Target's (NYSE: TGT) second-quarter 2020 earnings report, issued Aug. 19, was so vigorous it seemed divorced from the realities of big-box retail. The company saw year-over-year comparable-store sales growth of 24.3%, powered by digital comparable sales growth of 195%. Even excluding e-commerce sales, store-based "comps" rose roughly 11% against the second quarter of 2019 -- an impressive feat given the continuing pandemic headwinds buffeting in-store shopping in the U.S.
Target's comparable sales strength resulted in a 25% jump in revenue against the prior-year quarter and an 80% leap in net income, to $1.7 billion. Several reasons illustrate why Target is well-suited to reap economic gains during the COVID-19 era.
Most obviously, the nationwide retailer is benefiting from the one-stop-shop nature of its operations, as its merchandise categories, like those of competitor Walmart, span groceries, electronics, apparel, furnishings, sports, and children's toys. Both Walmart and Target are capitalizing on consumers' desire to limit potential coronavirus exposure by buying as many necessities from a single store as possible.
Advantages may multiply over the next few quarters
A broad merchandise selection will only carry a retailer so far, however. Target's recent success is rooted in the company's decision several years ago to avoid building out a distribution network to service online orders, relying instead on stores to fulfill digital sales. CEO Brian Cornell expounded on this strategy on the company's earnings conference call:
Store-based fulfillment is uniquely suited to our business model because of the way it fits within our overall strategy. In particular, it aligns with our merchandising approach, which is based on curation, both in our stores and online assortments.
As a result, the majority of our digital demand is driven by items that are already available in our stores, which positions us to efficiently rely on those locations to fulfill the demand.
Unlike many fellow retailers that have seen explosive digital sales during the pandemic, but have sacrificed margin as they've scrambled to fulfill e-commerce sales, Target's gradual refinement of its online strategy meant that it was uniquely prepared to meet the crush in demand of the last few months. The company's "same-day services" -- in-store order pickup, drive-up (curbside service), and use of its local delivery service Shipt -- were optimized well before the onset of COVID-19. Target reported that stores filled 90% of its revenue over the last three months.
Cornell's words also shed light on how Target generated so much operating leverage during the quarter. Part of Target's brand strength lies in its uncanny anticipation of consumer tastes and aesthetics, and this quarter, it apparently needed only to point customers to its digital channel to move curated merchandise already waiting in stores. Target saw dramatic increases in apparel, office furniture, and home decor orders, as customers began to adapt to the reality of an extended duration of remote work and online schooling. Electronics sales jumped 70%, spurred by demand for home electronics and gaming equipment.
Servicing a higher volume of sales without undue process change manifested in Target's gross margin this quarter, which increased by 30 basis points to 30.9% over the second quarter of 2019. Moreover, operating expenses rose by only 12%, or one-half the rate of sales growth, causing operating income to leap by 74% to $2.3 billion.
Burgeoning sales, expanding margins, and robust operating income support management's confident posture regarding shareholder-friendly actions. While Target suspended share repurchases last quarter as a precaution during the pandemic, it didn't alter its dividend schedule. The company has generated $3.7 billion in free cash flow during the first six months of 2020, against a dividend payout of $667 million. To boot, its return on invested capital, or ROIC, improved by 2 percentage points annually in the 12 months ending June 30, 2020, to 17.2%.
The market dynamics that Target is exploiting will remain in place for the time being, as the U.S. is, unfortunately, continuing to see rising COVID-19 case counts this summer. Part of the company's near-term harvest is likely to convert to permanent advantage, however. CEO Cornell mentioned on theearnings callthat Target has gained $5 billion worth of market share from competitors in just the first six months of the year. A widening customer base bodes well for the retail giant's post-pandemic income statements. Up 20% year to date, Target has emerged as a surprisingly solid buy among retail investments in 2020.
10 stocks we like better than Target
When investing geniuses David and Tom Gardner have a stock tip, it can pay to listen. After all, the newsletter they have run for over a decade, Motley Fool Stock Advisor, has tripled the market.*
David and Tom just revealed what they believe are the ten best stocks for investors to buy right now... and Target wasn't one of them! That's right -- they think these 10 stocks are even better buys.
*Stock Advisor returns as of August 1, 2020
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.