While no-moat Target’s (TGT) 24% second-quarter sales growth was exemplary and will lead us to raise our 2020 top line target (previously 7% revenue growth) and, by a high-single-digit percentage, our $98 per share valuation, we caution investors that the firm’s post-pandemic standing still remains unsettled, as competitive pressure on the top and bottom lines will remain for years. Target’s balanced online and in-store growth in the quarter (with the latter seeing 11% comparable expansion despite the pandemic and rising e-commerce penetration) reinforces our faith in its use of stores as omnichannel fulfillment centers, but the shares’ trading price leaves no room for error despite accelerating retail digitization that creates cost and price pressure. So, we suggest long-term investors await a more attractive entry point.
The top-line growth came alongside 280 basis points of operating margin expansion (to 10%), with cost leverage offsetting higher store, fulfillment, and wage spending. The surge did not fully offset first-quarter profitability strain, but the 30 basis points of year-to-date operating margin deleverage (to 6.5%) is well ahead of our prior 180 basis point decline expectation for the year. We are encouraged by management’s indications that Target’s second-quarter unit cost for digital fulfillment fell 30% against the year-ago period, with expense leverage, improved processes, and greater adoption of same-day fulfillment options (which are cheaper for the chain than shipping orders to homes) contributing. Some of the updraft will abate as sales normalize, but we believe Target’s omnichannel capabilities have improved, a critical assumption in our forecast that its long-term operating margins remain near fiscal 2019’s 6.0% mark despite rising competition. However, we expect shoppers’ pandemic-related behaviors to normalize as the crisis ends, with greater price competition limiting Target’s ability to turn scale into durable long-term margin expansion.
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