across social media.
Issues with theft
Target has been experiencing a significant increase in theft in recent years. The company estimates that theft will cost it $500 million this year, and combined with inventory shrinkage from 2022 (a $800 million profit hit), it stands to lose $1.3 billion in profits from theft.
Police data shows grand theft at Target is still up notably in cities like Chicago and San Francisco. Aside from the ease of theft, in the past, criminals would have to find a way to fence stolen merchandise, which could be difficult and risky. However, with the rise of online marketplaces, criminals can now easily sell stolen merchandise on websites like Amazon and eBay (EBAY, Financial).
Target's response to theft
The staffing shortages that have plagued the retail industry in recent years have made it more difficult for Target to prevent theft. Rising minimum wages means fewer employees are on the floor, making it easier for individuals to steal merchandise without being caught.
Target has taken a number of steps to address the problem, but only time will tell if it can get this under control. By contrast, Walmart suffers around $3 billion a year in losses via theft, which equates to 0.40% of total sales. In 2022, Target’s profit loss from theft has equated to twice that rate.
It is too early to say whether Target's efforts will be successful in reducing theft. However, the company is committed to addressing the problem and is taking a number of steps to make its stores more secure. In January, Target hired 30,000 new security staff, and has security guards at many stores checking receipts and bags. Only time will tell if this works, but a more normalized theft loss dollar amount per year would be in the $400 million range.
Competitive advantages
Despite the issues with theft and low number of distribution centers to support delivery times, Target does have many competitive advantages that continue to deliver higher brand value.
First, the company has successfully positioned itself as a "cheap chic" retailer. This means that while it offers products at competitive prices, it also emphasizes style, quality and design. This unique positioning allows Target to attract a demographic that is looking for value without compromising on aesthetics.
Second, Target has over 30 private label brands, such as Cat & Jack, Goodfellow and Threshold, that offer quality items at low prices. The retailer also offers a credit card, the Target RedCard, which offers immediate discounts and incentives to cardholders. This not only encourages repeat purchases, but also provides the company with valuable data on shopping habits.
Digital presence and in-store experience
Target has made significant strides in improving its digital presence and integrating online and offline shopping experiences. This includes services like order pickup, drive up and same-day delivery, which have become particularly valuable in the context of the Covid-19 pandemic.
Even its physical stores offer better service as they are known for their clean, well-organized layout and superior shopping experience compared to many other discount retailers. Some stores also include a Starbucks (SBUX, Financial) cafe and a CVS (CVS, Financial) pharmacy, making them a convenient one-stop shop for consumers.
Long-term outlook
How do we determine durability or economic moat? One way is to think whether Target will be around in 10 or 20 years doing the same thing and improving the customer experience. I certainly believe the company will. Right now, Target is on track to use around $5 billion to fund strategic initiatives, ranging from opening 20 new stores and remodeling over approximately 175 stores this year. It is also rolling out free returns with drive up, so you no longer need to get a cart, take it in and sit in line.
In the first quarter, GAAP earnings came in at $2.05 per share with over 5% growth in same-day services and north of a 1% increase in foot traffic in stores.
Analysts' expectations and dividend growth
Looking out long term, analysts are expecting the company to see earnings growth rates to accelerate, with average calls for $15 a share by 2029.
Target is also known for its strong and consistent growth in dividends. For the last 54 years, the company has not only paid dividends, but increased them as well. Right now, the yield stands at 3.3% and, if history holds, the currently quarterly payment could grow from $1.10 to well over $3 every three months by the end of the decade.
Conclusion
Could the U.S. fall into a recession this year or next? Sure. Regardless, people will still shop at Target. More importantly, the company will continue to get more valuable.
